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KapStone Paper and Packaging Corporation (NYSE:KS)

Q4 2013 Earnings Conference Call

February 11, 2014 11:00 ET

Executives

Roger Stone - Chief Executive Officer

Andrea Tarbox - Chief Financial Officer

Analysts

Adam Josephson - KeyBanc

James Armstrong - Vertical Research Partners

Steve Chercover - D.A. Davidson

Al Kabili - Macquarie

David Woodyatt - Keeley Asset Management

Operator

Good day, ladies and gentlemen, and welcome to the Q4 2013 KapStone Paper and Packaging Corporation Earnings Conference Call. My name is Whitley and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

The information in this earnings call contains certain forward-looking statements within the meaning of the federal securities laws. These statements reflect management’s expectations regarding future events and operating performance and speak only as of February 11, 2014. These forward-looking statements involve a number of risks and uncertainties. A list of factors that could cause actual results to differ materially from those expressed in or underlying any forward-looking statements can be found in the company’s filings with the Securities and Exchange Commission, such as its annual and quarterly reports. The company disclaims any obligations to revise or update such statements to reflect the occurrence of events after the date of this earnings call.

I would now like to turn the conference over to your host for today, Mr. Roger Stone, CEO. Please proceed sir.

Roger Stone - Chief Executive Officer

Thank you. Good morning and thank you all for joining us. As usual, Andrea Tarbox, our Chief Financial Officer is on the phone with me, but this time, we are about 1,300 miles apart, so we can’t use any hand signals.

As you can tell by all the bullet dots in our press release, we believe we had a great quarter and year although it could have been better. Along with two mill plant shutdowns in the fourth quarter, one of our mills experienced serious productivity issues, which have now been resolved. Our mix was substantially poor, particularly in December. Our higher priced product volume was lower and we ran a lot of unbleached pulp to fill the gap caused by slower demand. A demand in our mix had returned to normal and our January prices were actually $23 a ton higher than December’s prices.

Container demand was stronger for the industry in December at 5.7%, but still lower than November, which is normal. Our December was very strong with over a 15% gain and more importantly we were up 6% in January and this was held down by some weather-related issues. These numbers we think, however, speak well for the industry’s improvement in demand. Prices in everything we do, has been remarkably stable. In the quarter, export linerboard was off about $10 a ton, but I would attribute that mostly to mix as we ran more heavy weights relative to light weights, which sell at a premium. And also a higher percentage moved to different destinations, which historically have had different values.

And now, I will turn it over Andrea who will run through our numbers and then I will return with a few comments on outlook. Andrea?

Andrea Tarbox - Chief Financial Officer

Good morning everybody. Psychologists have shown that people really don’t like surprises, whether the surprise is predetermined to be either a good one or a bad one. Yesterday’s surprise release of KapStone’s earnings 30 minutes before the close of the market is a good example. The outside firm that we engaged to post our presentations accidentally posted our presentation an hour earlier than that they had been instructed. You witnessed the results. Fortunately, leveler heads are now presiding.

So, let’s turn now to what’s really important and that’s KapStone’s remarkable story. The presentation for today’s review of the fourth quarter and full year 2013 results is located on our fresh new website, www.kapstonepaper.com in the Investors section for those of you who haven’t already located it. As usual, we will start on Slide 3, which is clearly one of our favorites depicting KapStone’s remarkable growth in key value drivers. Net sales, adjusted EBITDA and adjusted free cash flows grew at compounded annual growth rate of 41%, 37% and 33% respectively over our seven year operating history. More remarkable is that these robust results were achieved despite a fairly tepid economy. As we look at these results remember that the fourth quarter of 2013 was the first quarter we had a full quarter of Longview’s results included. Cash generation is particularly important to KapStone. In the fourth quarter of 2013 KapStone generated free cash flows of $89 million or $0.92 per share. KapStone’s free cash flow for the 2013 full year was $202 million or $2.09 per share and was up $111 million or 122% over the prior year.

