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Rock-Tenn Co. (NYSE:RKT)

F1Q 2014 Earnings Conference Call

January 29, 2014; 9:00 AM ET

Executives

Steve Voorhees – CEO

Michael Kiepura – President, Consumer Packaging and Recycling

Jim Porter – President, Corrugated Packaging

Ward Dickson – EVP & CFO

Analysts

Scott Gaffner – Barclays

Anthony Pettinari – Citigroup

George Staphos – BofA Merrill Lynch

Mark Wilde – Deutsche Bank

Alex Ovshey – Goldman Sachs

Philip Ng – Jefferies & Company

Mark Weintraub – Buckingham Research Group

Chris Manuel – Wells Fargo

Chip Dillon – Vertical Research Partners

Adam Josephson – KeyBanc Capital Markets

Steve Chercover – DA Davidson & Co.

Mark Connelly – CLSA Limited

Operator

Good morning. My name is Kathy. I will be your operator for today's conference. At this time, I would like to welcome everyone to the Rock-Tenn First Quarter Fiscal 2014 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 January 29, 2014. (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 the conference.

Steve Voorhees

Thanks, Kathy. Welcome to everyone who's listening to our call. I'm Steve Voorhees, Chief Executive Officer. I'm joined in the office this morning by Ward Dickson, Chief Financial Officer; and Jim Porter, President of our Corrugated Packaging business.

For those of you following the weather, we're having a memorable couple of days in Atlanta. I believe Mike Kiepura is calling in - President of our Consumer Packaging and Recycling businesses, is calling in from home. Are you there, Mike?

Michael Kiepura

I am, Steve.

Steve Voorhees

Okay, excellent. Okay. So, we'll start with our forward-looking statement.

During the course of this 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. These risks and uncertainties are described in our filings with the SEC, including our most recent 10-K. We will also refer to non-GAAP financial measures during the call and have provided reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the appendix of the slide presentation.

I'm going to start with a discussion of our operating results, and then Ward will discuss our input cost, balance sheet, pension, and other financial matter – measures. I will complete our prepared remarks with comments on our outlook, and then Ward, Jim, Mike, and I will be available for your questions.

The success of our team in executing our strategy drove our 23% increase in earnings per share. We generated over $250 million in free cash flow, and we used that cash to pay down debt, contribute to our pension plans, pay our dividend, make an acquisition, and buy back stock.

And we did all of this while reducing our leverage ratio from 1.95 to 1.84x. We have a lot of energy around a well-balanced set of actions to satisfy our customers, reduce our cost, invest in our businesses, and deploy our cash flow, where we can have the greatest impact for our shareholders.

Net sales increased by 3% over the prior-year quarter. Higher pricing more than offset reduced volume.

Over the last 12 months, credit agreement EBITDA has increased by 27% to $1.5 billion. This is over $300 million higher than one year ago.

Our free cash flow per share in the December quarter was positively impacted by higher pricing, and also by our taking the opportunity to accelerate the collection of a portion of our accounts receivable portfolio on very attractive terms. Ward is going to discuss this accounts receivable facility in more detail in his commentary.

These favorable items were somewhat offset by lower corrugated volumes and the associated cost of producing at lower levels. The net result of these and other factors was that our free cash flow of $3.46 per share was 26% higher than one year ago. Free cash flow of $11.87 per share over the past 12 months is 49% higher than last year.

Our leverage ratio of 1.84x is nearly a full turn below where it was just one year ago. We have the ability to provide our shareholders with strong current cash flow returns, and have significant flexibility to improve these returns by deploying this free cash flow to implement our strategy and/or returning this capital to our shareholders through dividends and share repurchases.

The Corrugated Packaging and Display businesses showed significant improvement as compared to last year. Our Consumer Packaging business improved upon its already solid results. Taxes and other items generated a $0.10 per share improvement, primarily due to lower interest expense, with the remainder due to a lower effective tax rate.

Turning to our Corrugated Packaging business. Industry box volumes as reported by the Fiber Box Association on a per-day basis were flat on average in October and November. The December numbers won't be published until February 3.

Industry containerboard mill operating rates averaged 92% for the quarter, as compared to 96% one year ago and 97% in the September quarter. Industry shipments of containerboard to export markets declined by 2% from the prior-year quarter.

RockTenn's export shipments of 214,000 tons increased by 5% over the prior-year quarter. Our 273,000 tons of domestic sales of containerboard to third parties were 55,000 tons less than the prior-year quarter. Our average day box volumes of 304 million square feet declined by 3% compared to the prior-year quarter and 0.5% sequentially.

We saw declines in demand for food, beverages, and household product categories. Most other sectors were stable.

Our volumes were also affected by the closure of five more plants over the past year, raising the total over the past 2.5 years to 20. Finally, we have continued our commercial focus on profitability and customer value.

While we have had some disruption to box shipments due to weather and other related items in July – in January, given a stable overall market environment, we expect our box volumes for the entire fiscal year to be approximately flat compared to last year. Our combined shipments of containerboard and corrugated boxes were 1.81 million tons during the quarter, down 3.6%. This compares to last year's shipments of 1.88 million tons.

We reacted quickly to this reduction in demand, and drove a corresponding reduction in production during the quarter. Our operating rates averaged 89%, with aggregate downtime of approximately 250,000 tons.

This compares to a 98% operating rate and 31,000 tons of downtime in the prior-year quarter. 93,000 tons of the 250,000 tons of downtime was for maintenance downtime, including annual major maintenance outages at our Fernandina Beach, Florence, and Hodge mills, each of which was completed on or ahead of our expectations. Fernandina Beach came up three days early, reflecting positively on our planning, engineering, and execution capabilities.

