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MeadWestvaco (NYSE:MWV)

Q2 2011 Earnings Call

July 27, 2011 10:00 am ET

Executives

Mark Lewis - Chief Financial Officer of Community Development and Land Management Group

E. Rajkowski - Chief Financial Officer and Senior Vice President

James Buzzard - President

John Luke - Chairman, Chief Executive Officer and Chairman of Executive Committee

Jason Thompson - Director of Investor Relations

Analysts

Peter Ruschmeier - Barclays Capital

Phil Gresh - JP Morgan Chase & Co

Alex Ovshey - Goldman Sachs Group Inc.

Mark Connelly - Credit Agricole Securities (NYSE:USA) Inc.

Mark Weintraub - Buckingham Research Group

Mark Wilde - Deutsche Bank AG

George Staphos

Gail Glazerman - UBS Investment Bank

Operator

Ladies and gentlemen, thank you very much for standing by, and welcome to the MeadWestvaco Second Quarter Results Conference Call. [Operator Instructions] And also, as a reminder, today's conference is being recorded. I would now like to turn the call over to your host, Mr. Jason Thompson. Please go ahead.

Jason Thompson

Thank you, Perky, and good morning, everyone. This morning, we announced our results before the market opened. The notification of this morning's call was broadly disclosed. And further, this morning's call is being webcast at mwv.com. Slides that accompany this call are available there as well. I'll briefly remind you that certain statements we make are forward looking and are not guarantees of future performance and are subject to known and unknown risks and uncertainties described in our public filings. Furthermore, contents contain time-sensitive information that, although correct today, may change with the passage of time.

All the results we show this morning are presented on a continuing operations basis. For the second quarter, we reported income from continuing operations of $89 million or $0.51 per share. Excluding special items, adjusted income from continuing operations was $94 million or $0.54 per share. Now here to tell you more of our results of second quarter are John Luke, Chairman and CEO; Jim Buzzard, our President; and Mark Rajkowski, CFO. I'll now turn the call over to John.

John Luke

Thanks, Jason, and good morning. MWV delivered another solid performance during the second quarter. We are consistently generating higher sales and earnings by executing market-focused strategies that have given us a strong product and geographic mix in each of our businesses. As we entered 2011, we expected there to be some challenges in the global economy, including uneven consumer demand in developed markets and higher cost for some materials, and we planned for these external realities. Even as these challenges began to emerge in the second quarter, we delivered solid results. Our revenue increased by 9% and we generated record second quarter adjusted income from continuing operations of $94 million or $0.54 per share, a 40% improvement compared to last year. Specifically, we made gains during the quarter through an emphasis on value-based pricing and growing our business with key global customers. We also continued to see a beneficial impact from the leading positions we've built in fast-growing regions such as China and Brazil.

Sales across emerging markets grew by 22% in the quarter. Our success in these and other areas had a clear and positive impact on our performance. With these strong results, we continue to demonstrate that the step change in our performance is sustainable. And we are positioned to grow beyond these levels by further leveraging both the earning power of our business model and market participation strategies in each of our segments. That includes the significant value creation opportunities and upside potential that we see in our Land Management and Specialty Chemicals businesses, where we're continuing to see excellent progress.

We'd like to thank those of you who participated in our Investor Day, highlighting these 2 value drivers for our company. I think you will see that our performance during the second quarter was in line or exceeded the expectations we set out in that presentation, with CDLM marking a few key derisking milestones on important development projects and Specialty Chemicals having another record quarter of sales and earnings growth as it makes continuing progress implementing its business strategy.

We also had very good results in the end markets we serve with our 2 packaging segments, Packaging Resources and Consumer Solutions. Combined sales in food, beverage, healthcare, personal care, home and garden, tobacco markets were up $75 million or 9%. As we've discussed on other occasions, we are increasingly looking at our performance through the lense of our progress in these end markets. And we'll share more of these detail when we complete the transition to our new segment-reporting structure later this year.

Our biggest gains during the quarter were in the large global packaging market for food. We have extended contracts with large brand owners such as Kellogg's, General Mills and Schwan for retail food packaging and we're working towards commercialization of innovative products, including packaging for salty and oily snacks and a shopper-ready packaging solutions for store shelves that will be part of our growth platform going forward. Recently, one of our designs, a new snack package for cookies and crackers called Evertain won best packaging concept at Kraft Foods' innovation day contest.

In beverage, while there've been some volume challenges due to consumption trends in Europe and North America, we're excited about the growth opportunities we've identified in both emerging, as well as developed markets. During the quarter, for instance, we placed a number of new beverage packaging machines with Coca-Cola, Danone and others that will lead to increased revenue growth in the future.

In healthcare, we recently released data from a significant study that validates the adherence-enhancing characteristics of our Shellpak product, proving that packaging alone positively impacts the way patients take medication. This is a breakthrough finding that addresses one of the very important challenges in the healthcare market. We believe that our growth opportunities with new and existing customers are better than ever based on this data, and we've already won new business for Shellpak with one of the India's largest pharmaceutical companies. Beyond adherence packaging, we're also becoming a proven supplier of pumps for the healthcare market. Sales were up more than 20% in our medical pumps business as we gain share from established competitors.

In the beauty and personal care market, the demand for luxury and masstige products such as perfume and skin care continues to be strong in Europe, despite lower overall discretionary spending. Our fragrance pumps and airless dispensers are doing very well in Europe and we have augmented that success with new wins in India during the quarter.