Slide 4 is the financial snapshot of our 2013 full year results compared to 2012, indeed record smashing results were achieved. Some key items to note are net sales of $1.7 billion, adjusted EBITDA of $333 million, adjusted net income of $138 million and adjusted diluted EPS of $1.42 all of which were records for KapStone. Notable here is that we didn’t just squeak by the prior year results, but we in fact increased our adjusted net income and adjusted diluted EPS by over 90%.

On Slide 5, we have analyzed the changes in sales and adjusted EBITDA from 2012 to 2013. Net sales were up $531 million or 44% and adjusted EBITDA was up $150 million or 82%. Clearly the Longview acquisition was the key driver of our improved results. Longview added $440 million in revenues and $116 million of adjusted EBITDA for the five and a half months since the acquisition. In addition, legacy KapStone achieved record results for the year ago in both net sales and adjusted EBITDA. Higher prices were the key to the record results with average mill selling prices for 2013 up $44 per ton to $666 mainly reflecting the domestic containerboard and corrugated price increases. Higher prices added $77 million to net sales and adjusted EBITDA.

Legacy domestic container board sales were up 15% resulting from higher demand for ultra performance containerboard grades coupled with increased use of containerboard for internal consumption. Increased domestic sales and usage resulted in lower export containerboard sales, down 30%. Legacy’s corrugated product sales volume increased 4% year-over-year including benefits from the new Aurora facility. The cumulative effect of inflation during the year negatively impacted adjusted EBITDA by $33 million and was primarily driven by higher fiber costs resulting from the extremely wet weather in the Southeast for 2013 as compared to the very dry 2012 year. Our planned outage costs were higher by $5 million due Charleston’s tri-annual outage in second quarter 2013.

Turning to Slide 6, we have 2013 results for the five and a half months of our Longview acquisition. Total net sales for that period were $440 million and adjusted EBITDA was $116 million. In the fourth quarter adjusted EBITDA hit $62 million benefiting from significant continuous improvement activities over the past six years and the $3 million of benefits from synergies. By year end 2013, we had transacted on $9 million of annualized synergies. We are maintaining the target of $18 million of annualized synergies by year end 2015.

Looking more closely at Longview’s fourth quarter results, seasonal weakness negatively impacted net sales and adjusted EBITDA. As a result Longview had a less favorable product mix and a higher quantity of roll pulp reducing adjusted EBITDA by approximately $3 million from their normalized mix. Fortunately their first quarter 2014 mix has returned to normal levels. Longview has been highly accretive from day one. In the fourth quarter Longview earned $0.28 of adjusted diluted earnings per share bringing their total contribution for 2013 to $0.52. To arrive at this, we adjusted Longview’s earnings by excluding any one-time acquisition charges, but we included all interest expense and amortization of related financing fees attributable to the acquisition.

Slide 7 is a summary of our fourth quarter results compared to both the prior year’s quarter and to the previous sequential quarter. Fourth quarter 2013 net sales were $563 million and adjusted EBITDA hit $110 million. Adjusted net income for the fourth quarter of 2013 was $44 million, up $31 million or 230% – 238% year-over-year and fourth quarter adjusted EPS was $0.45, up $0.31 or 221% from the fourth quarter of 2012.

To get more color on these changes, let’s move to Slide 8, which shows the components of the changes in net sales and adjusted EBITDA from Q3 to Q4 2013. Keep in mind, that in Q4, we had planned annual maintenance outages at two of our mills that increased our cost and reduced the tons of paper available for sale by 12,500 tons. Net sales were up $24 million or 4% while adjusted EBITDA was down $7 million or 6%. Inclusion of a full quarter of Longview’s results added $42 million of net sales and $8 million of adjusted EBITDA. Offsetting the benefits from Longview was the impact from the planned maintenance outages, which reduced adjusted EBITDA by $11 million. Lower legacy mill production volume of 16 million tons, I am sorry it’s not 16 million either –15,000 tons resulted primarily from the planned outages. However, the remainder of lower production was the result of isolated production issues. This decline in productivity reduced adjusted EBITDA by $3 million. Finally, seasonally less favorable product mix at the legacy mills lowered average mill revenue per ton by $6 to $677 in the fourth quarter and impacted adjusted EBITDA by $2 million.