The remaining 157,000 tons of downtime resulted from a combination of actions, including flowbacks across our mill system and the temporary idling of the paper machine at our Seminole mill. These actions allowed us to adjust to our customers' softer demand in the quarter, while giving us flexibility to ramp back up to meet the strengthening in demand that we saw in the second half of December.

Turning to the current quarter, in January we have had interruptions to containerboard mill production due to weather and the related factors of approximately 25,000 tons. On January 21, we brought back up the idled machine at Seminole.

Based on our expectations of corrugated segment shipments in the March quarter at a level comparable to last year, we expect to run full for the balance of the quarter. This will allow us to accommodate 84,000 tons of major maintenance outages, primarily at West Point and Panama City, and build a modest amount of inventory to support our business for the second half of the fiscal year.

Corrugated segment sales of $1.65 billion were up 3.9% over last year's December quarter, with higher prices more than offsetting reduced volumes. EBITDA margins increased from 15.4% to 16.3%.

Corrugated Packaging segment EBITDA for the December quarter was $269 million, 10% higher than last year. Prices increased by $119 million, or $65 per ton over last year.

Sequentially, containerboard prices increased by $9 per ton, reflecting better markets and mix than we had anticipated at the beginning of the quarter. Commodities and freight cost increased by $43 million.

Recycled fiber composite averages increased approximately $17 per ton over last year. Virgin fiber cost increased by about $1 per ton. Together, fiber cost increases account for $36 million of the $43 million increase in commodities and freight cost.

Natural gas costs increased by $0.20 per MMBtu. Electricity cost increased by 1.2%. This resulted in higher energy costs of $3 million.

Freight cost were unfavorable by approximately $3 million. Amortization of deferred outage cost increased by $6 million.

The cost of the 250,000 tons of downtime, excluding the increase in amortization of deferred outage cost, was $22 million. This includes cash maintenance cost expensed in the quarter and the labor and other semi-fixed cost of economic downtime, including slowbacks.

Turning to the productivity of our box plant system. Our average volumes per box plant during December were 2.8% higher than last year.

We achieved a record low level of box plant [inaudible] in December. Corrugated productivity tied the division high during the quarter.

Diecutter productivity achieved an all-time high in the month of December. All of these result from the hard work of our team across the RockTenn box plant system.

This past weekend we began operating one of our new Flexall folded willers in our box plant in Richmond, Virginia. We'll start up another one in Humboldt, Tennessee in March. These are the first two of a total of six we will install during FY ‘14.

Last week we started up a new die cutter in our box plant in Liberty, Missouri. This $7 million investment has a very attractive return based on improved quality and higher productivity.

In our containerboard mill system we have several key capital projects underway, including the second phase of our Hopewell capital project scheduled as part of the month-long outage beginning in early April. The wood yard modernization project at Florence is underway, and scheduled for completion this summer.

Last week we completed the sale of our only wholly-owned box plant in China for approximately $5 million. This was essentially book value. We continue to own an interest in a joint venturer box plant in China that is very successfully operated by our partner.

Because the primary audience for our conference call is investors, I don't expect to regularly report on our safety results. However, safety is of utmost importance to our Company, and we invest a lot of time on safety initiatives designed to increase employee engagement and improve our safety performance.

In the December quarter, we reported our best ever safety results for our Corrugated business. All considered, I'm very pleased with our Corrugated Packaging results this quarter, as our team demonstrated their ability to operate very successfully in a very fluid environment.

Now to our Consumer Packaging segment. SBS industry backlogs as of January 15 were 504,000 tons. This was up approximately 36% from one year ago. RockTenn's SBS backlogs now stand at 3.5 weeks, in line with our expectations at this time of year.

CRB industry backlogs as of January 15 were 120,000 tons, down by about 19,000 tons from one year ago. RockTenn's CRB backlogs now stand at four weeks. This is above our expectations for this time of year.

The SBS and CRB price indices published in PPW have been flat since September of 2013. At this point it was implemented, the vast majority of the board price increases we have anticipated.

The stable market environment contributed to strong financial performance in the quarter. Sales increased by 4%.

EBITDA margins remain stable in the 17% range. Total Consumer Packaging segment shipments of 378,000 tons increased by 2.6% over last year. This includes the 1% increase in our shipments of converted products.

Even though November and December historically represent the low months of demand for our consumer packaging board grades, there was no falloff in orders, and we took no economic downtime in the SBS and CRB grades in the quarter.

Our Consumer Packaging business segment EBITDA of $80 million in the December quarter increased by $3 million over the prior-year quarter. Higher prices and volumes more than offset cost increases.

Assuming that the market environment continues to be stable, we expect our results in Consumer Packaging for the remainder of the year to be in line with our prior-year results. Consistent with our long-held strategy of investing for competitive advantage, we are investing $11 million in the new printer and die cutter for our Nicholasville, Kentucky folding carton plant.

This investment will generate an attractive return by increasing productivity, reducing waste, reducing maintenance and repair spending, and adding additional contribution margin. We expect this project to be operational in June of this year.

The Merchandising Display business supports consumer products companies by supplying in-store displays designed to promote their products and increase sales. Our Display team includes customer relationship managers, project managers, creative designers, and very flexible manufacturing and assembly operations.