The home and garden market was very difficult during the all-important spring lawn and garden season because of bad weather patterns in North America. Our business with customers such as Scotts Miracle-Gro was down compared to a banner season last year. However, we grew in the home cleaning portion of the business in Europe and Asia, in part due to share gains we are winning with the recently acquired Spray Plast platform of trigger sprayers.

In Brazil, the economy's been going through a natural cycle of slower growth compared to the peak last year, which was the highest growth in more than 2 decades. Markets for Rigesa's corrugated packaging are in line with our expectations, softer in the southeastern region in Brazil that include Sao Paolo and Rio, but more resilient in the faster-growing northeastern region. During the quarter, we began operations of the new corrugated packaging plant in Aracatuba and we're enthusiastic about the pace of growing orders as we ramp up this new facility. Our long-term outlook for all of these packaging markets continues to be very positive, and we've generated a great deal of momentum by focusing our participation in these growing consumer product categories, momentum that has translated into better results over the past several quarters and positions us for excellent profitable growth going forward.

Before turning to Jim, let me summarize by saying that we are gratified by our continuing progress and have confidence that we can continue to successfully execute our strategies, strategies that offer significant promise for our shareholders. We recognize that economic uncertainties exist both here and around the world. And while not immune to these uncertainties, we'll be prepared to respond to challenges that may come our way. I'll now turn to Jim for a report on our operational and segment performance. Jim?

James Buzzard

Thanks, John. The results from our businesses during the quarter were very good. We had combined segment earnings of $231 million, a record for the second quarter. Our 9% sales growth was driven by value-based pricing initiatives across our businesses and by the impact of foreign currency exchange from sales in Europe and Brazil. Our successful price increases reflect the improved market participation strategies and are an important part of our effort to grow the business and stay ahead of input cost inflation.

I'll now provide some details about the contributions from each of our segments to this performance. Additional information is available in our press release and the slides that accompany this call.

In the Packaging Resources segment, sales were up 10% in the second quarter as we continue to generate strong pricing for our value-added products. Our business is especially strong in global food markets, with both pricing and significant volume increases during the quarter for food service paperboard, retail food packaging in Europe and Asia and liquid packaging in China, as well as market share gains in North American food markets. Pricing was also strong for beverage and tobacco paperboard while volumes were in line with overall consumption trends in these markets. Overall, shipment volume for bleached paperboard was higher compared to the second quarter last year while Coated Natural Kraft was down on the same basis.

And in Brazil, pricing for Rigesa's corrugated packaging continue to be very strong, reflecting the value of our differentiated offering in this market. But consistent with John's comments about the economy in Brazil compared to record growth last year, we had somewhat lower year-over-year volumes for corrugated packaging for many of the end markets we serve. We continue to be very positive about these markets in Brazil, and the investment in our corrugated packaging business there remains on track. The aggressive schedule we have established will have a new paperboard machine starting up by the middle of 2012.

Earnings in the Packaging Resources segment were nearly $100 million during the second quarter, up about 40% compared to last year. The improvement is primarily due to the pricing momentum and product mix improvements we've been able to drive in each of our markets, as well as increased manufacturing productivity at our facilities.

In the Consumer Solutions segment, revenue increased by 4% during the quarter, with a large portion of the increase coming from the foreign exchange impact of our sales in Europe and emerging markets. Pricing and product mix improvement also contributed to increased sales and were higher across almost all of our end markets. However, we did not see the kind of volume growth we expect in this segment.

Volumes were mainly impacted by beverage, where trends were in line with ongoing challenges in North American markets. We are partnering with our soft drink and beer customers to help them develop new solutions that will accelerate growth outside North America, especially in emerging markets. An example is our new beverage packaging machine that can be tailored to economically meet the specific multipack opportunities for small sizes and limited runs in places like China. More broadly, we had 14 new machine replacements around the world, outpacing the rate we saw last year and leaning to higher cart and volume for both new and established customers.

We did see volume trends during the quarter improve month-to-month for both personal care and healthcare packaging. Shellpak sales are trending higher as we add new drugs and customers, including increased business from Wal-Mart as they ramp up a new drug in their pipeline. And while our volume of dispensers for hand sanitizers and lotions are still below the high water mark during the peak of the H1N1 virus, we have seen improving sales in each of the last several months, which has added to the strong growth we continue to see in fragrance and airless dispensing solutions for the personal care market.

Earnings in Consumer Solutions were 5% lower than during the second quarter last year, principally due to the ongoing impact of higher resin costs. Resin costs flattened out at the end of the second quarter but remained well above last year's levels. We are recouping this inflationary costs with price increases, but the lag between contractual price increases and resin cost increases continues to negatively impact operating earnings.

In the Consumer & Office Products Segment, sales and earnings growth in the quarter were above our expectations. The shipment season for back-to-school in North America falls during the second and third quarters. And this year, we benefited from earlier sell-in of both branded consumer and time management products. Tilibra, our school supplies business in Brazil, also worked proactively with major customers to have a more consistent supply of products, which led to higher sell-in of consumer products compared to last year. Along with this shift of sales volume and product mix improvement, productivity gains also contributed to segment earnings performance. As the back-to-school season begins at retailers across North America, we are well positioned with major customers, have a good lineup of licensed products and expect growing contributions from our new line of early learning products for preschool students. Also, retailers have indicated that advertising will increase this year, which should drive traffic in the stores. The degree of success, however, will be driven by retail sell-through and replenishment orders, which depends on the consumer.

In the Specialty Chemicals segment, we had record sales and earnings for continued success with our marketplace participation strategies, including benefits from our innovative Pine Chemicals product for the ink, adhesives and oilfield drilling markets, as well as the busy summer season for asphalt road paving in North America.