Turn to Slide 9, which shows the components of the changes in net sales and adjusted EBITDA from the fourth quarter 2012 to the fourth quarter of 2013. Net sales increased $252 million or 87% and adjusted EBITDA was up $72 million or 189%. The Longview acquisition added $241 million of net sales and $52 million of adjusted EBITDA and was the primary driver once again for the change in the quarter. Legacy mill operations benefited from higher prices by $17 million. Adjusted EBITDA also benefited from higher corrugated products volume and improved product mix quarter-over-quarter. However, production interruptions in the high fiber cost partially offset the EBITDA gains.

On Slide 10, you can see that KapStone is producing an accelerating high-level of sustainable free cash flow. Adjusted free cash flow calculated by starting with cash flow from operations and subtracting capital expenditures was $89 million for the fourth quarter of 2013 or $0.92 per diluted share and was up $74 million or 493% over Q4 of 2012. Q4 is typically one of our best quarters for cash flows and Q1 is typically the worst. CapEx for the quarter was $40 million, including about $11 million for maintenance-related projects. Strategic capital spending included $7 million for the Charleston paper machine upgrade project completed on February 5. We have been very rapidly de-levering our debt. And on December 31, our debt to EBITDA ratio was 2.7 times, down from 3.8 times on July 18 when we closed on the Longview acquisition.

Our reward for this de-levering is that our interest margin on our $1.2 billion of debt outstanding will be reduced by 25 basis points in early March, resulting in a $3 million annual reduction in interest expense. We paid down $89 million of our debt since September 30. As of December 31, we had $13 million of cash and $395 million of revolver borrowing capacity in addition to our $300 million accordion provision in our credit agreement to provide for future borrowings.

On Page 11, we have some brief comments on our pension plans and taxes. On a consolidated basis, our pension and postretirement benefits are over-funded by $47 million as of December 31, 2013 and our funded status has improved by $60 million year-over-year, thanks on the over-funded status of Longview’s salary plans. Good investment returns and a lower discount rate during the year. The effective income tax rate for the fourth quarter was 31.6% compared to an adjusted rate of 36.9% a year ago. In 2013 the effective income tax was lower due to the recognition of the $5 million reversal of the tax reserve for the AFTC credit. Recent guidance from the IRS relating to the taxability of the AFTC indicates that the credit is not subject to federal income tax. This benefit was partially offset by higher state income taxes including rate changes related to the Longview acquisition. The full year effective tax rate was 34.7%, down from 2012 primarily due to the recognition of the Black Liquor credit. KapStone’s federal cash tax rate for 2013 was 2%. I am afraid those days are behind us.

On Slide 12, we have summarized some key assumptions to keep in mind for the first quarter of 2014. Last week, we announced the Kraft paper price increase of $50 per ton effective March 1, 2014. We expect the full benefit of this increase by mid-second quarter 2014. We expect the annualized benefit from this increase to be approximately $30 million. We have already been realizing the seasonally improved product mix over Q4. Our mills will have two less production days in the fourth quarter of 2013, but our corrugated plants will have two more shipping days.

From a production perspective, current planned outage and maintenance should cost approximately $14 million or $3 million more than Q4 of 2013. In addition, we have the loss of 14,200 tons due to the Charleston machine 3 project completed on February 5. We have included in the appendix of this presentation a quarterly schedule of our expected maintenance expense in lost tons. We expect minimal fiber cost increases in the quarter. The extreme weather conditions experienced so far this year have been the topic of much discussion in many of the earnings calls. However, for KapStone, we have had some increases in energy costs, but minimal disruptions in our operations so far. At this point we have incurred a little over $1 million of additional costs, but there seems to be a bad weather cycle that we are going through and we can no more predict what the weather will be than our weather forecasters. We expect our CapEx to be approximately $30 million for the quarter including $7 million for the completion of the Charleston machine number 3 project.