This $700 million business is strategic to RockTenn since it provides us the opportunity to build deeper relationships with consumer products companies, and also provides a sales channel for our Corrugated and Consumer Packaging businesses. Changing trends in the retail shopping environment characterized by increased online shopping is leading to stronger demand for point-of-purchase displays from our customers.

Merchandising Displays achieved record sales of $184 million in the quarter. Segment EBITDA margins were 11.9%.

The promotional environment remains healthy, and we expect continued solid results for the remainder of FY ‘14.

In late December we completed the acquisition of MPG Holding, Inc. This was a specialty display company based in Chattanooga, Tennessee.

They support a number of retail clients. This business adds meaningful relationships that complement and improve the relationships we have with consumer products companies.

We paid $60 million for the $75 million sales business. After cost synergies, which are primarily moving purchases from external suppliers to internal sources, we paid less than five times EBITDA for this business.

Our Recycling business had a challenging quarter, as they adapted their business to soft export markets for recovered fiber and the changing requirements of our containerboard mill system.

We broke even for the quarter. I expect Recycling to earn $3 million to 4 million per quarter for the remainder of the year.

Beginning with the December quarter, we no longer record the shipment of recovered paper to our internal containerboard and paperboard mills as an intersegment sale. We record these transactions as a transfer of inventory at cost plus an administrative fee.

Only the administrative fee is recorded as revenue in the Recycling segment. This change is appropriate, given that almost 60% of the segment's fiber sourcing is for our internal mills.

With this change, segment sales for FY ‘13 as reported in our September quarter release of over $1 billion have been revised to $494 million. Segment income remained the same at $14 million. With that, I'll now turn the call over to Ward. Ward?

Ward Dickson

Thank you, Steve. Wood fiber costs were effectively flat as compared to the September quarter, and were about 3% higher than same quarter last year.

The cold and wet weather in January has put some pressure on loggers, and we are seeing some modest increases. Our natural gas cost is effectively flat on a sequential basis, and with the cold weather in January we are seeing higher natural gas prices. Prompt month prices are approximately $5.13 per MMBtu, and the 12-month strip of approximately $4.57 per MMBtu compared to an average of $3.60 in the December quarter.

For the balance of this fiscal year, we expect that recovered fiber markets will reflect moderately higher pricing. As Steve mentioned earlier, at the end of December, our net debt was approximately $2.7 billion.

Our LTM credit agreement EBITDA was $1.525 billion, and our credit agreement debt to EBITDA ratio was 1.84 times. We have over $1.7 billion in liquidity available to us for general corporate purposes.

Last week, Moody's upgraded RockTenn's debt rating to Baa3 for investment grade. Coupled with our BBB positive outlook rating from Standard & Poor's, we now have investment-grade ratings from both agencies.

We have a very strong credit profile to support our business strategy. During the quarter, we generated free cash flow of $254 million.

In the December quarter we entered into a new ongoing accounts receivable sale program. As of December 31, we had received $65 million of incremental proceeds from this accounts receivable sale program.

We entered into this program because it accelerates the collection of receivables at a slightly lower cost when compared to our accounts receivable securitization lending facility, currently less than 1% per annum. We expect to sell a second tranche of receivables during the March quarter. When we look at the impact of this program and other working capital changes for the full year 2014, we expect a reduction in net working capital of approximately 2 to 3 days on a days sales outstanding basis.

Let me highlight some of the key assumptions for the second quarter and the remainder of the fiscal year. Our effective tax rate for the December quarter was 35.8%, within our normal range of 35% to 37%. We expect a book tax rate for the second quarter in FY ‘14 of approximately 35% to 37%.

At December 31 we have recorded unused US federal, state, and foreign net operating losses and tax credits that can be used to offset a total of $485 million in cash taxes. We expect to use most of the remaining $149 million tax benefit of our US federal net operating losses, primarily during FY ‘14.

We will use our remaining US federal tax benefit of $230 million in cellulosic biofuel, alternative minimum tax, and other federal tax credits during FY15. Based on current assumptions, we estimate our cash taxes at approximately $40 million in FY ‘14, and a cash tax rate of approximately 10% in FY15 and 30% in FY16. We continue to expect that our capital expenditures will be the range of $525 million to 550 million for FY ‘14.

During the December quarter we received IRS approval to change the ending date of the plan years of the former Smurfit-Stone US defined-benefit plans from December 31 to September 30. This change has a twofold benefit.

First, it will simplify administration of the plans, and second it will reduce our required estimated minimum contributions in FY ‘14 by $15 million. We estimate that the expenses related to deferred outage costs for the containerboard and bleached paperboard mills will be about $103 million for FY ‘14. With that, I will now turn it back over to Steve, who will discuss our outlook.

Steve Voorhees

Thanks, Ward. We previously provided free cash flow guidance for FY ‘14 in the range of $12.50 the $13.50 per share.

As Ward described, we expect our investment in working capital to go down by two to three days sales outstanding, or $58 million to $75 million. While the amount of downtime and the cost of downtime in the December quarter were higher than I had anticipated at the beginning of the quarter, we have also updated our outlook for FY ‘14 for the impact of weather in the current quarter and the change in the price of natural gas and other commodities. The net result of all of that is I am increasing our free cash flow guidance for FY ‘14 to the range of $13 to $14 per share.

I conclude our prepared comments by underlying our confidence in our ability to provide our shareholders with strong current cash flow returns and the ability to improve those returns by deploying our free cash flow to further develop our strategy, and/or by returning this capital to shareholders through dividends and share repurchases. Now, Ward, Jim, Mike, and I are now available to respond to your questions. Operator?

