KapStone Paper and Packaging's (KS) CEO Roger Stone on Q2 2014 Results - Earnings Call Transcript

Aug. 1.14 | About: KapStone Paper (KS)

KapStone Paper and Packaging Corporation (NYSE:KS)

Q2 2014 Results Earnings Conference Call

July 31, 2014 11:00 AM ET

Executives

Roger Stone - Chairman and CEO

Andrea Tarbox - Chief Financial Officer

Analysts

Adam Josephson - KeyBanc

Ketan Mamtora - BMO Capital Markets

James Armstrong - Vertical Research Partners

Danny Moran - Macquarie

Taylor Saunders - Barclays

Steve Chercover - D.A. Davidson

David Neuhauser - Livermore Partners

Debbie Jones - Deutsche Bank

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter KapStone Paper and Packaging Corporation Earnings Conference Call. My name is Philip and I'll be your operator for today. At this time, all participants are in listen-only mode. Later, we will be conducting a question-and-answers. (Operator Instructions). As a reminder, this conference 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 July 31, 2014. These forward-looking statements involve a number of risks and uncertainties.

A list of the 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 call.

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

Roger Stone

Thank you. Good morning and thank you all for joining us. As usual, Andrea Tarbox, our Chief Financial Officer is with me. Obviously today is not a good day to announce earnings, bad planning on our part. But as you can tell from our release, we believe that we had a excellent second quarter and our team still believes that the best is yet to come.

And now I'll turn it over to Andrea who run through our numbers and then I'll return the comment on a number of different subjects before opening the phone for questions. Andrea?

Andrea Tarbox

Thank you, Roger. Good morning, everybody. I know you will wanted to hear about KapStone's view on MLPs. So I am going to start this off directly talking about MLPs. In the second quarter of 2014 KapStone delivered MLP results which stand for the most lucrative period for KapStone. So when you hear MLP and KapStone referred together please think of MLP in that context.

So let’s start the discussion beginning with slide three, the second quarter of 2014 for KapStone was not second in any measurement but rather all key metrics for the second quarter set all time records. We have highlighted our second quarter net sales, adjusted EBITDA, and adjusted EPS performance for the past five years where you can see our continuous profitable growth. Year-over-year net sales of $590 million were up $264 million or 81%.

As Roger pointed out in our earnings release our profits more than doubled year-over-year. Adjusted EBITDA of $126 million was up year-over-year $70 million or 125% resulting in adjusted EBITDA margin of 21.4%. Q2 adjusted EPS of $0.58 was up 142%.

In addition we made much progress on our previous announced initiative. The $50 per ton craft paper price increase was implemented by the end of the quarter. In April we completed the upgrade to the Longview paper machine enabling us to produce ultra high performance linerboard while increasing efficiency. The voluntary separation plan at our legacy mills was well received and we now expect the program to reduce annual personnel costs by approximately $5 million.

On slide four, we've listed our key financial results as compared to both the prior year quarter and from Q1. Sequentially, our results demonstrate how KapStone bounced back from the nasty winter weather and seasonalities that impacted us in Q1. I’ll detail the key drivers of the changes between periods on the next to slides.

Moving to slide five, we’ve detailed the sequential changes in our net sales and adjusted EBITDA results from Q1 2014 to Q2 2014.

Our net sales increased $41 million in the second quarter, primarily on higher production volumes. Volume increased due to reduced planned maintenance downtime which added 8,900 tons compared to Q1; one additional mill production day or about 7,500 tons between the sequential quarters; incremental gains from recent capital investments that at Charleston and Longview; and then seasonally reduced inventory levels from Q1. We also benefited from the $50 per ton price increase on kraft paper, which was implemented in Q2 and should be fully implemented in Q3.

Adjusted EBITDA increased $30 million, primarily on higher volumes, lower maintenance expense and thankfully much nicer weather. Additionally, the kraft paper price increase and better product mix also contributed to the improved adjusted EBITDA.

Turning to slide six. We have bridged our performance for the second quarter of 2013. The Longview acquisition is the primary driver of the change in both net sales and adjusted EBITDA. We'll dig into Longview on a little more depth shortly. First, just in case, I haven't impressed enough you with our records.

