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Rock-Tenn Company (NYSE:RKT)

F1Q2012 Earnings Call

January 25, 2012 9:00 am ET

Executives

Steve Voorhees - CFO

Jim Rubright - Chairman and CEO

Analysts

Philip Gresh - JPMorgan

George Staphos - Merrill Lynch

Mark Wilde – Deutsche Bank

Chip Dillon - Vertical Research Partners

Mark Weintraub - Buckingham Research

Philip Ng - Jefferies

Al Kabili - Credit Suisse

Steve Chercover - D.A. Davidson

Bill Hoffman - RBC Capital Markets

Operator

Good morning. My name is [Gweney], and I will be your conference operator today. At this time, I would like to welcome everyone to the Rock-Tenn’s First Quarter Fiscal 2012 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. (Operator Instructions) As a reminder, slides are being presented today as a part of the conference call. These slides can be accessed at www.Rock-Tenn.com under the Investor Page. Ladies and gentlemen, this call is being recorded today, January 25, 2012. (Operator Instructions) Thank you.

Your speakers for today’s call are Mr. Steve Voorhees, Chief Financial Officer; and Mr. James Rubright, Chairman and Chief Executive Officer. Mr. Voorhees, you may begin your conference.

Steve Voorhees

Thank you, Gweney. Welcome to Rock-Tenn first quarter 2012 conference call. This is Steve Voorhees, Chief Financial Officer. I'm joined by Rock-Tenn's Chief Executive Officer, Jim Rubright.

During the course of this call, we will make forward-looking statements involving our plans, expectations, estimates and beliefs related to future events. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from those that we discuss.

We include a description of these risks and uncertainties in our filings with the SEC including our 2011 Form 10-K. During the call, we may also refer to non-GAAP financial measures. We provide reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the appendix of this slide presentation, which is also available on our website.

Jim is going to begin with a commentary on the performance of our businesses during the quarter, and then I will discuss the progress we're making on capturing synergies as well non-operating items in our financial statements. After our prepared comments, Steve and I will be available for questions. Jim?

Jim Rubright

Thanks Steve. We reported $1.18 per share in adjusted earnings in a period marked by lower export demand and pricing and falling pulp pricing. In addition, our earnings were lower than the sequential period as we expected due primarily to the combined effects of seasonality because the period from mid-November through January is our seasonally weakest period particularly in the container board business, and the major maintenance outage expenses that we incurred in the quarter as we had no major maintenance outage expenses in the September quarter.

These seasonally market factors primarily impacted our Corrugated sector where our earnings declined $0.39 per share. We continue to maintain our progress integrating Smurfit-Stone acquisition and even though our corrugated segment earnings were down sequentially the acquisition was still $0.15 per share accretive during the quarter.

Consumer Packaging was down about $0.03 per share as lower recycled fiber prices and natural gas costs had a greater proportional impact in offsetting seasonal weakness in that business. Our Recycled earnings were down about $0.01 a share since recycled plant margin normally compress in a period of fall in recycled fiber prices. Steve will detail the changes in both expenses in Other that we show slide 6.

Our trailing 12-month EBITDA, credit agreement EBITDA was about $1.3 billion and free cash flow at $64 million for the quarter as we used substantial funds to build primarily container board inventories and to fund our pension plans as we detail in slide 8.

As you can see, we generated $307 million in cash from operations. This of course is non-GAAP number but it is in fact the cash available for the uses that we've shown. The largest of the ongoing uses were $82 million in capital expenditures, $69 million in pension contribution in excess of expense and $69 million of billed container board inventories as we discuss to support our planned outage use in the spring.

In addition, we paid $89 million to acquire Corpak, and we paid $13 million to Smurfit’s former CEO, which was an acquisition related payment that had to be differed for six months under Section 409A of the Internal Revenue Code. Steve will comment later on the proceeds from property sales, all of the resulted in net debt increase $31 million in the quarter.