Question-and-Answer Session

Operator

Thank you. At this time, we will begin the question-and-answer session. (Operator Instructions). Just a reminder, there will be two-question limit per person. One moment please for our first question.

Scott Gaffner with Barclays. You may ask your question.

Scott Gaffner – Barclays

Good morning.

Steve Voorhees

Good morning.

Scott Gaffner – Barclays

I just wanted to go back to a comment you made on the corrugated segment. If I heard you correctly I think you said – you thought box shipments would be flat for the segment for the full year. You were down 3% in the first quarter. I think you said flat in 2Q. If you are getting the flat in the full-year, are you looking for some sort of increase in the second half of the year around box shipments? And if so, why?

Steve Voorhees

You heard that correctly. We do expect flat shipments. I think just continued execution of our strategy. I think we've been pretty clear about what we're trying to do.

Scott Gaffner – Barclays

Okay.

Steve Voorhees

But you did understand that correctly.

Scott Gaffner – Barclays

Sorry. But there's no – I mean are you expecting – because you mentioned earlier you saw declines in the first quarter in food and beverage and household categories. I mean is there something in the end markets that you are expecting? Or is this more in your control than just you know improving end market trends?

Steve Voorhees

It's a combination of both. I think demand for boxes is – we look at it is very stable. It's a very significant product in our economy and we think the implementation of our – of what we're doing will result in the flat shipments for the entire fiscal year.

Scott Gaffner – Barclays

Okay. And just on pricing I mean you thought you were going to see a $10 decline. You said you saw a $9 increase sequentially...

Steve Voorhees

Yes.

Scott Gaffner – Barclays

…in pricing. Can you just walk us through a little bit more detail? I assume it was a mix issue. But maybe you could flush that out a little bit? Thanks.

Steve Voorhees

Yes, yes. I think the primary driver would be the mix among boxes export and domestic sales to third parties.

Scott Gaffner – Barclays

Thank you.

Operator

Thank you. Our next question comes from the Anthony Pettinari with Citi. Your line is open.

Anthony Pettinari – Citigroup

Good morning.

Steve Voorhees

Good morning, Anthony.

Anthony Pettinari – Citigroup

Yes. You indicated a stable pricing environment across businesses in the quarter, and I was wondering if you could talk a little bit about what you are seeing in containerboard export markets maybe in January you know given potentially weaker emerging markets and maybe FX if you've seen impacts to pricing on the export front.

Steve Voorhees

Anthony, I'm going to ask Jim Porter to respond to that.

Jim Porter

Good morning Anthony. I think that we're seeing, generally, a firming in containerboard demand across the global marketplace. And along with that, there's firming prices.

I think as we reflect on the prior quarter, we saw some softening across the globe but that has fully bottomed and we're now seeing firming in most all of our markets.

Anthony Pettinari – Citigroup

And can you remind us of the geographic mix of your exports maybe last year. Did you expect any change this year in terms of South America, Europe?

Jim Porter

Yes. We sell in all of the major markets across the globe and we don't see any significant shifts. Europe, Middle East, Latin America and Asia is a fairly balanced portfolio and we continue to look at serving our customers in each of those regions on a relatively stable basis. There was some flex. However, we try to maintain stability in those regions.

Anthony Pettinari – Citigroup

And you're seeing prices basically firm in all the regions that you serve?

Jim Porter

We are.

Anthony Pettinari – Citigroup

Okay. I'll turn it over.

Operator

Thank you. George Staphos with Bank of America Merrill Lynch. Your line is open.

George Staphos – BofA Merrill Lynch

Thanks. Everyone, good morning.

Two questions. The first one on pricing, Steve and Jim. Back to the question on mix, if I heard you correctly and correct me if I'm wrong, you said that your export shipments were actually up in the quarter. I think you said something to the effect of 5%. I think box – and let's call it domestic containerboard was broadly down you know 3%.

[Almost equal] [ph] I would expect that to be more negative for mix than positive. I realize you were describing the mix versus your expectations. But could you be a little bit more specific in terms of how that work together to give you a, I guess an almost $20-per-ton improvement in your mix versus your prior expectations?

Steve Voorhees

Yes. I understand your questions. I think you don't have our prior expectation so it's hard to make the judgment.

George Staphos – BofA Merrill Lynch

Sure.

Steve Voorhees

The judgment. I think our overall shipments in corrugated and the corrugated segment were down 3.6%. Our box shipments were down less than that. In fact, there were down around 3% is actually little bit less than that. And so, the higher proportion of the domestic third-party and the export and the – resulted in the change of mix.

George Staphos – BofA Merrill Lynch

Okay.

Steve Voorhees

I'm sorry. I can't get more specific. But that's what it is.

George Staphos – BofA Merrill Lynch

I appreciate the additional clarity anyway. I guess the next question I'll ask is again on corrugated. Can you remind us on where you stand with the implementation of Kiwi[ph]? And how good you feel about how confident you feel in terms of the visibility you have into your numbers, your P&L, all of those things that you'd like to control and have line of sight to in your corrugated segment – in corrugated business of the box plant network? Thank you.

Steve Voorhees

Okay. George, I'm going to start and then Jim will add color.

We now have the box plant system in 42 of our box plants. We expect to complete implementation in all of our US box plants by the end of June. I think with respect of impact on our operations, I'm going to hand it over to Jim.