Legacy KapStone’s operations in Q2 2014 also achieved all time records. Full benefits from the early 2013 containerboard and corrugated products price increases and the 2014 kraft paper price increase benefited both top and bottom-line results. Average mill revenue for all of our product lines increased $21 per ton to $685 per ton year-over-year. Legacy volumes increased 16,000 tons, adding $14 million of revenue. Higher volumes of kraft paper and corrugated products accounted for the increased volumes as additional containerboard produced was redirected from outside sales to fulfill demand from our internal converting operations. We also benefited from higher kraft paper sales volumes as customers accelerated shipments prior to the price increase. The higher volume added $4 million of EBITDA. Finally inflation primarily from labor benefits and input cost impacted adjusted EBITDA $7 million.

On slide seven, we have outlined the record second quarter results for the Longview operations inquired in 2013. As both net sales and adjusted EBITDA exceeded pro forma second quarter results which is impressive given Longview ops 4,100 tons of production due to downtime to upgrade a paper machine and incurred $4 million of plant outage expense in Q2 2014. On a sequential quarter basis, Longview’s adjusted EBITDA benefited from improved mill operations over Q1 which added about $5 million; better weather for Longview also which resulted in a $2 million improvement in operations; Q2 also had one more production day versus Q1, equating to roughly a $1 million; and finally in the second quarter of 2014, Longview reduced Q1’s seasonal strategic inventory build by approximately 5,000 tons.

Synergies transacted on totaled about $16 million as of the end of Q2 with a total of $21 million of annualized benefits now indentified to be completed by late 2015.

Moving to slide eight, you can see we finished the second quarter of 2014 with a net debt to EBITDA ratio of 2.7 times and we had $49 million of cash on hand. Our weighted average interest rate is now 2% and 60 basis points lower than our year-end rate.

These changes resulted from the April 2014 bank amendment which reduced the pricing grid by 25 basis points and from our improved leverage ratios. Together these changes reduced our annualized cash interest by $6 million.

Our available revolver balance as of June 30, 2014 was $395 million and we have $300 million of availability from an accordion provision in our credit agreement. Net cash generated from operations improved $15 million to $70 million versus a year ago and was up $39 million over Q1. Adjusted free-cash flow for the quarter was $28 million, up $22 million over Q1 but down $11 million year-over-year.

Strong seasonal June sales and slightly increased seasonal DSO resulted in $25 million of higher AR at quarter end. Also negatively impacting free-cash flows for the significant strategic CapEx projects for the paper machine upgrades. CapEx for the quarter was $41 million, including $13 million for the Charleston machine number three and the Longview machine number 10 upgrade project and was $25 million higher year-over-year.

On slide nine we have outline some key assumptions to keep in mind for the third quarter. We do expect kraft paper price increase to be fully implemented by Q3 of this year with approximately an additional $5 million benefit in the third quarter. Our product mix and average margin should continue to improve in the third quarter as well.

Regarding production and shipping. Q3, 2014, has one additional day for both mill production and corrugated shipping as compared to Q2. Production in Q3, 2014 should benefit from 5,400 more tons and Q2, 2014 due to no expected loss from planned maintenance downtime.

And finally, we anticipate gaining additional benefits from the two recent machine upgrades over the course of the second quarter as we continue to work through the learning curves as the new capability. Planned maintenance outage expense should be approximately $5 million in Q3 consistent with Q2. Our fiber cost should be relatively stable as compared to the second quarter. We expect to recognize an additional $1 million to $2 million of expense related to the voluntary separation initiative in the third quarter with the remaining expense up to $1 million to be incurred in Q4. However, we should also start benefiting from the $5 million annualized savings in Q3. Finally, we anticipate CapEx for the year to be in the $120 million to $125 million range.

With that I'm now going to turn the call back to Roger.

Roger Stone

Thanks, Andrea. As strong demand for all of our mill product line is just good, our backlogs continue to be strong, container bookings are solid across the whole system and up 5.9% in the quarter. July numbers appear to be running at even stronger rate than the second quarter numbers. And in the unbleached kraft paper initiatives, demand is growing which is something I haven’t said in many years. For those of you who have listened to these calls overtime you might that I had often talked about the potential for unbleached kraft paper growth if the city ordinance is against plastic bags in retail stores came to past.

Recent statistics would seem to indicate that demand as indicated by a shipments on operating rates has grown substantially in the first half of the year, it is up 6.8% from last year. Unbleached kraft for bags and sacks is up 11.4%. Multi wall shipping tax plus 2.7% and converting kraft is up 6.2% clearly the figures would indicate that retail bags are changing.