Not only are certain trends in our favor in these markets, but we are gaining business with both new and existing customers from strategies to clearly quantify the cost and performance benefits of our formulations versus competing technologies. Volumes of carbon for evaporative emissions control were lower than the prior year in previous years' quarters as global auto productions fell following the tsunami in Japan. The major Japanese automakers have indicated the production is normalizing, so we should see some recovery moving forward. And we've also worked to offset this temporary declines in auto markets with gains in purification carbon from global food, water and beverage markets.

In Community Development and Land Management, we continue to generate sales of rural and recreational land during the quarter. We closed on approximately 4,700 acres for gross proceeds of $11 million, or an average price per acre of about $2,300. We also made excellent progress in the development business, achieving some significant derisking thresholds by securing approvals for infrastructure funding for our Parks of Berkeley development in Summerville, near Charleston, South Carolina. These milestones not only add value to our profit by eliminating some of the risk to development, they've also helped to generate interest from top-tier home builders and commercial developers for lots in the first phase of the project. As we discussed in depth at our June investor event, Charleston remains a very attractive market for residential and industrial development, including properties that can take advantage of the expanding Port of Charleston and new Boeing Dreamliner assembly plant in the region.

Now I'd like to turn the call over to Mark to discuss some of our financial metrics for the second quarter. Mark?

E. Rajkowski

Thanks, Jim. Second quarter reflected continued strong performance for MWV across all key financial metrics. It was the eighth consecutive quarter of year-over-year improvement in earnings and operating cash flows. Our results reflect the changes we've made to our business model to create a more consistent and higher-performing company that is generating the strong returns in this still a challenging environment and set to outperform under more normal economic conditions.

Some highlights from the second quarter include sales growth of 9%, driven by price and mix improvement and a very strong contribution from emerging market sales. Record second quarter adjusted EPS of $0.54, driven by a 21% improvement in adjusted operating profit, which, at $176 million, was also a record, and very strong cash flow from operations of about $160 million. I'll now review our second-quarter results and then provide our outlook for the current quarter.

Starting with sales, our 9% improvement was driven by strategies to increase business and gain market share in our most profitable markets, as well as to increase pricing based on the value that we're delivering to our customers. Our continued success in these areas resulted in price/mix contribution of 6 percentage points in the quarter, and our growing positions outside the U.S. also led to significant positive impact from foreign currency exchange. Our sales continue to be strengthened by the diverse geographic mix of our business portfolio, including leading positions in emerging markets where we delivered 22% growth in the second quarter.

Our revenue increases continue to be accompanied by improvements in our gross margins. We expanded margins with improved price and mix from our advantage product offerings and by leveraging our enhanced operating platform, which drove 250 basis points of year-over-year improvement to adjusted gross margins during the second quarter. We're continuing to deliver excellent manufacturing productivity with ongoing operational excellence initiatives and higher utilization rates from our streamlined asset base.

With our sharpened end market focus, we are increasing investments in new product development and commercial capabilities that we expect will continue to translate into profitable growth for our company. While $18 million of the year-over-year SG&A increase is noncash items, including stock-based compensation and the impact of FX translation, the remainder is primarily driven by growth investments across our business units. The innovation and commercial capabilities that we're funding have enabled the expansion of our market positions in food, beverage, personal care and healthcare, as well as the growth that we've seen in emerging markets. These investments are important components of our plan to substantially improve our business model, as evidenced by this quarter's record operating profits and expansion of our operating margins to over 11%.

As I mentioned at the outset, cash flow from operations was very strong during the second quarter, more than doubling to over $160 million. Higher earnings were the primary driver of the significant improvement over last year. We are expecting to generate solid free cash flow levels for the full year, which we defined as cash after CapEx and dividends, but before project-related commitments that include our expansion project in Brazil and new Covington biomass boiler.

During the quarter, we invested $151 million in capital bringing our total capital spend through the first half of the year to $264 million. Approximately 1/2 of our year-over-year to date spend is related to the expansion of our Brazil business, which is progressing very well. For the full year, we expect total CapEx to be between $650 million to $700 million, which includes approximately $300 million for our Brazil expansion and $50 million for our Covington biomass boiler.

Now, turning to our outlook for the third quarter. We expect to extend our record of year-over-year profit growth in the third quarter. However, comparisons in the back half of the year do get tougher as we begin to fully cycle last year's pricing action and expect to see greater inflationary pressure across key raw materials and freight. We are also closely watching global demand trends, which have been particularly uneven in the U.S. and Europe due to the significant economic and unemployment challenges consumers still face in these regions. We will address these factors by continuing to shift our product mix towards higher value solutions and pursue value-based pricing, by continuing to penetrate fast-growing emerging markets, particularly Brazil, China and India, and by continuing to realize manufacturing productivity gains.

Now a quick rundown of our third quarter outlook by segment. In the Packaging Resources segment, as we head into the busiest season for our products, we expect profits to be modestly above our record segment profit in the second quarter. Order backlogs are at 3 weeks for bleached paperboard and 5 weeks for Coated Natural Kraft, which is a normal level for this time of the year. We're continuing to generate solid demand and targeted higher value food and beverage grades. We also expect to continue to benefit from pricing actions taken over the last 12 months, albeit to a lesser extent as many of the more significant pricing actions that we've taken over the last year occurred in the first half of 2010. We expect high single-digit increases in costs for raw materials and freight, as well as an outage at our marked paperboard mill to partially offset these positive factors.