Jim Porter

The implementation of the Kiwi [ph] plant system is just one of many standardized operating platforms that we're deploying across the enterprise. The installation is going very well and I continue to be optimistic about the improved consistency and ability to have stability across the system and the capability to better forecast demand, our supply, on-time deliveries, in general, enhancing the overall efficiency of serving our customers.

But it – again as just one of many and we're seeing the traction in all of the areas of our business and a much higher level of engagement of our coworkers, and I think we're just seeing a much higher degree of execution within our business across many, many areas.

George Staphos – BofA Merrill Lynch

Okay, thank you.

Operator

Thank you. Our next question comes from Mark Wilde with Deutsche Bank. Your line is open.

Mark Wilde – Deutsche Bank

Good morning and congratulations.

Steve Voorhees

Good morning.

Mark Wilde – Deutsche Bank

A couple of questions. The first one is I wonder – either Steve or Jim – can you just talk about the amount of sort of incremental creep that you've generated across the system over the last 30 months?

Steve Voorhees

We're – because I can't even think in time, Mark.

Mark Wilde – Deutsche Bank

Yes. I'm sorry. I was just – I was struck last year when I was down at Chesapeake that you know as of last – you could actually put about 8% incremental volume through that mill since you'd acquired it from Smurfit, and that hasn't been a mill that you've been talking about. You've been talking about the capital programs and a lot of other ones. So, I just – I wonder in total what this adds up to?

Jim Porter

So, Mark, I would answer like this. We're very focused at improving the efficiencies in all of our mills and that means improving our uptime from a maintenance perspective, improving the execution of our scheduled outages and incrementally improving machine speeds and overall efficiency. So, it is really a daily quest at each one of our mills.

However, we're also keenly focused on matching our supply with our customers demand. And so, the concept of creep is yes there as long as there's creep in demand. If there's not creep in demand, you won't see us exceeding our productive capacity. So, that's really how I would look at the question.

Steve Voorhees

Yes. Okay, Mark. So, here's some numbers. In 2011 in the 10-K, we reported total containerboard capacity of 7.992 million tons and then the K we just filed at 7.85 million tons.

The difference – the math is Matane we took out, which was 176,000 tons. And the residual which you know would be – I don't have the number but you can calculate might be 40,000 tons would be the creep.

Now, we have a project at Hopewell, which is going to add on the order of 120,000 tons that will be operational this summer. I think we've been very consistent that while we will have the capacity, there's also cost savings that we operate at the same level. So, we continue to be looking at this kind of to match for our production to meet our customer demand. Hopefully, that's helpful.

Mark Wilde – Deutsche Bank

Yes. I would have thought Steve, actually, just given what I've kind of actually heard that some of these other mill sites that incremental creep would have been greater then.

The other question I have is just in terms of kind of growth going forward, you've got the balance sheet back in good shape, you're operating well, and you know we came into the company, Steve, the stock was in the low to mid teens. You've created a lot of shareholder value by execution and by acquisitions. And I'd like to just get your thoughts on where you might acquire going forward. I think particularly in the containerboard business, you know we're all curious about how much more could you grow domestically and do you need to start to expand internationally if you want to grow?

Steve Voorhees

I guess – you're on the issues as we're looking at them. Our balance sheet is in terrific shape. I think we can grow across any of our businesses. I think you run into [Inaudible] potentially domestically at some point. And we do export, as Jim said, around the world and I think there is the potential – yes, there would be that would expand internationally.

We're in that fortunate position of I think where we have an impetus to act to create shareholder value but we don't have a need to act rationally but we've bought back stocks this past quarter, we talked about buying back our stock as it means to – and make sure we have appropriate leverage on our business, which we said is about two times. But we're continuing to look at I think all of the opportunities and just judge them on their merits.

Mark Wilde – Deutsche Bank

Okay, that's helpful. Good luck in the coming quarter, Steve.

Steve Voorhees

Thanks, Mark.

Operator

Thank you. Our next question comes from Alex Ovshey with Goldman Sachs. Your line is open.

Alex Ovshey – Goldman Sachs

Thank you. Good morning, guys.

Steve Voorhees

Hello.

Alex Ovshey – Goldman Sachs

Good morning, Steve. So, couple of questions for you. So, if we're talking flat demand for the year and seminar coming up, is the implication there that you're not assuming any further lack of order downtime for the balance of the year as you see it today?

Steve Voorhees

I think what we said was for the rest of this quarter, we have visibility into – we expect around full. I think beyond that time, they're assuming variables to coming on the outlook beyond, you know, primarily demand variables for boxes but also the export markets. We don't have visibility into business and beyond right now the month of March with respect to our plans to operate.

Alex Ovshey – Goldman Sachs

Got it, Steve, understood. Very fair and very helpful. And then the second thing if we just took their $22 million of sort of downtime costs and divided up with a number of tonnage that's you know on economic lack of order downtime. You know you need – you get to a number per ton. Is that you think a fair proxy to think about you know your lack of order downtime costs per ton on go-forward basis this time if you have to take it?

Steve Voorhees

There are so many variables. I think it's hard to say that would be a fair proxy. It is what we believe it was in December, based on the downtime that we took.

Alex Ovshey – Goldman Sachs

Yes. I think the reason that's so important is that's some pretty reasonable number. I mean I sort of think about what people tend to talk about in the industry. It's sort of north of $200 a ton and that number is well below that. So, I think that's interesting that's why I asked the question. So, okay. I – but it seems like in the quarter certainly was obviously reflective of what it was for you.

Steve Voorhees

Right. And just – I'll repeat. I was very pleased with the [inaudible] our entire business had to adjust to that.