Since this is one of our largest new product lines this news is obviously very encouraging. And as to prices the kraft paper price is complete increase is complete and despite of the new recycle capacity we’ve had not customer push back on kraft linerboard prices. On semi-chemical medium prices, we have adjusted our prices down $10 a ton inline with pulp and paper weeks analysis. We only sell semi-chemical on the west coast and not a lot of it so this is not a big deal for us. Prices are up to stable in our other mill products, container prices are also stable and moving slightly on the upside.

With regard to today’s current hot subject of creating an MLP and with our wood base mills, it’s an interesting concept, we are studying it to see if it makes sense for us. As a company we are focused on maximizing long-term shareholder value and any decision would be made on that basis.

In closing, 2014 should be an outstanding year for our company and our focus of optimizing our system along with additional strategic both opportunities should continue to build greater shareholder value.

And now we'll open up the phones for questions.

Question-and-Answer Session

Operator

Alright. (Operator Instructions). And our first question comes from the line of Adam Josephson from KeyBanc. Please proceed.

Adam Josephson - KeyBanc

Roger, Andrea, good morning.

Andrea Tarbox

Good morning Adam.

Roger Stone

Good morning.

Adam Josephson - KeyBanc

Andrea, that MLP lead-in was a serious tease by the way.

Andrea Tarbox

Well, that's what a lot of people call me. Anyway we are moving on from that, yes.

Adam Josephson - KeyBanc

Sticking on MLPs for a second, Roger, can you just talk about some of your thoughts with respect to the potential tax leakage, with respect to the other benefits of the tax shield versus the benefits of getting a higher multiple in an MLP structure than your current multiple? Can you just share some of your thoughts along those lines with us?

Roger Stone

Well, you are sort of pioneering here. So, a lot, there is certainly a lot of speculation as to what will happen, if somebody does that. And the tax situation is complicated by the age of assets and how we put them on the box.

So, we're studying that. I mean, I think it's a very interesting idea. But very clearly, if we don't think it's going to be a long-term value for the shareholders. And if that’s going to be long-term, I just have to imagine that be in a short-term, but that's possible certainly.

So, we’re looking at it very carefully and it’s kind of intriguing. But we’re not sure that it would be in the shareholders’ interest as of yet to pursue that.

Adam Josephson - KeyBanc

Right, right got it. One question on the input cost inflation that you are experiencing, with respect to the recent wood fiber cost increases in the southeast. How much would you attribute to rising demand from pellet mills and how much to the wet weather? And to the extent a lot of it is related to the pellet mills and to what extent is that a long-term concern of yours? It seems like that is potentially a longer-term issue.

Roger Stone

I think it is a longer-term issue, it’s hard to imagine why that’s environmentally friendly and for years cutting trees was it environmental friendly. But that it’s amazing how view has changed. But we really haven’t felt in the southeast the pellet pressure in the prices. Seen all that’s contemplated being built obviously it could be an issue. But it hasn’t been a problem yet. The West Coast had suffered because housing hasn’t rebounded the way we expect it to. So, I would caution the West Coast are higher than we have planned them to be and that’s because the wood ships are not being created because of return to good housing numbers. If numbers come back as anticipated and they were anticipated to come back months ago that should drop the wood cost on the West Coast.

So, in general our prices per ton prices per ton on hardwood and softwood in the southeast have been pretty steady for us and lower in the Carolina, North Carolina particularly, but pretty steady. And the West Coast has been higher, but hopefully if we get break in housing, that will change.

Adam Josephson - KeyBanc

Got it, thanks for that Roger. And just one more on costs, we've been hearing about how OCC prices are biased upward over the long-term but obviously what’s happened over the past couple of years is that they've gone down and at the same time wood fiber prices have gone up. Is it reasonable to expect the continuation of these trends? And if so, what are the broader applications for the industry if in fact virgin costs are going up and recycle there, flat to down?

Roger Stone

Well, I have a view that China is going to need more and more of our fiber. And the growth rate in China has slowed but it's still a pretty good rate. So I think the long-term line on recycle fiber has to be up. In fact it has been and has been good for everybody. And I don’t' see a lot of pressure frankly on wood unless we keep doing silly things with our wood rather than making products out. And that's -- it's country that can do silly things. And so I think that the wood -- the existing wooden base mills have a substantial advantage in cost and in stability and far more volatility on the recycle side as we all know. And I think that will continue.