As I mentioned, Corrugated segment earnings reflected the seasonality of our business and major maintenance outages, as well as a significant production loss that at our West Point white top liner board mill that was caused by a power failure, which combined to reduce container board production by 81,000 tons in the quarter. Our segment earnings was $16 million lower due to container board sales volume, $13 million lower and lower export and pulp prices, $14 million lower from seasonal sales mix changes, which I will detail, and were about $14 million higher due to softening commodity input prices from primarily recycle fiber. We detail these changes further in slide 10.

Commenting on our seasonal converting sales mix generally in the December quarter, we have a higher proportion of sheet sales, which have lower margins and a higher proportion of sales, the national count direct merchandisers, which are driven by the holiday season. These mix changes should reverse as we move out of the second fiscal quarter particularly into the third and fourth.

Our overall converting volume trends were positive with converted product shipments up 5% over the preceding quarter on a per day basis and up 2.6 % Q1 fiscal '11 on a per day basis. Over the course of the year, we exited about 2.5% percent of our total box volume on the basis of pricing decisions that we made in rationalizing the Smurfit business portfolio, although we had replaced most of these volume by the end of the first quarter of fiscal 2012.

Our Consumer segment continues to perform very well with segment income down only $2 million in our seasonably weakest period. EBITDA margins increased 90 basis points primarily due to lower recycled fiber costs. Segment income increased $9.3 million over the prior year quarter. About two thirds of that was earnings from former Smurfit display plants that are now included in our consumer segment, and one third was from higher sales and operations improvement in the legacy Rock-Tenn business.

We did take some unexpected economic downtime in our Stroudsburg mill this is an 80,000 ton per year coated recycle mill that produces especially greater paperboard that substitutes for coated natural craft in many applications. Our four other folding carton and recycled board mills did not take any economic down time in the quarter.

Our Merchandising Display business continued to have very strong sales and very good results.

Our outlook for the second quarter and the balance of the year is tempered by the possibility of continued weakness in the export markets, although we do believe these markets have bottomed and we see evidence of improving pricing, as well as through continuation of highly competitive domestic box markets, which in turn assumes essentially flat domestic demand conditions.

While we expect the benefit in January and February from lower recycle fiber costs, our expectation is that recycled fiber prices will trend up over the balance of the quarter reflecting the passing of the Chinese New Year. But ultimately recycled fiber prices and a potentially significant benefit to Rock Tenn will depend in large part upon the strength of returning Chinese demand.

We are now taking economic down time in our container board sector in the second quarter due to the export market conditions I have described, and again some economic down time in our Stroudsburg specialty coated recycled board mill to match up with our customer demand.

We expect to take major maintenance outage down time of about 47,000 tons in the second quarter which is about the same as what we took in the first quarter and then in the third quarter we will take about 145,000 tons and none in the seasonally strongest fourth quarter.

Our needed inventory bill will continue in the second quarter bringing it to a peak at a total of about 150,000 tons and then that will unwind completely in the third quarter.

Given where we are in integrating the Smurfit acquisition and the schedule of capital deployment particularly to improve mill operations and assuming that all other things are equal to our view today over to the conditions we are experiencing today, we do not expect to see significant earnings improvement until the fourth quarter of ’12 in the first and second quarters of ’13 when we complete our major projects at our Hodge and Hopewell Mills, and until we have addressed some of the legacies of the Smurfit mill performance issues.

The Hodge and Hopewell projects themselves which I have spoken on about -- combined to about a 140 million of the projected capital cost we forecast in 2012 and 2013 these projects are very high returns averaging in the approaching 40% and as viewing them on the most conservative basis as possible which is looking solely at direct mill production costs and assume no other major changes in our mill system.

We also expect to continue to employ the capital. We said for spending to remedy the basically legacy performance issues in the Smurfit mill system is about $100 million of that capital in 2012, and we are confident that that will resolve a number of the production and quality issues that we are experiencing that have been affecting the profitability and cost structure of the segment, particularly in the most recent quarter.

In addition, we will continue to run higher than normal staffing and business transaction cost as we continue to optimize our box plant system then higher administrative and IT costs as we execute a major systems integration changes we discussed. These IT projects involve the SAP and JD financial system conversion for this Smurfit business and conforming all of this former Smurfit box plants to Rock-T's IT operating system model.