Turning now to Slide 13, we have summarized our thoughts on the key assumptions for the 2014 year. We will have a full year of Longview operations versus five and a half months in 2013. We should benefit from a full year of domestic containerboard and corrugated price increases. We do not expect the West Coast medium reductions to have a significant impact. We should have the benefit of almost eight months of the $50 per ton Kraft paper price increase. We expect to have slightly higher costs for raw materials as the year progresses. CapEx should be approximately $110 million. I just want to reiterate that approximately $50 million of the CapEx is maintenance related and the remainder is strategic spending for which we expect returns of three years or less. Our average interest rate using today’s LIBOR rates and our new margin rate would be about 2.25% when our rates reset in early March. Our estimated income tax rate is expected to be 35% and the cash tax rate unfortunately will be slightly higher.

Now, I will turn this back over to Roger. Thank you.

Roger Stone - Chief Executive Officer

Thank you, Andrea. Demand seems to be improving. Our mill backlogs are very good and we expect to run full except for plant shutdowns. We are optimistic about increased mill demand. Our mills should improve given our increased ability our mix should improve given our increased ability to run lightweight high performance grades. The weather however, I guess on the forecaster will get better. I am sure it will, but honestly I haven’t the faintest idea as to when. Last week, we announced if I can, March 1st as Andrea covered $50 a ton Kraft price increase on all grades. And finally and as our wish, we remain very positive about our 2014 performance and our ability to generate significant cash flows. In short considering two mill outages, poor productivity at another mill, a 19.5% fully allocated EBITDA looks pretty good to us.

Thank you for joining us and now we will open up the phone for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Adam Josephson with KeyBanc. Please proceed.

Adam Josephson - KeyBanc

Roger, Andrea, good morning.

Roger Stone

Good morning.

Andrea Tarbox

Good morning.

Adam Josephson - KeyBanc

First question about the production problems, can you go into more details about those production problems and when you stopped having them?

Roger Stone

Well, they were mostly pump mill related, and pulp related. And those issues were resolved, I believe before the end of the year, but it caused as we said just low productivity through a period of the quarter.

Adam Josephson - KeyBanc

Okay, in terms of the weather that you both talked about earlier, I think you talked about $1 million of higher costs so far. Can you go into more detail about where those disruptions and higher costs are coming from and it sounds like you think things will get better, but there could be some bumps on the road. Do you think you are seeing less in the way of weather interruptions than your peers and if so why?

Roger Stone

I am sure, we are seeing – I think our peers are experiencing the same thing we are. Most of this energy cost, most of it is energy cost, you have to turn on extra boilers to keep the mills hot, warm, we have used up and we have had the shutdown of one machine at Charleston, you could expect the energy cost to go up because there is less productivity and you got two machines per ton. And one small thing, Atlanta had a snowstorm which paralyzed the city and we were – ours was no different. That’s the first quarter event and we were down for a day and a half, but as mostly energy more than anything else.

Adam Josephson - KeyBanc

Got it, now thanks Roger. And in terms of the Kraft paper price increase, I mean what prompted that announcement and is the market particularly tight and if so why?

Roger Stone

Well, no question our demand is very, very strong and unusually so. I can’t tell you what. It’s perhaps related to California having a war on plastic bags, but I have no evidence of that. But it seems to me that should have some effect, but across the board and our product lines demand has improved substantially, our backlogs are quite larger than normal and it seem to be a good time to restore margins.

Adam Josephson - KeyBanc

Thanks for that, Roger. And just one last one about box demand I know you said demand seems to be improving, your mill backlogs were healthy I mean how would you characterize box demand today to what it was say three, six, nine months ago to the extent its changed in any meaningful way?

Roger Stone

Substantially stronger, we measure in the box plants everyday our 10 day backlog. And I can’t give you a comparative figure, but I can tell you we are substantially bigger at all plans than it was last year.

Adam Josephson - KeyBanc

It’s great, thank you, Roger.

Roger Stone

You’re welcome.

Operator

Our next question comes from the line of James Armstrong with Vertical Research Partners. Please proceed.

James Armstrong - Vertical Research Partners

Good morning and thank you for taking my questions.

Roger Stone

Good morning Jim.

James Armstrong - Vertical Research Partners

(Technical Difficulty)

Roger Stone

You are cutting off, I can’t get it.

Andrea Tarbox

Right, James, you cut out completely.

James Armstrong - Vertical Research Partners

Can you hear me?