Alex Ovshey – Goldman Sachs

Perfect. I'll turn it over. Thanks very much.

Operator

Thank you. Our next question comes from Philip Ng with Jefferies. Your line is open.

Philip Ng – Jefferies & Company

Good morning, guys. Switching gears, I just had a question in your consumer business. If I heard you correctly, you're expecting EBIT to be flat for the rest of the year. With pricing flowing through them, I'm kind of surprised EBIT from the flat in demand seems to pick up a little bit here.

Steve Voorhees

Yes. Mike, can you take that one?

Michael Kiepura

Sure. My – I think it's a combination of – there is price recovery but that's also offsetting amount [ph] of the input costs on both energy and on the fiber side. So, in balance it would appear to be you know flat relative to last year.

Philip Ng – Jefferies & Company

Okay. And Mike, you've – and then the commentary about pricing you guys fully have it flowing through. Is that $8 million Delta [ph] benefited from a bridge standpoint in the quarter good run rate going forward the rest of the year? Or is that a good way to think about it? It gives – it's different nuances in terms of timing and odds and stuff?

Michael Kiepura

There are certainly the nuances with the timing. But we would expect to get the benefit of the pricing that we have you know for the most part implemented at this part – at this point to continue to flow through at the balance of the year.

Philip Ng – Jefferies & Company

Okay, okay. That's helpful. And then, just quickly on the containerboard segment, you're obviously expecting demand to pick up a little bit in the back half of the year. Is that mostly a function of your view of the broader market? Or just from a competitive landscape standpoint that when things aren't getting – things aren't as choppy as it was late in the year?

Steve Voorhees

I'll start and then Jim could add-on. There's a seasonal inquiry that you would expect in the June and September quarters. And then we're also positive on what we're doing in the box business.

Jim Porter

Yes, Steve. I think that really covers it. I think we have the seasonal improvement that is usually there in the second half of the year as we see demand for products escalating somewhat. Our execution were clear. It's improving. And we I guess have some optimism that the economy is on a slightly improving trend.

Philip Ng – Jefferies & Company

Okay. And lastly, you know just gives you – on the free cash flow side you guys bumped it up and you brought back a good amount of stock during the quarter. How should we be thinking about the cadence of buybacks over the course of the year? Pretty balanced or is that going to be a little more backend loaded?

Steve Voorhees

Yes. The – it's – we're going to use the stock buybacks to manage our leverage ratio and we continue to look at opportunities across the business. And so, we don't have a specific outlook. It's really going to be balance sheet and opportunity driven. So I can'1t tell you whether it will be even or whether it'll be lumpy. I can't totally see at the end of the year how it turns out. But frankly, we've described our attitude toward that and we're going to take that attitude and it'll play out how it plays out.

Philip Ng – Jefferies & Company

Okay. Thanks, guys. Good luck on the quarter.

Operator

Our next question comes from the Mark Weintraub with Buckingham Research. Sir, your line is open.

Mark Weintraub – Buckingham Research

Thank you. I like – I got disconnected for a few seconds. I hope this question wasn't already answered. But on the free cash flow guidance, you raised it by about $0.50 and at the same time you talked about the working capital shift, $50 million to $75 million. So basically, did the working capital go up by about $0.80? And then all of the other items was about a negative $0.30? Is that the right way to look at it?

Steve Voorhees

That's right. Yes.

Mark Weintraub – Buckingham Research

Okay terrific. Thanks for the clarification.

Operator

Thank you. Our next question comes from Chris Manuel Wells Fargo. Your line is open.

Chris Manuel – Wells Fargo

Good morning, gentlemen, and congratulations on making it work. I understood you got some pretty ugly stuff down there in Atlanta.

Steve Voorhees

It is an interesting time. It's...

Chris Manuel – Wells Fargo

It's balmy minus 7 here in Cleveland this morning. So, anyway I did a couple of questions for you here and this – I recognized this is sort of a difficult one to maybe gauge but you know either Steve or Jim, if you could take a stab at it, I'd appreciate it.

When you look at inventory levels, you know, at your customers at boxes, things of that nature. Given where you guys operated in the quarter, our looks at demand for the underlying consumer what's getting pulled out is showing some – is seemingly some modest acceleration, things getting better.

So, I guess my question at this point do you feel that you know you've have kind of got your own inventories and the customer inventories are closer to where there should be? And kind of to your point that you're anticipating some box growth the balance of the year. How would you maybe help us to think about that?

Steve Voorhees

Just – look, our inventories are aware we want them to be. We actually reduced inventory by – was it 12,000 tons?

Jim Porter

12,000 tons.

Steve Voorhees

During the quarter and although – so where our inventories are just on plan. With respect to our customers inventories, I just have to tell you I don't know how they stand. I don't have a very good feel for that.

Jim, do you have...

Jim Porter

I'd have to say that they're somewhat in the middle range and maybe on the skinnier side that the middle, but beyond that I don't think we can really forecast them. I mean we often look at the industry data on the history of inventories and there have been some trending to lower average levels over time. But right now, I think the overall stock flow looks are pretty healthy across the – our industry.

Chris Manuel – Wells Fargo

Okay, that's helpful. And then you know one last kind of follow up being – as you're thinking about looking at M&A opportunities today and balanced with what you're seeing with some of your return oriented projects, you know I think some of your return oriented projects that have been giving you high teens low 20s returns. Is there anything that is different with the – you know I think you talked about maintenance capital in the past being 350-ish. This other kind of $200 million you're spending that's – is there anything different with that today? Or how you would be evaluating M&A opportunities?