It’s really not practical to segregate all of these cost and showing adjusted earnings, and we have not attempted do so, and we can’t capture the related synergies until these projects are all completed later this year in the case of the Hodge project and next with respect to the Hopewell project and the realignment of the financial systems in the box plants.

These factors combine to support our view that the primary integration and performance benefited the integration of the acquisition will show up in the fourth quarter 2012 upon completion of the Hodge capital project and a number of the maintenance projects we will do during our major maintenance outages in the second and third quarter.

And then, again in Q2 of 2013, which will be upon completion of the Hopewell project and the completion of the financial system box plant changes I've described and again, the continuing benefit of maintenance capital and box plant plan realignments that we are putting in place today.

That concludes my operating comments, and Steve will now discuss progress on synergies in certain financial matters.

Steve Voorhees

Thanks, Jim. I'm going to start with the progress we've made on the integration. The run rate of synergies and performance improvements increased by $23 million in the quarter to an annual rate of $133 million. We've broken out the $133 million between synergies and performance improvements.

Synergies are profit improvements that are a direct result of the combination of the companies. Performance improvements are profit improvements that we’ve achieved, and that do not flow directly from the combination.

Our synergy run rate was $109 million and our performance improvements include $15 million from box plant closures and $9 million from staff optimization, primarily at the containerboard mills.

Going forward, we will continue to report our progress toward achieving our synergy target of $150 million by the end of calendar year 2012. We continue to expect to achieve performance improvements of $400 million by the end of calendar ‘13, which is two and a half years from the completion of the acquisition.

Quantifying these improvements and separating them from the other changes in our business over time was a distinction without a substance to difference. The same is true for the non-capital expenditures necessary to achieve the performance improvements, all of which have been captured in our aggregate capital expenditure guidance of $480 million declining to $500 million for the year, declining to a run rate of $350 million in fiscal 2014.

As such, in the future, we want to report performance improvements and the associated capital expenditures except for discrete items, but rather reflect these items in our reporting of normal operating results.

Through the end of December, we spent $56 million of the expected $130 million in cash restructuring cost. The $130 million includes what we expect to incur for all the box plant closures to-date and the cost to integrate our administrative processes. We expect that most of the remaining $74 million in cash restructuring cost will be incurred during fiscal year 2012. Our conversion from Smurfit-Stone’s SAP financial system to JD Edwards will be completed at the end of the March quarter, a significant milestone that will allow us to move closer to completing the administrative portion of the integration activity.

Many of our box plants have been collaterally located on sites that have proven to be valuable for other users. To-date, we have received proceeds from the sale of real estate and other assets of $13 million, and our current estimate for total proceeds from the planned closures to $66 million. This will offset about half of the cash restructuring cost.

Turning to our key cost inputs, wood cost increased compared to the September quarter by nearly $1 per ton. This is in line with seasonal patterns, and was more than offset by the decline in recovered fiber prices by about $30 per ton in the quarter.

We have benefited from the continued decline in natural gas prices. The twelve-month NYMEX stood at the time of our last conference call was $3.92. Today it’s approximately $3.

During the first two weeks of January, we converted our Stevenson mill from using fuel oil to generate steam to using natural gas to generate steam. This is replacing approximately 10 million gallons of fuel oil per year with 1.5 Bcf of natural gas. At today’s prices, this benefits to mill by over $10 per MMBtu or $1 million per month.

We are converting the boiler systems at three more of our mills from fuel oil to natural gas. Like contracting with local gas marketers and distribution companies to our natural gas lines to the mills. The dollar savings are significant. We expect the West Point Hopewell and Fernandina Beach Mills to replace fuel oil with natural gas by the end of this calendar year. Including the Stevenson Mill, the four projects will replace approximately 36 million gallons of fuel oil per year with 5 Bcf of natural gas.

We expect that the total natural gas conversion project cost of the four mills will total approximately $25 million, of which we spent $2 million to-date. We estimate the annual benefits from these projects at current prices to be $45 million to $50 million.

We should realize the full run rate to savings in fiscal year 2013. We have included these R&D projects in the performance improvement targets we previously mentioned.