Andrea Tarbox

Now, we can.

James Armstrong - Vertical Research Partners

Oh, sorry, where do you see the strong demand in containerboard coming from, is there any specific sub-segment that is really showing strong demand growth or is it across the board?

Roger Stone

It’s broad-based, it’s across the board, it’s in all areas of the country, that’s a statement I can make by just about all of our plans. So, the comparisons are really substantial.

James Armstrong - Vertical Research Partners

Okay, very good. And then on the export numbers, your export volume in the fourth quarter jumped quite a bit as you talked about. Will that reverse end of the first quarter as you move stuff as the demand grows domestically and is there - how different are the realizations between export, your export and your domestic?

Roger Stone

Well it’s a dramatic difference. Yes, I think I pointed out that first of all in December we had a big roll pulp shipping month to fill in the gap. And I think our January prices I think I already said were $23 a ton higher than December’s price, which would reflect substantially less roll pulp already some but not much. And that would be the major difference although our higher priced products have comeback in demand Kraftpak and even DuraSorb. And as I said and we think we’re going to have lots of orders for our machine rebuild in Charleston because that’s a popular grade and we always have a lot of demand for it.

James Armstrong - Vertical Research Partners

Alright, very good. And then lastly your sales volume has been above your production volume for the last few quarters. Is that a sustainable trend going forward or is there a point where your inventory gets so low that you can’t support that anymore?

Roger Stone

You’re right. Our sales will be comparable to production and not way ahead. So, our only hope there is we have a lot more production and clearly capital project one in almost completed in Longview and one completed in Charleston should help give us more productivity and more products.

James Armstrong - Vertical Research Partners

Very good. Thank you very much.

Operator

Our next question comes from the line of Steve Chercover with D.A. Davidson. Please proceed.

Steve Chercover - D.A. Davidson

Couple of my questions have already been answered. But I don’t know if Randy is on the call, but I was wondering if you found anymore million dollar bills lying on the floor of your legacy mills?

Roger Stone

Yes, I think the combination of (research) I think the companies are learning a lot from each other and benefiting and Randy put together teams together to take advantage of that. And simple things like reducing breaks at Longview by the technology we used in Charleston. Yes, we think there is lots of opportunity because of the talents of the combined organization to reduce cost. And.

Steve Chercover - D.A. Davidson

So the synergy target remains $18 million and then operational improvement would be the synergies yet again but not more..

Roger Stone

There would be a gain on top of the synergy.

Steve Chercover - D.A. Davidson

Yes, okay. Switching gears a little bit, can you talk a bit about saturating kraft because I think you had a price increase in Q4? But it doesn’t seem like you have the pricing power in that grade despite both highly consolidated industry and your ability to manage supply?

Roger Stone

Well generally speaking – the price of that product unfortunately is usually set once a year. And we got – our price increase was successful, wasn’t a lot, but was successful. The – I suspect prices will maintain where they are for the balance of this year close to it. And so we – yes the answer would have to be we don’t have the pricing power, that’s somebody with the market share that we do have would normally have.

Steve Chercover - D.A. Davidson

Okay. And my final question would be on kraft paper. Clearly you’re optimistic about the near term given your backlogs and your pricing initiatives. But are you concerned that some of these newsprint conversions are going to target the kraft paper segment as opposed to liner board and medium?

Roger Stone

Well, some already have because it is easier for newsprint machines to try to make the grade. On the other hand you go to remember it is a recycled sheet and tare this often an issue. But I think some of them have quite successfully gotten into Kraft paper business. And yet demand has been growing in spite of that. In terms Kraft paper business right. So it’s just showing remarkable growth based upon what’s happening and we are very optimistic this will be a successful price increase.

Steve Chercover - D.A. Davidson

Great, okay, thank you very much.

Operator

Your next question comes from the line of Al Kabili with Macquarie. Please proceed.

Al Kabili - Macquarie

Hi, thanks. Good morning. Just Roger wanted to circle up with your comments on the same that the solid an uptick in the box demand and I wanted to get your sense as whether you think that’s unique to KapStone or do you think that’s happening within the broader industry as well?