In the Consumer Solutions segment, we expect profits to be similar to year-ago levels. Price/mix improvement, including the recovery of high resin cost through contractual price escalators and continued productivity gains will be the main drivers of improved performance. We expect these benefits to be largely offset by higher cost for raw materials, particularly resin and as well as freight.

In the Specialty Chemicals segment, we expect another strong year-over-year increase in profits. Benefits from continued solid demand across Pine Chemical and activated carbon markets, price and mix improvements and higher productivity levels are expected to drive substantially improved earnings. However, inflation in certain raw materials and freight cost will partially offset these positive factors.

In the Consumer & Office Products segment, sell-in and sell-through of branded consumer products for the back-to-school season are the key drivers of second and third quarter results. Overall, we're expecting segment profit to be flattish with last year's strong performance.

In our Community Development and Land Management business, real estate market conditions make it difficult to forecast sales and earnings. As we outlined at our Investor Day, we are continuing with our approach to marketing that we expect will generate premium values per acre. That said, buyer confidence in response to macroeconomic trends has remained relatively weak. As such, we're expecting land sales at levels consistent with the just announced second quarter. With that, I'll now turn it back to John.

John Luke

Mark, thanks very much. To summarize, we're pleased with the results we deliver during the second quarter, consistent with our record of continuing progress in recent years. The strong product portfolio and geographic mix of our business that we have carefully built across the set of targeted growing markets has proven to be a competitive advantage and a source of substantial value for our shareholders. While not immune to the challenges that may come our way in the global economy, it is this leading position that gives us confidence in our ability to respond to any such challenges and to continue our solid performance going forward. This will conclude our prepared remarks, and we'd now be happy to address your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Mark Connelly with CLSA.

Mark Connelly - Credit Agricole Securities (USA) Inc.

John, just a couple of things. Can you talk a little bit more about Brazil? You got a pretty aggressive timeline there and I'm assuming that you'd already have a sense of how that's going and whether the slower economy in Brazil is going to change your expectations for the product -- projects' payoff?

John Luke

Mark, you were breaking up a little bit. But so if I don't fully answer all of your questions, come back, because I'm sure you will. I think with respect to Brazil, we are very confident, as Jim indicated, in the rate of progress we're making and the plans that we're developing. I think we're seeing clearly a little bit of variability in the Brazilian economy. None of which was unexpected given the very high rate of growth we saw -- record rate of growth we saw 12 months ago. But as we look ahead at the investments that are being made in the industry, the investments are being made and further planned in infrastructure, the outlook for Brazil over the coming years should be good. So our progress, both in the installation we have underway and in the market development to support that installation, we're very comfortable with.

Mark Connelly - Credit Agricole Securities (USA) Inc.

Okay. And just one second question. Obviously, SG&A is up and you're spending on a bunch of different things. Covington's a pretty big project. Can you give us a little bit of a sense of the timing of the benefits that come with both of those big spending initiatives?

John Luke

Yes. Let me start an overview, and I'll ask Jim and Mark to pipe in with any follow-on comments. I think with the SG&A, certainly, that's supporting directly our investment in market participation strategies. In some cases, we are already beginning to see the benefits of that. In other cases, over the next 12, 18 months, we'll see and we'll link the progress we're making right back to specific investments we've made, whether it is in innovation, both design, the development of technology, whether it is in specific expansion of our capabilities in emerging markets or whether it is broadening our product mix. So all of those things are things that will be coming along nicely. Clearly, the Covington project is going to take some time to complete, but we would expect fully to be seeing the benefits of that as we move into 2014.

E. Rajkowski

Yes, John, I Just would add a couple of points. One is that, Mark, I think we are already seeing some of the benefits of investments that we've been making in SG&A. As you'll look at the bottom line, our operating profit is at a record level. We've been able to expand our margin, and a large part of that is a function of our ability to bring new higher value-added products to our customers. And that enables us to get better pricing and better margins. So I think we're seeing some of that already. We are seeing volumes improve in certain subsegments of our business such as food, components of beauty and personal care and healthcare. And that's what has us very excited about the future is that we do think there's really some upside in those end markets and in our emerging markets to deliver good volume growth in the years -- quarters and years ahead.

John Luke

Yes. And I would just come back on that and supplement what Mark has just said, Mark, by noting that if you're really going to grow and grow in new areas, as we are, the kind of investments we're making are very logical and appropriate. And so we're very bullish as we -- we're methodical, but we're very bullish about how and where we're spending the money and about the upside potential, the real stick-to-your-ribs kind of growth that's going to come from it.

Operator

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

George Staphos

I guess I wanted to dig a little bit into your success thus far in food packaging markets. Can you talk at all about whether you're having any success in installing machines in the food markets? And then generally speaking, if you could parse the market a bit more, where you're having the most success with your board or product offerings on the converted side?

John Luke

Let me comment, George, it's John, at the outset and I'll ask Jim or Mark to follow on there. I think you raised the interesting question with machines. This is an area where we clearly excelled in beverage bringing tremendous efficiencies to our customers' businesses in enhancing the quality and efficiency of their overall supply chain. And these are things that we'll be actively considering as we broaden our participation in the food business. We have, as we've talked, also developed and have in test, or further will in test, several game-changing platforms that will be important as well, particularly as it gets to packaging that enhances our customers' product on store shelves. Much of what we've done to date relates to specific converter partner, brand owner, led partnerships that relate to the careful selection of our board to package and present to consumers brands that our customers want to market more successfully. And I mentioned the contracts that we have with customers like General Mills, Kellogg and others, and these are just examples of where we have a significantly enhanced participation and in all of these cases where we're working diligently to work with a group, a select group of converter partners, to accomplish this end. Jim?