At the Solvay Mill, we recently entered into an arrangement with the current steam provider that will enable us to terminate our existing steam supply contract later in this fiscal year and enable us to transition from coal to natural-gas based steam for the mills.

We will receive an amount of money from our counterparty that will fund our acquisition in construction of a natural gas package boiler plant.

The existing steam supply contract at Solvay would have run through 2018, with the cost of coal and the environmental cost and uncertainty of our coal based steam supply, and considering the availability of natural gas supply from the Marcellus shale. This is a very good deal for Rock-Tenn.

Turning to our guidance on certain financial statistics, there were no major changes to the first three line items on the slide as compared to what we provided you on our last conference call.

We continue to estimate depreciation and amortization for the year in the $550 million range and corporate and interest expenses for the March quarter to be $26 million and $32 million respectively.

Our book tax rate for the first quarter was 38.3%. The tax rate was six-tenth of a percent higher in the first quarter due to the one-time adjustment to deferred state income taxes rising from the Corpak acquisition.

We currently expect our book tax rate in fiscal year 2012 to be between 37% and 38%. Our cash tax rate would be substantially lower as we use our available federal net operating losses and other tax credits on our books to offset cash taxes. Unsold or unused tax items aggregate to approximately $388 million and reduce future federal cash taxes.

You may have seen that Capstone recognized $63.6 million tax benefit following an IRS audit in which its position that slack liquor products were not taxable was accepted. Rock-Tenn has $254 million tax reserve that we will reserve to receive the same outcome in our loss.

As we disclosed on our last conference call, we have conformed the accounting for major maintenance outages and the legacy Smurfit-Stone mills to Rock-Tenn's policy of recognizing the expense ratably over the period from the time incurred to the next scheduled outage. Since we started accumulated the expense recorded in connection with acquisition there was only $2 million of maintenance outage expense recognized from the September quarter.

In the December quarter, we recognized $6 million in maintenance outage expense. This expense will increase as outages occur. We expect this expense to increase to $17 million to $19 million in each of the last two quarters of this year.

At the end of September, our net debt was $3.4 billion and our credit agreement debt to EBITDA ratio was 2.7 times. Liquidity was $1.3 billion at the end of the quarter including the $227 million of new funding from the term A2 that we completed in December of 2011. This liquidity is more than adequate to support our business as well as to fund the plan called for $300 million 2016 9.25% notes in the March quarter. Overall, our balance sheet and liquidity are in very good shape and are able to support the business.

That concludes my planned remarks. Jim and I are now available to respond to your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Philip Gresh, JPMorgan. Your line is open.

Philip Gresh - JPMorgan

Just thinking about on the quarter and the results they're obviously there below the Street, seems like may be some of that was seasonal, may be the Street is a little high for that, but what would you say in the actual results in the quarter kind of surprise you relative to what you initially thought?

Jim Rubright

Well, we don’t give specific guidance as you know, but that doesn’t mean we don’t model the business. Phil, we are pretty familiar with your model, and I think we were pretty consistent in our view with respect to where the quarter would come out until the export just fell out a bit which really happened in about October. I don’t think people appreciate fully the extent of that for Rock-Tenn. I mean, proportionately we are the largest exporter, and we export a lot of white top. And when you lose that it's disproportionately adverse because of the higher margins we've got on white top line or then brown.

We were faced with a situation in which a couple of European but very large international supplier fired lawsuits essentially its European demand and came in and took the Middle East markets out in that ultimately corrupted Latin America. So we look, you know, we had a choice to essentially follow the pricing behavior down or just draw the line and we chose to draw the line. So, we take quarter over quarter -- yeah, the year-over-year quarter in Q1 2011 we exported about 15% of our total container board production; in the first quarter 2012 we exported about a 11% of our total production and, as I indicated, we lost a fair slug of white in that process. So that was really the major driver for us.