Roger Stone

I would have to believe it’s happening within the broader industry. Our prices are – as I pointed out our prices on just about everything are stable or stable to up. And I think yes and since we have – we are represented in far more markets than we used to be in U.S. because of Longview. Yes, I would say that it’s going to be an industry situation. I would doubt very much if we were unique in that regard.

Al Kabili - Macquarie

Okay, and you are talking December as well as what you are seeing thus far in January despite the weather, is that what you are referring to kind of this uptick is before that the industry box data was pretty flattish overall?

Roger Stone

Yes, as you all know, I do yes, that’s why I emphasized January was completed and we were up 6% higher than we were the previous January in real terms. And I think that that’s pretty good. And I really don’t – I would doubt if we were unique.

Al Kabili - Macquarie

Okay, that’s encouraging. Thanks for the color there Roger. And I also wanted to circle up on your comments on the Kraft paper side and you are seeing some pretty solid demand there. If I look at the legacy KapStone business I think your Kraft paper shipments look like they were down double digits year-over-year and maybe there is a shift going on to Longview or just help us with the – what sort of parsing out your view on the demand at the legacy KapStone shipments on the Kraft side kind of being down quite a bit in the fourth quarter?

Roger Stone

Yes, well, that’s right. Well in the fourth quarter of course we had downtime at our other Kraft paper mill, that’s one of the issues. But we have been very successful in switching the – certainly the number four machine at Roanoke Rapids from paper to high performance lightweight linerboard. And we can now – and we have that ability to do some of that on three, so the mill has run full. And therefore, that demand has either disappeared or gone someplace us. And we are quite happy and that mill is running beautifully. The – as you know Longview has a big Kraft paper business and a very broad base kinds of quality that they can run from very lightweights and so the heavyweights to extensible.

But the backlogs are very good. I don’t know if can contribute all of that to California or attribute it to all of California I doubt it. And we have more competition as somebody known by some of the converted newsprint machines which find the lighter weight it’s easier for them to run, I guess. And yes as I said backlogs are very, very strong. So there is something happening out there in their business. Usually they don’t give this – in my experience don’t get this long as they are today and it gives me a lot of confidence and I think we can manage our capacity very well. A lot of flexibility in with alternative grades and so we feel good about this and in fact very excited about it.

Al Kabili - Macquarie

Okay, very good, it sounds encouraging. And I guess the final question from me is one to Andrea. Any thoughts Andrea as for as range for free cash flow that you might be thinking about for 2014 and along those lines, pension that you addressed, pension expense on the P&L, is there – do we see a tailwind from that as far as the on P&L impact?

Andrea Tarbox

On the first one, yes I certainly think about the free cash flows for 2014, but unfortunately I can’t really share that with you because we don’t forecast our earning, so I can’t.

Al Kabili - Macquarie

Alright, I thought I would try.

Andrea Tarbox

Well, it’s a good try. And as far as the pension is yes, it does flow through to the P&L and so positively. So we don’t have pension expenses. We potentially have pension income.

Al Kabili - Macquarie

Income and anyway you can size up the tailwind for us Andrea as far as for ’14 versus ’13?

Andrea Tarbox

Well, I mean we never really – pensions for legacy KapStone were always relatively small. And I think our expense was typically in the $4 million to $5 million range. And so going forward now with these assets, pension assets that we have from Longview, we expect – it will probably be sort of neutral, I mean we might have a little bit of income. We don’t have the expense. We might have a little bit of income particularly as we look further down the road as to what to do with these assets. Right, so at this point I mean wouldn’t expect the big impact either way. I mean you are not going to get a huge benefit, but there will be some benefit in 2014. And I don’t if I directly answered that question, but like I said it depends on what we do with the plans, right.

Al Kabili - Macquarie

Okay. That’s helpful. I appreciate that. Alright I will turn it over. Thanks again. Good luck.

Andrea Tarbox

Thank you.

Operator

Your next question comes from the line of David Woodyatt with Keeley Asset Management. Please proceed.