Adam Josephson - KeyBanc

Thanks a lot Roger, I appreciate it.

Operator

All right. Our next question comes from the line of Ketan Mamtora from BMO Capital Markets. Please proceed.

Ketan Mamtora - BMO Capital Markets

Good morning, Roger, Andrea.

Andrea Tarbox

Hi Ketan.

Ketan Mamtora - BMO Capital Markets

You talked about half containerboard price is being relatively stable. Can you comment at all on supply dynamics on the recycle side and if you're seeing any pressure there on prices?

Roger Stone

Well, all we know is we learn from our customers. And because we’re really not in that business and the market basis, we sell just a little recycled product. And in the Northeast, you hear stories about special deals, lower prices, introductory stuff and so on like that. But we don't know anything for sure at all because all I know is the people who claim they’re buying recycled fiber in their comments on the quality of it also buy kraft linerboard. And they intimate better pricing. But we really can't tell you, we know nothing for sure other than what we hear like most people here.

Ketan Mamtora - BMO Capital Markets

Okay, that's helpful. And then just switching gears to toward the box business, can you talk about what are the operating rates right now at your box plant? It just seems to me that the last couple of quarters have been pretty good on the box side. And then just generally, I mean if you were to grow your box plant footprint, what regions or markets would be most attractive to you?

Roger Stone

Okay. Well, first of all, our box plants, we had a fair amount of capital spent on the box plants, upgrading particularly the legacy plants as we adjust them to have more business. And demand and growth of the box plants is very good. The ideal markets for us to grow in, I don’t want to go at all of our markets, but clearly it’s the Southeast where our mills are located and we have a lot of hopes on that basis that we can grow. But there is a lot of major market throughout the country that we don’t participate in and clearly, we are looking hard at those if that’s the nature of the question.

Ketan Mamtora - BMO Capital Markets

Yes, okay. That’s helpful. I will jump back in the queue.

Roger Stone

Thank you.

Operator

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

James Armstrong - Vertical Research Partners

Good morning.

Roger Stone

Good morning Jim.

Andrea Tarbox

Hi.

James Armstrong - Vertical Research Partners

Hi. My first question is on your production versus how much you've been selling. You've been either selling out of inventory or you wouldn’t need to have been buying on the open market as your sales have been higher than your production for a while now. If this continues, should we expect the debottlenecking projects or potentially using the extra fiber at the Longview facility at sometime in the future?

Roger Stone

Well right, if we are buying a lot more tons than we’re producing okay, certainly that wouldn’t be incentive to increase our capacity at a faster rate if we got. Currently we reduced inventory in the quarter, some of that was strategic inventory build up on the West Coast and some of it was as a result of the kraft paper increase. But I have to say that our two machine upgrades, the reliability keeps improving every month; they keep running at better rates and it would indicate to us, that our capacity is understated. And so that we'll be able to produce enough of the grades that we make for our own needs.

James Armstrong - Vertical Research Partners

That's extremely helpful. Thank you. And then on that inventory number, there have been a lot of competitors who have complained about shipping costs and the availability of railcars and trucks. Are you seeing similar dynamics and do you think that KapStone will be holding higher levels of inventory as you go forward to reduce those, to reduce the cost associated with shipping?

Roger Stone

Well, I think we're probably at the effective level for at our box plants. That we want to be, we have reduced inventory substantially at our box plants. And I suspect we'll hold these levels, we're comfortable with the current levels.

James Armstrong - Vertical Research Partners

Okay fair enough. And then lastly, given how good the Longview acquisition has been, at what debt level would you be comfortable doing another Longview sized acquisition?

Roger Stone

Well, if I could find another Longview sized acquisition, obviously I'll be comfortable than doing it. But I think that, if you can find projects that have that kind of strategic fit and cash flow and returns. We will be obviously; we would pursue that, if we could find it.

We think that frankly, what's available out there is that we could make happen or for other people to try to make happen. It's a much smaller scale than we have seen over the last few years. And I suspect that our acquisitions will be smaller and more strategic in that regard. But if we find something that we think is overwhelmingly good for the shareholders obviously we’ll find a way to pursue it.

James Armstrong - Vertical Research Partners

Good enough. Thank you very much.

Operator

And our next question comes from the line of Al Kabili from Macquarie. Please proceed.

Danny Moran - Macquarie

Good morning. This is Danny Moran on for Al.

Andrea Tarbox

Hi, Danny.