The second thing is with respect to I will come back to what we were seeing in the export markets by the way, but with respect to modeling our business with significant reduction in recycled fiber pricing but as you noted our benefit from fiber the $15 million is just less than what you get if you multiplied recycled fiber by the average index change over the quarter. There are several effects. First, you got seasonally higher wood cost which firstly offset it. Secondly, about 15% of the net benefit in OCC reductions are going to be lost because of the reduction in the price that you get for DLK, and then third, we have a just an inventory and in transit issue which ultimately cost about six or somewhere between $6 million and $7 million of the expected reduction if you just multiply recycle fiber price and then the remaining about $5 million of benefit that we didn’t show up was a function of just regional index changes versus Chicago OCC. So I think it’s very hard for your guys to model them without having going through a quarter like this one but those with the two major impacts.

Now, commenting on what we see on both of them, frankly the time period in which to really judge where recycle fiber is going or probably February and March as we really understand the impact of returning Chinese demand following Chinese New Year you know, price of the China are up a little bit but frankly our view is that its going to of return somewhere between where it is to possibly as high as it was at the end of the last year by the end of this year. The extent of the return of Chinese demand will really materially impact the possibility that earnings could be better than we are suggesting if you don’t have a return to that level of peak OCC pricing. We don’t see it today but OCC pricing is volatile and difficult to predict.

We have also in our guidance taken a pretty bearish view with respect to export volume pricing essentially saying it is little change from the current market. That may be bearish given what we are seeing. Actually the most recent market feedback we are getting very much supports the fact that we bottomed and are seeing various pricing opportunities in the marketplace. Certainly the market feedback, we are getting with respect to pricing is little more positive and, as I indicated, with our major markets we really held the line in Latin America and because of the large share we have got there and I think our customer relationships with essentially, I think maintain pricing better than the spot pricing in the marketplace and order are firm there,

In addition, in Latin America, we had a number of orders that we turned away on price that ultimately that people placed orders with producers who didn’t produce and ship. So some of those orderings that are starting to filter back to us as people need the supply and where the more of the reliable supply on that market.

So all of these things combine to tell me that we had a pretty distressed period of time in the fourth calendar quarter, our the first quarter, and that they may improve significantly over the course of the balance of the year, but we are not building significant benefit into the guidance we gave earlier. In addition, even if it does improve, it is going to show up way in this quarter and second quarter that we're through January now and if you, by the time those order pass through ultimately show up in sales, you really out in our fiscal third quarter. I would say that definitely the markets bottomed and now the question is just how much is it going to improve and just what that they will do expect out there.

Philip Gresh - JPMorgan

Okay, thank you for all the color there. I guess my final question is just as we look at the quarter ahead, it sounds like, if I'm reading what you are saying correctly, the synergy run rate next quarter might actually be below what we saw in the first quarter, just because of the timing of your projects. And then falling under that is the seasonal mix may also not come back until the following quarter as well. So am I right about that? And if so, does that mean you know, we should be thinking about profits being down quarter-over-quarter next quarter just kind of be very explicit about it?

Steve Voorhees

It’s difficult to model within that degree of precision and as I say we don’t really attempt to try to give specific earnings per share guidance. With respect to the issues you raised, yes. With respect to the second question and that is the seasonality will reserve over this quarter, because really you don’t come out of it through a lot of January and the mix change is particularly getting out of the sheet mix and so forth, a lot of that you will see in the second quarter. So from the timing standpoint I think you are reading that right.

I don’t expect the synergy run rate to be lower than it was in the first quarter. I think it’s basic what we are seeing as we think that’s going to be essentially flat, because we will get some incremental procurement savings, but not a lot, and really that the major drivers of the synergies and operating improvements as I mentioned we will show up in Q4 ‘12 and then Q2 ‘13. But we still have a clearly high degree of confidence with respect to the returns we expect out of those projects in what we’re doing.

Operator

Your next question comes from George Staphos, Merrill Lynch. Your line is open.

George Staphos - Merrill Lynch

Thanks for all the color on the market factors and export, and obviously, it was a challenging market more so than we would have modeled. I guess were there any execution issues from the way you were in the export portion of your business and that maybe caused you some performance or was it purely just the market, as far as you could see? That was my first question. Second question, could you quantify for us how much impact you had from the West Point outage?