David Woodyatt - Keeley Asset Management

Yes. The tax rate for the quarter comparison is only – it looks like it’s only given on the GAAP results and you get the 31.6 versus 36.9, but to get the tax rates comparison on the adjusted earning per share which I think most analysts focus on that those numbers aren’t given but most of the reconciliation between GAAP and adjusted are some pure tax items, so it looks like the tax comparison would be quite different on adjusted earnings per share, I try to make that calculation and I get 34% for this latest fourth quarter and only 25% tax rate on the prior year fourth quarter which is – those numbers are roughly correct?

Andrea Tarbox

Well, when we build the tax effect for the special items are the items we are adjusting out. We use the normalized tax rate, so I am not sure – so we would be getting to the 31.6 I am not sure what numbers that I will be happy to.

David Woodyatt - Keeley Asset Management

Well, that’s where you would convert to the earnings per share affects that you show down below?

Andrea Tarbox

Yes.

David Woodyatt - Keeley Asset Management

But if you take the actual income state—the GAAP income statement and actually adjust the dollar numbers for the differences between GAAP and adjusted, that’s how I get those tax rates. And I think some importance because on the surface it looks like you benefited from a lower tax rate in the fourth quarter when in fact on the adjusted earnings per share, it looks like you actually had a much higher tax rate?

Andrea Tarbox

Right, well the reason for that is – so let me explain the reason for that is that we have that $5 million credit for the Black Liquor and so we pulled that out for the adjusted.

David Woodyatt - Keeley Asset Management

Right and that’s...

Andrea Tarbox

Right, exactly, so when you pull that credit out.

David Woodyatt - Keeley Asset Management

So for the prior year fourth quarter you have got a tax item that goes the other direction.

Andrea Tarbox

Yes.

David Woodyatt - Keeley Asset Management

And that’s why, it looks like you actually have a much higher – I guess 34 versus 25, so it looks like lot of people like to talk about quality of earnings and whether tax rate goes up or down or whatever but most people focus on the adjusted numbers and it looks like the tax rate is actually a fair amount higher on the adjusted numbers not lower?

Andrea Tarbox

Well it is because (Technical Difficulty) out because we tried to neutralize.

David Woodyatt - Keeley Asset Management

Yes.

Andrea Tarbox

What our goal is to neutralize those tax rates for unusual things like that (Technical Difficulty). So yes to your point yes, so we had the benefit of that (Technical Difficulty) actual unadjusted (Technical Difficulty) makes it higher.

David Woodyatt - Keeley Asset Management

Yes.

Andrea Tarbox

Yes.

David Woodyatt - Keeley Asset Management

Yes, right, okay. Well I maybe make a little suggestion in the future since most people focus on the adjusted earnings per share, it would be helpful to see what the tax rates are in comparison are on the adjusted numbers not just the GAAP numbers, but I think that suggestion –anyway thank you very much.

Andrea Tarbox

Okay.

Roger Stone

You’re welcome.

Operator

Your next question comes from the line of (indiscernible) with Deutsche Bank. Please proceed.

Unidentified Analyst

Hi, good morning. Can you talk a little bit about what you are seeing from a demand standpoint in the saturating Kraft market and any color if you can provide on sort of relative profitability versus Kraft linerboard and how it has moved over time?

Roger Stone

I’m sorry what was your second part?

Unidentified Analyst

The relative profitability of saturating Kraft versus Kraft linerboard and how it has moved over time?

Roger Stone

Not sure I understand the question. The – the first question was on saturating Kraft pricing, right.

Unidentified Analyst

The demand of saturating Kraft.

Roger Stone

The, demand, okay.

Unidentified Analyst

Yes.

Roger Stone

Well the demand has been relatively flat for us, we’ve had customer substitution and so on. But it’s been relatively flat, some areas of the world are stronger and up and some are down. We export close to 70% of our product line and Asia picked up in the fourth quarter. But I – we would expect this year that our saturating Kraft volume would be about flat to last year’s. And was there another question there.

Unidentified Analyst

Yes. So what I was trying to understand is if you can provide any sense on just relative profitability of this business versus let’s say a Kraft linerboard.

Roger Stone

I’m sorry, I’m not sure.

Andrea Tarbox

Roger, he is asking if there is a difference in the profitability between saturating Kraft and say Kraft linerboard.