James Buzzard

Yes thanks, John. Let me just supplement, George, with a couple of comments. Clearly, as I noted in my comments, Asia and Europe had been very strong for us in food. A lot of that is driven, as John suggested, by our engagement with the brand owner. And they're recognizing that the aesthetics and the styling of our board relative to competing products in Europe really helps drive sales off the shelf. And so we're seeing good success there. The strength of our CUK products in the frozen food markets is also a big advantage, so we see a lot less damage at the store shelf, a lot less returns coming back that the brand owners to pay for. So quantifying that value and selling is what really led to strong performance there as well.

John Luke

And I would just supplement that again with something I alluded to but didn't mention directly earlier. And that is that with products, as I mentioned in my opening comments, like Evertain, a new design, a mix of broad range designs, as well as new materials, enhanced materials, particularly some that we're exploring with unique barrier properties, will be all part of the mix that we'll be introducing to the food, as well as other markets.

George Staphos

Okay. I had sort of one follow-on and a related question then I'll turn it over. In Europe in particular, Jim, are you competing against the things like chipboard? Is that why you're having success with your product relative to whatever call chain and distribution chain issues the other boards may be having a problem with? And then the additional question, I mean, obviously, in the last couple of months, we've -- at least from the data, seen some weakening in box board markets. You've seen some announcements. Obviously, your performance has been very good, but related areas in packaging are showing some deceleration as the quarter ended. Can you help us a little bit with how your early third quarter trends have been?

James Buzzard

In terms of the frozen food markets, that's not only Europe, but it's also in North America as well. And that's primarily against coated recycled board products and, to a degree, against SBS as well. The styling and the aesthetics that I've talked about would be against FPB and other competing boards. I think as we came out of the second quarter and into the third quarter, as we look at our order intake, it actually has been pretty steady for the first 2 or 3 weeks of July. And our backlogs, I think, as we noted, have been holding at 3 weeks, which for this time in year is where we would expect them to be. We would anticipate a little bit of an uptick in September and early fall. So we see it sort of playing out as it normally does this time at the back half of 2011.

Operator

And our next question comes from the line of Gail Glazerman with UBS.

Gail Glazerman - UBS Investment Bank

I was wondering if you could talk a little bit about the disruptions you're seeing, I guess, from the project down in Brazil? I guess they offset the productivity in PRG. I'm just wondering how we should think about that moving forward. I assume it would get a little bit stiffer as you move -- continue on with the project?

James Buzzard

Gail, I'm sorry, you broke up. This is Jim. I didn't -- are you talking about disruptions in Brazil?

Gail Glazerman - UBS Investment Bank

Well I'm Assuming you had -- you're showing negative net productivity in PRG but then you said you actually had positive productivity. So I'm assuming it has to do with the work you're doing in Brazil. Is that correct? And if so, can you give us a sense of how that will play out over the next few quarters?

E. Rajkowski

Yes, Jim can clarify that.

James Buzzard

Sure. Gail, at this point, no impact from the Brazil expansion. The negative productivity that you see -- saw within PRG, we had positive manufacturing productivity and continue to deliver that. Offsetting that, we have some onetime hits. And also, we offset our investments in growth against that as well. And so those are the primary reasons why you see a negative number. But from a manufacturing basis, continue to deliver good productivity and on track for the rest of the year to maintain that momentum.

Gail Glazerman - UBS Investment Bank

Okay. And there have been some reports in the trade press that you've been producing and selling some pulp from Evadale, can you talk a little bit about that, confirm whether you're not doing it and if this is just kind of the one-off or something that's sustainable moving forward?

James Buzzard

Sure. You're right. We have started the E2 backup to manufacturer pulp. I would note that we will not make bleached board off of that machine. Just the bleached softboard pulp rather. It really is an opportunistic move on our part. It lets us balance out the back-end of the mill. We can produce it very cost effectively. We can be in and out of that markets. So it really is a lot of good thinking by the team down there to help drive improved earnings performance. But we'll do it on an opportunistic basis.

Gail Glazerman - UBS Investment Bank

Okay. And just going back to the price cost in CSG. I mean I guess if resins are starting to stabilize, should we expect to start to see that gap narrow through the back half of the year, assuming costs kind of stay where they are at the end of third -- at the end of the second quarter?

James Buzzard

That's right. We saw a dramatic run-up really throughout the first quarter and the second quarter. At the end of June, they trended down a little bit. So as I noted, our prices lag that, and those are now going into place. And so we should see that begin to reverse itself.

Operator

And our next question comes from the line of Mark Wilde with Deutsche Bank.

Mark Wilde - Deutsche Bank AG

Just back on the box board business, you mentioned in your comments that you were likely to see more cost pressure ahead. But you also said that you're backlogs are basically just balanced at this point. Does this mean, kind of as we go through the second half of the year, you're unlikely to be able to do anything else from a pricing standpoint to offset those cost increases?

James Buzzard

Mark, this is Jim. I would not draw that conclusion. We continue to see cost pressure in freight, a number of the raw materials, TiO2, cost-regulated season [ph] and other things. But as those come through, we will continue to do our best in the marketplace to raise prices. And again, a lot of it will be about market participation strategies and where we put our board. So the combination of those 2 things will be front and center for the team.