Danny Moran - Macquarie

Can you talk a little more about the progress on the new capital improvement projects? And then if you could just update us on how you're feeling about the $45 million of accretion from the projects now that you are likely seeing that coming now?

Roger Stone

Can I talk about the two major mill projects that we’ve done? Is that what you’re asking?

Danny Moran - Macquarie

That’s right.

Roger Stone

Well I can tell you that, they look to be substantially better than we thought they would be, both in the quality of materials that they can make, the breadth of the material they can make and the sheer tons they can produce. There have been issues with reliability in terms of having three fantastic days in a row and have a bad day but that’s improving overtime, that’s just part of the ramp up process. And we’re towards the end of the ramp up process and the reliability is improving dramatically at windows. And we’re seeing in my opinion very good results.

Danny Moran - Macquarie

Okay. That’s helpful. And then I know it is not a huge increase but can you talk a little more about the driver of the CapEx lift in the guidance?

Andrea Tarbox

Well the increase and as just we have identified and improved more strategic projects. The maintenance CapEx for KapStone remains the same in the $45 million to $50 million per year range. So the increase in the CapEx is purely for more strategic projects.

Roger Stone

Yeah as we said many times before, we have a lot of good projects, some call it low hanging fruit that have very good short returns less than a couple of years. And more clearly as we identify them and believe them we're proceeding with them.

Danny Moran - Macquarie

Okay helpful. And then just last one from me, switching gears to the Longview business how should we be thinking about the back half of the year for the business on a year-over-year basis, is there any reason that earning shouldn't be up given some of the incremental flow through from the kraft paper price seeing some volume and some synergy realization?

Roger Stone

We don't forecast earnings but I can't say we expect to have a very good year end and too better than we've done in previous years.

Danny Moran - Macquarie

Okay, thank you good luck in the rest of the year.

Roger Stone

Thank you.

Andrea Tarbox

Thanks.

Operator

All right our next question comes from the line of Scott Geffner from Barclays. Please proceed.

Taylor Saunders - Barclays

Hi, this is Taylor Saunders sitting in for Scott today. Just switching back over to the input cost that you mentioned that the fiber costs are going to remain elevated I guess next quarter. I was wondering what your expectations are for the remainder of your input cost while freight likely remains higher and then chemicals and electricity as well?

Scott Geffner

Well we don’t see it in chemicals, we think freight, we might get a creep in freight but hopefully we can change our destinations to offset that. And in fiber, we see at our South Eastern mills pretty stable prices for fiber for the balance of this year. And we see in the West Coast stable pricing, but higher level than we would like to see in the West Coast. And that can change and be good for us if housing comes back.

Taylor Saunders - Barclays

Okay, great, that's very helpful. And then other than the higher input costs. Would you say there anything else operationally that was significantly surprising to you in the quarter that may have pressured margins?

Roger Stone

No, not really.

Taylor Saunders - Barclays

Okay.

Roger Stone

Not really, it's a good quarter. For a lot of reasons. No, not really.

Taylor Saunders - Barclays

Okay. And then lastly just switching over. I know we've talked about this on the calls before but just around potential pricing pressure from the new capacity that's come online, I know you said that you did take down your semi-chemical medium in line with receives new public forecast. So I was just wondering has anything major changed over there or were you kind of catching up as well from slow decline in price or what do you think over there from the new capacity?

Roger Stone

Well, that new capacity, good question and thanks for asking. That new capacity is all recycle, it's all geared obviously to the independent market most of that came in without customers, it's all geared to the North East for the most part, independent market. And so it is all that increase comparisons going for 15% of the industries consumption. So I suspect to guess a little crowning in there. But now it hasn’t influenced, I know it's hard to believe against historic pressure graphs overtime. But it hasn’t influenced the kraft price increase at all. I guess I said we got not push back from customers now we are saying I have this great spread between recycled and kraft paper and you guys have got to get competitive with recycle hasn’t happened at all.

And of course we are so loud, we have got 97%, 98% kraft (inaudible) operating rates so why would anybody suggest that. So prices have been very stable and [marked in] place where recycled prices probably haven’t been stable, but I can’t give you a lot of evidence of that.

So and kraft paper we have to remember is the basis since by far the largest part of the container packaging raw material, it is the basis for price movement on containers and therefore there is no movement downward, unfortunately there hasn’t been any movement upward either.