Jim Rubright

Yeah. The West Point and the export markets are related because West Point is an export market mill for some of the white top. And the total cost of the West Point outage was in the range of $5 million. We had both production loss and expense. So it was a pretty significant factor that I could explain you what happened, but it was basically a reactor failure and it just shuts down the mill. It’s just a small thing, it has really big consequences, and so we had to fix it and put it the way it should be, which we did in the quarter, but it was fairly expensive.

George Staphos - Merrill Lynch

Okay. And in general, just in export overall, was it purely market factors or were there anything that you might have been able to do that might have ameliorated the impact of the market factor with regard to your performance in export?

Jim Rubright

The pulp markets are the price taker, and we've exported it about what we thought we were going to export, 8,000 ton range of pulp from the containerboard sector; we don’t export in consumer. So no, I thought we do what we could do, but we took price. And, actually I think we had a pretty positive effect on, particularly, the Latin American market with our execution and our pricing strategy because somebody, we basically, as I say, I think we held the line on pricing and benefited from not matching price in that marketplace.

George Staphos - Merrill Lynch

Okay. I appreciate that. When we look at the investment thesis that you laid out over the years relative to Smurfit acquisition, a fair amount of it obviously is in generating cash and deleveraging, which you’ve done very well with your prior acquisition. Certainly, there have been some factors, including the GMI acquisition that have a reason, early in your ownership at Smurfit has prevented the debt pay down perhaps that you might have expected or project initial. I don’t know if that’s a fair comment but I would just like your thoughts there. And when do you expect -- when should we expect a more meaningful reduction in the debt for the company on a going forward basis?

Jim Rubright

Right. Well, you identified a lot of factors that we have spent a lot of time talking about. The first one is GML just fell into our lap and the timing was not what we would have liked, but it was, we just couldn’t, not do that transaction. That business has preformed very well. So there is $90 million that would have otherwise gone to debt reduction.

The second what we mentioned is the inventory build. And that inventory build is going to turnaround and that’s $80million, that’s really pretty significant.

And then lastly, we view the pension funding in excess of expenses a debt repayment. We always viewed the unfunded pension liability at Smurfit is simply an assumed acquisition liability because the pension plans are largely frozen, and they we’re running relatively low pension expense because of the 85,000 participants, 75,000 are frozen. So that’s just repaying debt and I think our X what we owe is $69 million was that the amount. So while we get, we payoff $69 million of acquisition debt there.

Ultimately, the unfunded pension liabilities remains pretty high, but that’s a function of the fact that right now if you look at the 10-year treasury on an inflation adjusted basis we have negative interest rates. We’re paying the federal government to owe their money right now. So do you think -- do we all think that’s really a normalized condition. It’s going to extend through the five-year period in which we anticipate funding that unfunded liability. Personally, I just don’t see how that condition can continue as it is and if you have a change in the discount rate that will dramatically affect our funding obligation. So we still look at it so we've reduced that liability by the funds that we’ve contributed.

George Staphos - Merrill Lynch

Okay. Last one, I’ll turn it over very quickly. You said the maintenance expense was, the average expense was $6 million I believe in the quarter that just passed. I think you said $17 million for this quarter, then $19 million for the remaining two quarters of the year. Did I get that right? Thanks guys.

Jim Rubright

It’s 7, not 17 and 19. It’s on bit of a slide.

George Staphos - Merrill Lynch

Okay, I will turn it over. Thanks.

Jim Rubright

And that’s just, that’s the maintenance expense. It’s not the production loss.

Operator

Your next question comes from Mark Wilde, Deutsche Bank. Your line is open.

Mark Wilde – Deutsche Bank

I wondered if you guys can put a little bit more color on what you’re seeing in terms of competitive box conditions, box market conditions? And you can put any kind of color around what might be going on broadly in box pricing?

Jim Rubright

We live in a competitive world. I think on slide 10, we showed our price mix, which is largely price adversely affected us by that $10 million in the quarter, that’s $10 million on segment sales, but it's really box price effects of a pretty competitive market.