John Luke

Yes. I would just reinforce what Jim has said, Mark, by drilling down on the notion of the market participation strategies. We continue to improve the mix of products that we're selling and with that, wherever we can, demonstrate the value that our products bring to our customers. And that bolsters the pricing that we seek to derive from those transactions.

Mark Wilde - Deutsche Bank AG

Okay. And Jim, I just -- remind because I can't recall. Have you ever done things like just put on freight surcharges to try to recoup some of these costs? Or do you prefer to go for kind of an across-the-board price hike?

James Buzzard

Mark, on the box board side, where we -- and domestically, particularly, we do have freight surcharges in place that we utilize. But things like some of the surcharges for Bunker C on exports, we try and get back through a general price increase. So it really is a mix of both strategies.

Mark Wilde - Deutsche Bank AG

Okay. All right. And then just back over to Brazil. I just want to be kind of clear on what exactly you're saying about down there. Was your box business actually negative from a volume standpoint in the second quarter?

James Buzzard

Yes, it was.

Mark Wilde - Deutsche Bank AG

Okay. And is that -- Jim, I know that there's a lot of produce that's exported out of Brazil. So I'm curious, is any of this just a result of a very strong, hey I, kind of limiting, say, produce exports? Or is it just more of a slowing in the overall economy?

E. Rajkowski

There's a modest impact from exports. Probably around 10% or 15% of our business goes into products that are eventually exported. So primarily driven just by what we see as a temporary slowdown in the Brazilian economy.

Mark Wilde - Deutsche Bank AG

Are there particular niches of your business where you see that slowing most pronounced down there?

E. Rajkowski

No, it was really pretty much across the board in all the markets.

E. Rajkowski

And again, I think, Mark, as you know, knowing Latin America as well as you do, that as we reinforced here, this relative softness has to be viewed in the context of last year's performance, which was just off the charts by any measure.

Mark Wilde - Deutsche Bank AG

Okay. And then, Jim, I wonder over in the Consumer Office products, is it possible for you to kind of give us a little differentiation here between kind of what's going on in the domestic market, what's going on in the international? And then within the domestic, sort of what's going on in terms of sort of the commodity businesses where I think you've been dealing with imports for many, many years versus the more -- the value-added products that you sell in domestic market?

James Buzzard

Sure, Mark. I'll take the domestic question first. We really have worked hard over the last 2 or 3 years to move out of the commodity portion of that business. So a big portion of what we do is what we consider to be value added. This is the big time of the year for that marketplace. So our sell-in into the stores has been very solid for us. The product placement in the stores looks very good this year. Our big retail partners are suggesting increased promotions as well. So all of the things are in place to have a good back-to-school season. Having said that, we're all holding our breath now because now it's up to the consumer to come in and spend. And given the economic situation, we just have to wait and see where that goes. That drives the replenishment orders in the back half of the season. But we're entering the season, we believe, places as well as we have been. Internationally, Brazil is -- their real back-to-school season is more December, January. So the comments there is we are -- we're performing better than we have. We've broadened our products base, so we're seeing better participation. But the real driver there will be Q4 and Q1 of 2012.

Mark Wilde - Deutsche Bank AG

Okay. Then the last question I have. John, is it possible to just share a few thoughts with us in terms of what's going on inside of Meadwestvaco right now in terms of succession planning?

John Luke

Mark, I think that we continue to address those questions in the context of our overall organization development. And this is something that the board actively works at as a priority area of it's responsibility.

Operator

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

Mark Weintraub - Buckingham Research Group

The cap spend, you clarified $650 million to $700 million this year. Any ability to give us a little preview as to what it might look like next year? And in particular, how much more of the Covington spend would there be remaining, as well as Brazil for next year?

John Luke

Yes. Mark, let me give you the highlights on that. We're expecting -- if you look at the big areas of spend, you have our Brazil expansion and also our new biomass boiler in Covington. So breaking those down, our investment in Brazil, we'd expect roughly 2/3 of that to be spent in 2011 with the remainder next year through the first half. So we'll see a ramping down next year of cap spend related to that project. On the other hand, with the biomass boiler, as we indicated in our comments, this year, we're expecting spending in the range of $50 million or so with a ramping up in 2012. So those will largely be offsetting the -- so that's really the way you can think about that. And those are really the biggest drivers of spend.

Mark Weintraub - Buckingham Research Group

So if I -- taking those numbers, should I be thinking next year's probably going to be in the $600 million to $650 million range?

John Luke

I'd say that's a fair view.

Mark Weintraub - Buckingham Research Group

And just one real quick easy one. When you talked in -- you have on the slides, on the third slide, it says Q3 outlook, modest profit growth versus Q3 2010. Is that compared to a $0.63 EPS number in the third quarter of last year? What was the base you're using for last year's EPS?

John Luke

I think our operational base was $0.62 per share.

Operator

And our next question comes from the line of Phil Gresh with JPMorgan.

Phil Gresh - JP Morgan Chase & Co

I was wondering if you could talk about what you're seeing in the box board markets from an import standpoint. I know imports have always been a modest factor, but it sounds like competition has increased recently. So I was wondering if you are seeing it at all in the markets you participate in for SBS or CNK.

James Buzzard

This is Jim. No, I can't say that the markets where we are playing we're seeing much impact at all.

Phil Gresh - JP Morgan Chase & Co

Okay. And then just following up on the cash flow side. Given the significant capital spending that you have in store, how are you thinking about incremental capital allocation from here? And how are you thinking about your target leverage right now given the macroenvironment?