Taylor Saunders - Barclays

Okay, thanks a lot.

Roger Stone

You are welcome.

Operator

And our next question comes from the line of Steve Chercover from D.A. Davidson. Please proceed.

Steve Chercover - D.A. Davidson

Hi Andrea, Hi Roger.

Roger Stone

Hi Steve.

Andrea Tarbox

Good morning Steve.

Steve Chercover - D.A. Davidson

Good morning. So I just wanted to get a sense of the market reception for your ultra-high performance liner. How is the volume ramping and what kind of premium are you receiving?

Roger Stone

Well we have many grades of high performance linerboard, we are receiving a premium on all of them but it’s different -- the lighter the rate the bigger the premium. And I would say conceptually that it is, I am sorry I shouldn’t meant to bring those numbers, it’s an increasing amount of our shipments, this is the light weight high performance, it’s a product that people appreciate and want.

Steve Chercover - D.A. Davidson

And so…

Roger Stone

And other box customers as well, internally it's important.

Steve Chercover - D.A. Davidson

And do you believe that right now you've got a real head start against the competition in that product line?

Roger Stone

Yes, I do, but there are others out there and there are undoubtedly others trying to be out there. And as you know, everybody understands what lightweight is and everybody understands what lightweight high-performance is. So you'll have a different view from a lot of people.

But, yes I think there is a definite effort of our companies to try to provide those products. On the other hand, most machines are not efficient to produce that and the switch box sale of the most of the Kraft linerboard machines are still on the 42 pound on heavier grades rather than the lighter weight grade.

Steve Chercover - D.A. Davidson

And what will be your capacity once you're really fine-tuned and presumably running at full on the machines?

Roger Stone

I'd be glad to get you that information. I can't give it to you up hand without being misleading. And I don’t want that.

Steve Chercover - D.A. Davidson

Sure, I can follow up with Andrea. And my other question was, if I've written this down properly, it sounds like the residual benefit of the Kraft pricing increase is about $5 million, it sounds like one day, an actual production day in the second quarter was worth $1 million so you will probably get another $1 million there. Can you give us a ballpark of what the increased mix might be worth in the quarter?

Roger Stone

Well, the increase value what's now that it's all set on the Kraft paper increase, it is about $30 million a year. I think I have given that number before.

Steve Chercover - D.A. Davidson

Yes, you said that. And I think Andrea said that it would be worth $5 million to you in Q3 as entering the key assumptions. So I was actually wondering what's the better mix?

Roger Stone

Better product mix. We can certainly develop that number, but we don’t have that number

Andrea Tarbox

And we wouldn’t normally forecast.

Steve Chercover - D.A. Davidson

Okay. Final question, forgive me if I missed this.

Andrea Tarbox

And just one more thing Steve, on that one more day at Longview of the 1 million but overall it’s couple million for total KapStone.

Steve Chercover - D.A. Davidson

Okay, thanks. And since we've got now one full month, we have few more hours in today, how have your volume trends been thus far in Q3?

Roger Stone

Terrific, terrific. I think I said that but in the container side it’s potentially container side that growth rates in July are stronger than a very strong second quarter. So that’s very good. And our backlogs for all our mill products are very good and strong. And so, we’re expecting to have a very productive third quarter and a very good third quarter.

Steve Chercover - D.A. Davidson

I hope so. Okay, thanks for that. I’ll let you get back to work.

Roger Stone

Thank you.

Operator

(Operator Instructions). And our next question comes from the line of David Neuhauser from Livermore Partners. Please proceed.

David Neuhauser - Livermore Partners

Hey, good morning, gentlemen. Good morning, Roger.

Roger Stone

Good morning David.

David Neuhauser - Livermore Partners

Hey, I was just going to ask a few questions regarding -- when you look at the capital structure and after the Longview acquisition, are you going to be using free cash flow at this point to sort of further delever the balance sheet or are you still on a hunt for the sort of big elephant hunting looking for further potential tuck-in acquisitions for the company?

Roger Stone

Our focus is obviously improve the balance sheet, we have a big build up in working capital this quarter which we don’t expect to have and that provide more cash for reduction. On the other end, if we find things that are strategically good for us and good for the shareholders, that generate a lot of cash flow and cash payback, we'll do that, we're comfortable with that it's 2.7, it's pretty good.