When you have, what we’ve had, Mark, which is a very long period of time of stable containerboard pricing and essentially not much of a recovery in demand, you’re going to get continued pressure on box pricing. And so, I think what we’ve got is what we’ve got until some major contingency in our business resolved itself or really something changes. So it’s just a competitive world.

Mark Wilde – Deutsche Bank

Yeah, I know you wouldn’t know all this in detail, Jim, but does it seem like it kind of goes to cross sort of your whole box mix, and I guess what I’m really getting at is, would you expect that containerboard prices are flat, box prices are going down, that even independent converters of corrugated are probably think some margin compression right now?

Jim Rubright

Well, I think they have to be because containerboard pricing is been held as held up. I mean, we’re not seeing a change in containerboard pricing and demand is fine. So maybe if you look, if you just take the exports away, our domestic demand has been fine and pricing has been fine.

So if we’re seeing compression as an integrated, if you don’t have the mills behind you and you’re an independent, you’re definitely seeing compression. If you’re seeing the same thing in the marketplace as we are, and we’re 50% national accounts and 50% regional and local accounts. So 50% of our business we’re out there with the independents.

Mark Wilde – Deutsche Bank

Okay. Next moving to this export weakness, I’m just assuming that the market doesn’t bounce and I’m hearing some of the same things that you suggested that maybe its bottom, that maybe there is a little bounce. But if it really didn’t bounce this year, would you make a capacity just more of a permanent capacity decision rather than just taking downtime?

Jim Rubright

Well, we’ll evaluate that as we move through the year, Mark. We certainly are responding to the demand signals in the marketplace now. If you drive by the Jacksonville Mill, you’ll see that it’s not operating, and that we’re pretty consistent in our approach to the business. So we’ll continue to monitor that situation.

Mark Wilde – Deutsche Bank

All right, and this is also Jim just you’ve never been a big exporter before other than I think kind of pulp part of Gulf States, but does this, the last quarter too and the drop-off in the export markets. Does that have you rethinking about sort of the channels through which you go to the export market?

Jim Rubright

Well we will rather view that we could improve the overall performance of the business by really disappointing ourselves with respect to the way in which we sold particularly in the Latin America and improve that market. And as I mentioned before, I think that had a positive effect on this quarter. But to a certain extent if you have this demand drop 4% to 5% in Europe, as you did in European converter, so they’re not going to rationalize temporary capacity. They are going to come into the marketplace. They’re going to have a pretty significant effect on price and that’s what we saw. So you immediately you, you withhold your capacity and we did some of both.

Mark Wilde – Deutsche Bank

Okay. Last question I had, page 38, in the slide that you’ve gone sort of that cost curve for your mills, and I just wondered if you could take the last three mills at the right St. Paul, Matane, and Jacksonville and you talk about sort of what your strategy is at each of those?

Jim Rubright

Yes, right now, we’re really evaluating the overall situation. We haven’t announced any major changes there. St. Paul is like you see Rock-Tenn mill its cash cost relatively high but it has extremely favorable shipping radius because it supports our Midwest box plants. It’s fine.

Matane is a little bit more challenged. We actually have the capacity to pulp virgin fibers in Canada, but virgin fiber in Canada is very expensive. Of course, makes no sense because all you see is trees around the place. But Canada can have whatever policies it wants to have. So Matane is a little bit challenge with respect to its cost structure and there is not a lot we can do from an investment standpoint.

Jacksonville has very high energy cost due to legacy energy contract that we simply fell into that. We believe, we can and need to restructure, and then we’ll evaluate the best answer there

Jacksonville also, we think we can improve the cost of fiber into the mill. We are making some steps to rationalize fiber supply and of course with our large recycle presence in the Southeast, I’m sure we can do some improvements there. But they’re not assets that capital will have a significant impact. They are what they are, all three of them.

Mark Wilde – Deutsche Bank

Okay. Last question. Is there any roll through from these OCC prices into the current quarter? In other words, was there any lag in terms of how the inventory rolled through such that we might see further reduction this quarter?