John Luke

Phil, I think that we've certainly benefited from what has been a strengthening of our financial position, cash balances and liquidity over the last several years through the downturn. And we're going to take advantage of that and we are looking at using a combination of cash, and as we mentioned also, some debt down in Brazil to fund our Rigesa expansion. And we do have cash that we expect to use to fund our biomass boiler in -- at Covington. But we'll look to maintain a relatively efficient and, I'd say at this point, probably conservative capital structure given what continues to be a uncertain economic environment looking forward.

Phil Gresh - JP Morgan Chase & Co

Okay. And then the last question just on Specialty Chemicals. As you think about the sequential trends here from second quarter to third, is there anything that you think would prevent you from seeing a profit improvement quarter-over-quarter? I mean usually, you do see that seasonally. So just any thoughts you have on that.

E. Rajkowski

So quarter sequential for the entire company, Phil?

Phil Gresh - JP Morgan Chase & Co

For Specialty Chemicals, specifically.

E. Rajkowski

For Specialty Chemicals. I think we're on that type of a trajectory, for sure, Phil.

Operator

And our next question comes from the line of Alex Ovshey with Goldman Sachs.

Alex Ovshey - Goldman Sachs Group Inc.

Question on box board pricing. Clearly, the momentum is pretty healthy there. And the presentation, it looks like you realized about $100 million benefit from higher box board pricing in the first half. Based on the increase that has already been implemented in the marketplace for both bleached board and CUK, what do you think the pricing benefit will be from box board in the second half of 2011?

James Buzzard

Alex, this is Jim. Clearly, I think as we noted, a lot of those actions were in the first half of 2010. So we've got a lot of the benefit to date. As you know, on the bleached board side, we have announced price increase in the markets right now that we're working through. And so we would expect to see some continued benefit, but it won't be as large at it has been to date.

Alex Ovshey - Goldman Sachs Group Inc.

Okay. And just to follow on the Packaging Resources business. Correct me if I'm wrong, but most of the bleached board business is going into or sold to third-party converters while the CUK business is integrated with the converting capacity and Consumer Solutions. Can you talk about what kind of pricing you guys are seeing on the converting side of the box board business and whether you're actually passing through the entire change on the tonnage basis in CUK on the converting side? Or is that going to happen over time as contracts are renegotiated there? How does that work?

John Luke

Yes, let me start. And Jim, you can fill in any of the blanks. But as we price our business on the converting side, we do so based on value and look to make sure that we get paid for the value of the service that we're providing. A lot of that business is done through contract with large customers. And those negotiations take place on a periodic basis. We've got longer-term contracts. And in there, we look to get paid for value but also ensure that we're protected for things like inflation in raw materials and in freight. So we are very much pricing to market and looking to get paid for the service that we provide in through those contracts.

Alex Ovshey - Goldman Sachs Group Inc.

Okay, that's helpful. Just a question on the land business. I think heading into Analyst Day, I think part of the rationale for the day was to provide a current detail to the marketplace to potentially have the share price better reflect the value of the land. Since that day, it doesn't appear like that's been the case. The stock's actually traded off modestly. And given the fundamental strength of the business, it seems pretty clear that the value of the land is not at all reflected in the valuation of the stock now. How frustrated are you with the fact that, that's probably the case, that the land, which is pretty valuable -- which is a pretty valuable asset doesn't appear to be at all reflected in the share price right now?

John Luke

Alex, I think you've noted something that, among other things, prompted our desire at the point in time we had the Investor Day to ensure that folks understood the dynamics of the business and, clearly, the upside potential with the clear strategies that are being developed. We would love to see a higher value reflected in our stock price. But we also recognize that the combination of 2 things will drive that: one, continued performance and demonstration of that performance; and with that, continued education of the investment community as to the underlying value. And along the way, hopefully, we will see much greater recognition of the intrinsic value of this property, as well as Specialty Chemicals, and we'll see that reflected in the stock price. But we recognize that we've got a job to do on both counts.

Alex Ovshey - Goldman Sachs Group Inc.

Maybe I can ask just one last question. On the Specialty Chemicals business, the margins there now or the EBIT margins are north of 25%. I think the long-term target that was presented at the Analyst Day was 15% to 20%. So what are you worried about in that business that you think longer term, the margins would have to compress from where they are today to what you think is a more normalized to 15% to 20% margin?

John Luke

Well, one of the things that we talked about down at our Investor Day is the fact that we are going to continue to invest in new products, in new markets. And that can, from time-to-time, certainly, as you initiate those investments, you don't get that peak level of return as you're doing that. So certainly, our sites remain high and we're going to be looking to deliver margins in that 25% target. But in running the business and as you go through the cycles of investment and looking to grow out your new products and in new markets, you are, from time to time, going to -- you're going to hit lower points. And that's really more a function of what we're thinking about there as opposed to any untoward series of events or competitive threats.

John Luke

Yes. And I think I would just pick that up and say that as you saw down in Charleston, Alex, we've got an excellent leadership group. And you've had a chance to see firsthand an extended grouping of individuals who are really helping drive that business forward. What we've got are opportunities in 2 areas. One, as Mark said, new areas of participation that we're very disciplined and discerning about defining and moving towards, but recognizing that they may bring some of the challenges Mark alluded to, as well as significant opportunities we're continuing to grow with the -- what we have now is a core mix of products and businesses, both here in Europe and, very importantly, in markets like China and, increasingly, India, not to mention Brazil. So we see an awful lot of profitable growth potential.

Operator

Our next question comes from the line of Peter Ruschmeier with Barclays Capital.