Clearly if we perform well in the next quarter just by adding the earnings to it, it will -- which should reduce our ratios but actual -- we’re committed to reducing actual debt but if there is something that's really good for the company and the shareholders, it will be pursued. We have plenty of credit capacity and if we need more, I’m confident that wouldn’t be a problem.

David Neuhauser - Livermore Partners

And do you foresee in the future as we go towards year-end this year or at some point to continue to sort of reestablish that special dividend as of -- as we saw the past few years?

Roger Stone

Well, the special dividend which there because our President said taxes on dividends are going to go up dramatically into the next year. And therefore, we thought what was the best thing we could do for our shareholders, and that was the special dividend. I doubt if we would have that special dividend if there wasn't going to be a plan substantial tax increase on dividends. But certainly as we said, there will come a time when we want to consider dividend. So, it’s something that we look at all the time, but we think that using our capital and using our energy to create a bigger price for our shareholders is better and then paying dividends at this time.

David Neuhauser - Livermore Partners

Okay. And in terms of -- this might have been asked earlier, I jumped on a little late. But in terms of this MLP structure that's being floated around and you're seeing a number of discussions about it. Did you chime in earlier or can you chime in a little bit of what your thoughts are regarding that as it relates to KapStone?

Roger Stone

Well, we think, it's a very creative thought, I put a lot of thought into. And we're studying it. And what I said when I commented and it's we believe that maximizing long-term shareholder value and we're studying it. If we firmly believe that it does that, we'll do that; I guess will be a positive thought, but clearly we're studying it, and we're learning more about it, it's an intriguing idea.

David Neuhauser - Livermore Partners

Okay.

Roger Stone

And but beyond that I can tell you that other than working on it and making some analysis and decisions, we haven't done -- made any decision yet.

David Neuhauser - Livermore Partners

So, you're not going to be sort of the first to market on this you’re saying?

Roger Stone

I don't know, we'll go-to-market -- I don't know. If we are convinced, when and if we are convinced that is the right thing to do. If we're convinced we're not going to wait for the market, we'll do it; if we're not convinced, no matter what the market does, we won’t do it.

David Neuhauser - Livermore Partners

Okay, fair enough. I appreciate it guys. Thank you again.

Operator

And our next question comes from the line of Adam Josephson from KeyBanc. Please proceed.

Adam Josephson - KeyBanc

Thanks Roger and Andrea, I appreciate it. Just a couple of follow-ups, one on fiber, again in the Southeast. Roger, just to clarify, you are expecting stable costs there for the balance of the year despite the possibility that pellet mill demand will continue to increase. So, can you just help me understand why your costs wouldn't go up if in fact pellet mill demand continues to grow?

Roger Stone

Well I guess it’s because there is adequate supply at the moment for both, but being the basic reason there has also been some mill shutdowns in those regions which put a lot of wood back on the market, but we look to have it in both hardwood and softwood and feel that this year it’s not an issue, next year it might be.

Adam Josephson - KeyBanc

Got it, okay. Just on cash flow, just with respect to the modest CapEx guidance increase and the working capital buildup in the quarter, have your full-year cash flow expectations changed at all since last quarter aside from just the slight bump in CapEx?

Andrea Tarbox

Not really, no.

Adam Josephson - KeyBanc

Okay. Just couple of other ones…

Andrea Tarbox

We think that buildup, it was just more of a timing thing on the AR side, so no.

Adam Josephson - KeyBanc

Yes. Okay. Roger, you talked about the extent to which domestic kraft paper demand is growing and has not happened for a long time. Do you consider this pickup sustainable, just based on the issues you mentioned earlier? And also what about your export -- can you talk about your export kraft paper demand as well, the extensible?

Roger Stone

Well, we export a fair amount, that extensible -- it is growing, people that need the extensible paper like people in the cement business are very worried about long-term supply. So I suspect, we suspect that the demand will continue to grow on that and our mix will change towards that within our capabilities. The total kraft industry seems to be skewed and based upon government regulations or local government regulations. And if that's just markets -- and it seems to I just can tell the growth has been heavily in the bag and sack grades. And assuming from those raw statistics, it's because of the ordinance has passed communities banning the use of plastic bags, particularly supermarkets and so on.

And so, we're gaining market share where for years, we lost substantial market share. And I don't know if it stabilizes at this level, I know Chicago has passed an ordinance for next year, which will obviously be changing.

So, it's strictly coming from a, I believe, I only have the raw figures in the category, but it seems to me that it's coming from the conversion back to paper from plastic in supermarkets. Where work city ordinances and community laws have changed requiring that. And so that's what's happened or is happening.