Unidentified Analyst

Thanks, Andrea.

Roger Stone

Yes, our saturating Kraft sells for more dollars per ton, it is not, it’s a tactical project, it is less profitable than linerboard in today’s market.

Unidentified Analyst

Got it. That’s very helpful. Thank you. Andrea just a quick one for you for cash taxes for 2014, do you think a 5% to 10% sort of a number is a good ballpark.

Andrea Tarbox

For 2014 we’re forecasting we believe at this point that cash taxes will be about 35% or a little bit higher. So our cash tax rates going up substantially from 2013.

Unidentified Analyst

Got it. Okay. That’s very helpful. Thank you. I’ll turn it over.

Roger Stone

Okay.

Operator

Your next question comes from the line of (indiscernible). Please proceed.

Unidentified Analyst

Hi, Roger, hi, Andrea, congratulations on the quarter.

Andrea Tarbox

Hi.

Roger Stone

Thank you.

Unidentified Analyst

Roger, I’m going to ask you to look into your crystal ball a little bit here, I know it’s not easy, but I just wonder if you can layout a scenario of what you think has to happen in the industry due to another containerboard price increase. And the reason I’m asking is anecdotally it is actually heard out there, there are large buyers of containerboard, industry buyers, they are actually looking to lock in prices for the second half of the year at a premium towards the current we add, which suggest to me that a, demand is probably little better than street is thinking and b, that prices the industry probably take a little more pricing maybe the same. I’m just curious if you could maybe look into your crystal ball and what do you think has to be placed for there to be another price increase?

Roger Stone

Well clearly if I’m right about container demand obviously a containerboard demand goes up right with it. And I – it looks to me that the odds are better pricing for the second half than not happy. The difference is, it’s a high class problem. It’s a difference between stability in our view and perhaps higher prices. There has been much said about the recycled mills that have come in and they have come in to the marketplace, but such the price of the whole product integrated line is the price of Kraft linerboard. And it seems to me and that capacity is not growing particularly. And it seems to me that given the demand scenario that we foresee, there is certainly the odds are better I think today that of having an increase some time this year than they were last year at this time. So, yes, I think there is a possibility.

Unidentified Analyst

That’s helpful, Roger. Thank you.

Roger Stone

Yes.

Operator

Your next question comes from the line of Adam Josephson with KeyBanc. Please proceed.

Adam Josephson - KeyBanc

Thanks, Roger and Andrea. Just couple of follow-ups. One is on input and supply chain costs, how much – roughly how much you are thinking that will go up by as the year progresses and which costs do you expect to be most inflationary?

Roger Stone

Well, fiber is always a problem if the weather is an issue. I suspect if I am right on containerboard, recycled fiber will be quite inflationary, if I am right about demand and China meets its manufacturing goals. I don’t see a lot of pressure on energy or chemicals, so those should be the two – that would be the big areas.

Adam Josephson - KeyBanc

Okay. And on the Charleston project that you recently completed, can you talk about how that went Roger and how much additional capacity that gives you?

Roger Stone

Well, I don’t have the capacity number, but it gives us additional capacity as project went very well, came in faster than we thought, than we originally planned. The machine is running beautifully at (indiscernible) full pressure on the press. The quality of the product coming off the presses appears to be outstanding off the machine. We added a little bit pulp capacity by working on some bottleneck issues and that will give us more fiber to produce more products are open, but specifically on the high performance lightweights. So I would say the project is going well. It will add tons to the organization. It will give even (indiscernible) a better mix, because they will not have to run some of the products some are lightweight that will now run in Charleston. So, overall, it’s a winning situation and exciting situation for us. And I am most impressed by the quality reports that I am getting today.

Adam Josephson - KeyBanc

Thank you, Roger. I appreciate it.

Roger Stone

Okay.

Operator

There are no further questions in the queue at this time.

Roger Stone - Chief Executive Officer

Well, okay, thank you. It’s been an uneventful 24 hours and that wasn’t so serious, it would have been fun. And I thank you very much for joining us and hopefully we will see what next quarter brings we remain optimistic. Thank you.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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