Peter Ruschmeier - Barclays Capital

Just a couple of housekeeping questions here on the cash flow, maybe for Mark. Do you have any guidance for us on cash tax versus book tax this year?

E. Rajkowski

Pete, I don't -- there's nothing there that suggests there's going to be a big gap between our book and cash tax. So...

Peter Ruschmeier - Barclays Capital

Okay. That's helpful. And in terms of -- is pension income still expected to be around $80 million for the full year?

E. Rajkowski

Yes.

Peter Ruschmeier - Barclays Capital

Okay. And then how do you think about working capital, either on a back half of the year basis or a full year basis in terms of source versus use?

Mark Lewis

I think as we've looked at the back half of the year and think about some of what we've got facing us in terms of our big outage at Covington and Mart [ph], we have consciously built up our inventory levels and we certainly expect those to be drawn down over the second half of the year. So I'd expect more of a source of cash coming from working capital than a use of cash.

Peter Ruschmeier - Barclays Capital

Okay. And as it relates to those 2 outages, Covington and Mart, is the economic cost of that primarily the lack of -- the opportunity cost? Or are there any quantifiable expenses that you're going to run through income statement that you could help us out with?

James Buzzard

Pete, it's Jim. It's really a combination of both. So normal recovery boiler outage at Mart and the expenses that are related to that for maintenance and then a more significant outage at Covington, which, again, there's some lost opportunity, but also the expenses related to the upgrade we're doing there, as well as recovery boiler outage there.

Peter Ruschmeier - Barclays Capital

Any way to quantify either on a standalone or a combined basis kind of the economic impact of those outages?

E. Rajkowski

Well I think we laid out in our comments last quarter, Pete, that the Covington outage, which Jim referred to, which is the more significant one, is we expect to have an impact of around $30 million.

Peter Ruschmeier - Barclays Capital

Okay, that's helpful. And coming back to EBITDA for a second, did you sell any tons in the second quarter? And looking to 3Q and beyond, how many tons do you think you could sell on a, say, on a quarterly basis?

John Luke

Pete, we're at a very modest impact in Q2 and we're really just ramping up at this point in time. So we're doing work in the markets and making sure we're doing this the right way. But you could assume we're up and running at a run-rate basis and doing what we think we can do, we might be in the 25,000 to 30,000 tons a quarter.

Peter Ruschmeier - Barclays Capital

Okay. And just lastly, maybe. As you think about some of the sensitivities about the macroenvironment, I'm curious on what you're seeing in back-to-school. If you can elaborate a little bit on kind of the mood and the tenor and your outlook for the third quarter, the types of behavioral order patterns and type of behavior you're seeing in the marketplace?

James Buzzard

Sure, Pete. As I said, going into it, we feel very good. The combination of our product and its placement in the stores and what we hear as the level of promotion all give us good feelings. But this is always the nervous time of the year for us. And I think everything that I have read suggests that the consumers are going to buy a little bit later. So I think we'll see it push back a little bit. And you have to believe that they will continue to be guarded in their spending patterns. And so the forecasts I've seen are sort of flat to maybe slight declines in back-to-school in total. How that plays out in our categories, we really have to wait and see. It's too soon for us to tell.

Operator

And our last question comes from the line of Chip Dillon with Vertical Research.

Chip Dillon

I don't know if you actually reviewed this, but the Mart Mill, which you said was going to be down in the third quarter, when was the last time that mill took an extensive shut? I don't believe it's every year in the third quarter, is it?

James Buzzard

It's a -- we have historically taken recovery boiler outages on an annual basis. It could move a little bit from quarter to quarter.

Chip Dillon

And was it last year in the third quarter as well?

James Buzzard

Chip, I'd have to confirm and get back to you, but I think it was in the fourth quarter.

Chip Dillon

So it's a little bit, if you will, a challenge. And you're making an improvement this year in the third quarter in resources versus last year without having had to incur the downtime last year. So just to clarify, it's a bit more of a challenge that you're overcoming this year?

James Buzzard

That would be correct Chip, yes.

Chip Dillon

And then second question is you had talked earlier about CapEx, which I know you're not solid on in terms of a number for next year. But if we sort of combine '11 and '12 and we're approaching, I guess, $1.3 billion, which is sort of, I don't know, 3x what you had spent say in '09 and '10, which makes sense given that the economy is better, but as we look beyond '12, it would seem like Rigesa's basically done, Covington would be done. Do you anticipate more projects or spending of this magnitude in '13 and '14, barring any changes or major acquisitions?

John Luke

Chip, let me answer that. And Jim and Mark can chime in. I think the short answer is that you would normally expect, and we would expect with our planning, to see a ratcheting down of capital expenditures as we move forward. Our capital expenditures outside of normal maintenance are and will continue to be driven by economically profitable returns on projects that will enable us to enhance our market participation and growth here and around the world. And so at whatever level we are spending, you can expect to hold us to the expectation of solid profitable -- economically profitable returns. But again, I would go back to say that the unusually strong level of spend now will clearly be ratcheting down in the wake of these projects.

Jason Thompson

That concludes our call, everyone. Thanks for joining us, and we look forward to speaking with you next quarter.

Operator

Thank you, ladies and gentlemen. This conference will be available for replay starting today at noon and will run until August 27 at midnight. You may access the replay service by dialing 1 (800) 475-6701 and entering the access code of 209106. You may also dial (320) 365-3844 and entering the access code of 209106. Those numbers again are 1 (800) 475-6701 and (320) 365-3844 and entering the access code of 209106. That does conclude your conference today. You may now disconnect.

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