Adam Josephson - KeyBanc

Right. No, got that. Just too, I was wondering on Reecey's cuts to semi-chemical mediums, Roger, were you surprised by that?

Roger Stone

Yes, we were. We had put when things were really tight last year on the West Coast, we had put an extra premium of semi-chemical medium, which we had given back earlier this year, there is still the premium, West Coast premium, but this is bigger than the normal West Coast premium. But we had no pressure for that $10 or it seemed, but they changed it and so we changed. We just do what we do.

Adam Josephson - KeyBanc

Right, correct. And just one last one on your M&A pipeline. Obviously just given the rapid consolidation of late, to what extent would you say your pipeline is smaller compared to a year ago, two years ago, and are you still confident that there are sizable opportunities out there in the foreseeable future?

Roger Stone

Well there is a lots interesting and strategic opportunities not the big ones that we’re saying. But there are things that are good for the company that if we can make them happen, we should make them happen.

Adam Josephson - KeyBanc

Great, thanks a lot Roger. I appreciate it.

Roger Stone

Okay. You’re welcome Adam.

Operator

Our next question comes from the line of Debbie Jones from Deutsche Bank. Please proceed.

Debbie Jones - Deutsche Bank

Hi, good morning.

Roger Stone

Good morning, Debbie.

Debbie Jones - Deutsche Bank

I jumped on the call a little bit late, but I just -- I know the topic has been addressed, but I wanted to know if you could discuss again the push towards the high-performance grades? Can you help us understand the steps that need to be taken when a customer chooses to use this product versus the standard weight border box? And are there changes they need to make at the back end of their operations? And, while I think this product sounds attractive, do you see an issue with the fact that there is a limited number of suppliers for this product? And that customers may not want to commit to one supplier? So I guess my question is do you need to see other producers move into this direction for it to really be embraced by the market?

Roger Stone

Clearly customers believe they don’t want to get into consuming a product that has only one supplier. There is no question about that. Its psychological I mean my view is if you save money by going to lightweight with high performance paper but unique to suppliers, so why not go 50% to lightweight and go 50% to what you’re using. So, but clearly there is reluctance among a number of buyers of not having more of available to choose and it's a concern of theirs.

But the average weight for the industry hasn't over the last few years anyway reflected a great move through that. So we know a lot has moved so obviously other grades might have gone heavier. And I might say this, we have high performance grades that are heavyweight they're just lighter weight than the traditional grades out there and performs. So those statistics kind of balance itself, there is no question. Traditionally you will find customer resistance to something new if supporting to them that they can't get from more than one supplier. And it makes sense having more competitors and that's just a good thing.

Debbie Jones - Deutsche Bank

Do you get a sense in your customers that they're pushing other producers to moving instructions?

Roger Stone

Some customers are pushing in that direction. We're still educating customers I hope we can make them real in that direction and we're succeeding in doing that. But we are not alone out there in doing that, a lot of people who have that capability are also doing.

Debbie Jones - Deutsche Bank

Okay. And then I'm sorry if I missed this, but your total maintenance impact I think it didn't really change much for 2014 but the timing just changed a bit can you comment just on if anything changed there?

Andrea Tarbox

Well actually I think it did go down for the full year because we brought down the expense in Q4.

Debbie Jones - Deutsche Bank

Yes.

Andrea Tarbox

So we are backing down a little bit from where we were before.

Debbie Jones - Deutsche Bank

Okay. Nothing like specific there but just revaluations.

Andrea Tarbox

So just how we go about timing how we go about doing work.

Debbie Jones - Deutsche Bank

Okay, great well that's helpful thank you very much.

Roger Stone

Welcome.

Operator

Ladies and gentlemen, this will concludes today's question-and-answer session of today's call. I'll now like to turn the call back over to Mr. Roger Stone for closing remarks.

Roger Stone

Well, thank you for joining us on this hectic day. And some from a reasonable call, you want answer what day is, market not going to be volatile and we'll release on that day. But, thanks very much I appreciate it. And if you're not confident that we feel good about the future, we feel very good about the future.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you all for your participation. You may all now disconnect. Have a wonderful day.

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KapStone (NYSE:KS): Q2 EPS of $0.58 misses by $0.02. Revenue of $590.44M (+80.9% Y/Y) beats by $16.14M.