Steve Voorhees

I don't think that there is a material difference. I will say, as we invest in our plans and I highlighted investments in the folding carbon plant and die cutter and [inaudible] Missouri then we have our flexes going in both in Richmond. I think as we do that, and as we are successful, I think we have the opportunity to come even more successful is that what happens in the plants is when they look at a piece of equipment, there's – I think we get another increment of performance from higher engagement from all of the employees and that makes it easier to do the next one. And as we get more experienced, I think we can develop a good pattern there.

When you turn that over to M&A opportunities, my biggest priority is to make sure that our existing businesses are as competitive as they possibly can be. And so the M&A is there to really make our overall businesses stronger. And mpg, which we haven't talked about a lot, is a great example of – we're very positive on how that impacts the display business.

So, we generate a return and that also helps our overall ability to meet our customers' needs from the display business.

Sorry. That's a long answer. But it's a combination of all of those. And I look at it in terms of balance and we're almost in a situation to where we can take advantage of the opportunities as they present themselves and maybe go out and create some opportunities on our own while we see them.

Chris Manuel – Wells Fargo

Okay. That's very helpful. Thank you, Steve.

Operator

Thank you. Our next question comes from chip Dillon with Vertical Research Partners. Your line is open.

Chip Dillon – Vertical Research Partners

Yes, and good morning, Steve, and welcome, Ward.

My first question has to do – just up verification. Ward, you were going to the use of this tax benefits. Did you say that the usage this you would provide $255 million? Was that right? And therefore, all of it will be used up by the end of '15?

Ward Dickinson

We're going to need most of NOLs during '14. Then, there's a remaining set of tax benefits, which is the 230.

Chip Dillon – Vertical Research Partners

Yes.

Ward Dickinson

We expect to use that during fiscal year '15.

Chip Dillon – Vertical Research Partners

Got it. Got it. So, in other words, they'll be done by '15? Got you. And then Steve on the – when you look at your portfolio, and obviously it's impressive to see the returns in merchandising displays, but the one sort of part that – where you don't really have a big market share is if you segment you know consumer packaging [inaudible] you're not you know certainly of the top players there and is that a business that you feel is one that you could see growing? Or is there a reason that you might – I mean you mentioned containerboard as being of – a certainly high priority. But this – does the bleachboard something that you can also see rock and growing in – through acquisition in the future?

Steve Voorhees

I think if there were an opportunity then that would be something we'd seriously look at. Our consumer packaging business was operated extremely well over the past several years. I mentioned the recapitalization or the additional printer and cutter as well.

I think that we're in a nice position and the folding carton business and our packaging board rigs of having the opportunity to grow.

Chip Dillon – Vertical Research Partners

Got you.

Steve Voorhees

And I think we did geographically mentioned on the last call – Mexico we could do that internally. But that's a business we've been very successful at to the extent we have opportunities we certainly take advantage of them.

Chip Dillon – Vertical Research Partners

Got you. And real quickly just the last one for Jim. I noticed you know with the restart of Seminole I thought that – and maybe it was just an interpretation, but that even there was some question about that machine longer-term. And does that restart have any – is there any issue in the marketplace that would affect that decision in terms of the success or lack thereof of some of the conversions especially the one in the South from newsprint to recycled containerboard?

Jim Porter

Okay. Well, that question I think has a couple of dimensions. One, our Seminole mills, we're just very proud of the progress that they've made and that team does one heck of a job of producing a very high-quality product. The cost structure has improved dramatically. And yet, they have been on the short end of the stick so to speak and have had to swing with us as we've matched much our supply with demand. But they do one heck of a job. And we will continue to look at that facility as to how we can help them drive costs out. But we will use that machine set to ensure that we're balancing supply with demand.

Now, as we shifted the second phase of your question as to the conversion, we're all aware of the capacity additions within the impact machine and the Atlantic packaging and newsprint machine. And I think they're trying to be successful at producing containerboard. I see some evidence of that. But we really don't run into a lot of head-to-head with them.

So, I can't comment on those success. I know they're working hard but they've got challenges, both in terms of capital and meeting the market quality expectations that our customers have.

Chip Dillon – Vertical Research Partners

Thank you.

Operator

Thank you. Our next question comes from Adam Josephson with KeyBanc. Your line is open.

Adam Josephson – KeyBanc Capital Markets

Thanks. Good morning, everyone.

Steve Voorhees

Good morning, Adam.

Jim Porter

Good morning, Adam.

Adam Josephson – KeyBanc Capital Markets

Jim, how would you characterize export markets at the moment? And how do you compare them to three or six months ago?

Jim Porter

I think as we commented earlier, I see them firming really in all sectors of the world. China has been – China and Asia have frankly been very stable over the last six months or so, continue to be firm. The rest of the world had a bit of a softening over the last quarter. But have firmed and we're seeing strong demand in all regions. And along with that, there's some corresponding firming prices.

Adam Josephson – KeyBanc Capital Markets

Got it. Thanks for that. And Steve, I think you talked about lower food and beverage and household product demand in your corrugated business but no such declines in your CRB and SBS businesses. And I'm just trying to understand that seeming disconnect.

Steve Voorhees

Mike, do have a comment on the food and beverage and consumer...

Michael Kiepura

I'd say on the consumer side typically food and beverage are really more food because we're really not a significant player on the beverage side. So of mix, 70 plus percent is on the food. And as you would expect that's pretty stable. And so, you know the industry trade association for the quarter over volumes were flat. We were up a couple of percent. So, we just think it's stable. I think it's a little more episodic with who your particular customers happen to be and for the quarter. And over a longer period of time, our base has been a little bit stronger than the overall market.

Adam Josephson – KeyBanc Capital Markets

Thanks a lot for that. I appreciate it.

Operator

Thank you. Our next question comes from Steve Chercover with D.A. Davidson. Your line is open.

Steve Chercover – DA Davidson & Co.

Thanks. Good morning.

Yes. I too was interested in the commentary on food and beverage, given my own behavior over the holidays. Are you seeing any offsetting I guess consumption? Is it substantial enough to – could you quantify was it coming online retail?

Steve Voorhees

You're talking about with respect to boxes for...

Steve Chercover – DA Davidson & Co.

Yes. I guess they call it the "Amazon affect". I mean is it tangible?

Steve Voorhees

You know we've tried to do that and really haven't come up with a – anything that I would describe is putting meaningful. I think we do see in the display business and made a comment about the impact of changes in the retail shopper trends. They are changing.

I think our customers are working to figure out how to market their products between online and in-store and just the way we experience it short-term as primary demand for displays is very strong.

I had somebody telling me about going to a store that if you have a headache, you can't order the cure online and expect to have an affect so you've got to go to the store that causes business of marketing that product or other markets like that having a promotional display can help by business.

Steve Chercover – DA Davidson & Co.

I see. Yes. We're kind of late in the cycles. I lot of the questions have been asked. But for two of the three new mills or conversions that you referenced are basically in the you know Syracuse region, so to speak. So, are you saying that you really haven't felt much impact, either on your fiber costs or your customer base?

Jim Porter

I can't say the – this is Jim Porter. I can't we haven't felt any impact because we certainly have. But ourselves a New York mill produces an extraordinary product that is in very high demand by our box plants and independent customers within that region. It has not affected at all the demand for the product. And so, we remain just fine in that regard.

Fiber, as you all those countries some softening and demand all over North America, as we've seen some of the decline from Asia. So the ripple effect of fiber is such that it's somewhat normalized. But you know, clearly, we see signs of those facilities acquiring fiber and talking to – with customers. But our assets continue to be disciplined.

Steve Chercover – DA Davidson & Co.

Terrific. Best wishes for '14. Thanks.

Operator

Thank you. Our next question comes from Mark Connelly. Your line is open.

Mark Connelly – CLSA Limited

I've just got one. Respect to downtime, you know the industry mantra is slow back is better than shutting machines down. You obviously have more of a hybrid approach with the Seminole. Should we assume that that's still a dynamic process? And with – you know because remember the slow back thing came up in the 1990s. The industry is so different now. I wonder whether you still look at this dynamically and say, “Do we shut the machine down? Or do a slow back across the system? Or is the difference just so overwhelming that we're just going to stay this way?

Steve Voorhees

Your comment on dynamic is spot on. I think every situation is different and I think we work hard to take a fresh look at every problem. Let's not assume the answer is the same as it was before. And so we went into this past situation recognizing we have to be very flexible and that was the answer of the – emerged. So, dynamic is per say, perhaps, description.

Mark Connelly – CLSA Limited

Super. Thanks.

Operator

Thank you. (Operator instructions) Mark Weintraub with Buckingham research. Your line is open.

Mark Weintraub – Buckinham Research Group

Thank you. I just wanted to follow up a little bit on your comment that market conditions are feeling better and certainly you highlighted that in the export market. Was that also true in a domestic market? Because at the same time you're talking about how January has been difficult and I don't know if that was more about a our cost issue or whether or not because of the weather that was also affecting the demand side. If you could just clarify on that that'll be helpful.

Jim Porter

I think we're seeing – this is Jim Porter. Again, I think we're seeing firming domestic demand as well. As we indicated, we brought back up our Seminole machines on January 21st and we now have all of our assets running at capacity and that is needed in order for us to match our supply with demand.

Yes, we did comment that we've had a tough winter so far in January and we've taken some hits and a number of our facilities. And today, we're fortunately – all operating, except I understand that Annapolis [ph] snowing down this morning. They'd do some challenges. So, we continue to feel the brunt of this weather pressure and it has had at hit.

But back to your comment on demand, I think we see it as full and we'll match it with our system.

Mark Weintraub – Buckinham Research Group

Great. And just one other – you also mentioned that you would build a little inventory. I assume that that is a seasonal thing for maintenance that you'd be taking later in the year. Is that how to think about that? Or...

Steve Voorhees

Well, as we indicated, we lowered inventory this past quarter by about 12,000 tons and we're now going into a shutdown season in which we have three of our mills plants to take approximately 83,000 tons of downtime in this quarter. The Panama City Florence and West Point Mills will be going down. And so we need to build a little bit of inventory to ensure we take care of our customers during the period.

Mark Weintraub – Buckinham Research Group

Okay. So this inventory – that's a small – we're talking small numbers in terms of inventory shift in behavior?

Steve Voorhees

We micromanage the inventories daily in order to be sure that we're taking care of our customers and matching our production capacity with demand.

Mark Weintraub – Buckinham Research Group

Terrific. Thanks very much.

Operator

Thank you. And at this time, I'm showing no further questions.

Michael Kiepura

Okay. Thank you very much for taking the time to listen to our call and we look forward to speaking to you next quarter. Thanks.

Operator

And this concludes today's conference. Thank you for your participation. You may now disconnect.

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