Jim Rubright

Well, yes, the inventory lag really should flow through and I think there is something in the range of $10 million to $12 million, if pricing stayed the same, as it was in December? It’s up a little bit; export pricing is up a little bit in January. We haven’t seen February yet and really it depends on what happens to pricing going forward. But there is a $10 million to $12 million roll through just as you indicate.

Operator

Your next question comes from Chip Dillon, Vertical Research Partners. Your line is open.

Chip Dillon - Vertical Research Partners

First question is little one, is the slide shows $19 million maintenance cost in the fourth fiscal quarter, but there is no downtime indicated for that quarter. I was wondering how you would reconcile those two?

Jim Rubright

We are amortizing the cost of outages. So when we incur an outage at say earlier in this fiscal year, those costs will be put on the balance sheet and recognized overtime, between the time of the initial outage and the next schedule of outage for the mill that took downtime. So, the 19, is the accumulation of those cost and that would be expensed during that quarter.

Chip Dillon - Vertical Research Partners

As we look at the next few years, sort of when you get to more steady state post Smurfit-Stone, I would guess that means then maybe a similar pattern as we’re seeing this year with pretty low maintenance expense in the first half of the fiscal year and bigger in the second half when actually you’re running the mills better?

Steve Voorhees

Right, Chip, we’re adopting a different accounting methods than Smurfit had. And just there was effectively no outage expense on the balance sheet at the time of the acquisition. So the buildup this year is really the accumulation of those cost over time. So you wouldn’t expect that buildup to occur. I think going forward, that amount of the $17 million to $19 million would be in the range of what we would expect going forward steady state.

Chip Dillon - Vertical Research Partners

Gotcha, for the quarter, okay. And then, on the total synergy and cost reduction and just to verify, I think you mentioned you expect to be at $400 million run rate by the end of fiscal ‘13, and ultimately at $550 million. Sort of how does that last $150 million phase in, will that be seen by the end of ‘14 or does it stretch into ‘15, I know that’s getting out there but just to kind of give as a feel for that?

James Rubright

Those two pieces to the number, and the $150 million is the synergy number that we’re defining as benefits that occurred from a result of the combination that we’re expecting to get to that run rate by the end of this calendar year. The second number the $400 million is a separate number. That’s what we’re expecting to get to a very longer period of time the first two and a half years of the acquisition. Those two numbers aggregate to the $550 million.

Chip Dillon - Vertical Research Partners

Gotcha, okay. So, by the end of ‘14 roughly is when you think you will see the full amount on both categories?

James Rubright

I think during fiscal year ‘14, yes.

Chip Dillon - Vertical Research Partners

Okay. Gotcha. And then -- and the last thing is on the natural gas side. I know that there maybe incrementally higher amount of gas usage in the fourth calendar or fourth fiscal quarter because of the cooler weather, but I noticed the energy cost could go up slightly even though we had that that one-fourth drop in the strip. Were there any hedges that were leftover from Smurfit-Stone that might have caused you not to see a bigger drop in energy? It seems like you’re seeing more this quarter when it’s even -- the weather is even more of an issue?

Steve Voorhees

Definitely not, thanks for asking that question. The number, which is on the slide is a, net of a price and volume variants. The price was positive. However during the colder months we consume more energy at our northern interior locations. And so that’s a net of us using higher volume combined with the benefit of lower price.

Chip Dillon - Vertical Research Partners

Gotcha. And then lastly, just as you think about the dividend, I know that there is -- as I go back in time it seems like there, is there a sort of way you think about going forward a policy in terms of--

We've not that of really you would like to visit more likely once a year and/or do you think we’re going to see a more sort of presents -- on a more ad-hoc basis depending on the conditions at any given point of time?

Jim Rubright

We have not thought of really making any change in our dividend policy or the view that we will pay dividend and we want to pay dividend that roughly replicates our market index. But our belief is that through investments in our business and that return is certainly for the foreseeable future. We’ll drive the best value for our shareholders.

Operator

Your next question comes from Mark Weintraub, Buckingham Research. Your line is open.

Mark Weintraub - Buckingham Research

First, I just wanted to follow-up a little bit on the $400 million profit improvement program. I think you noted in the prior question that you hope that that will largely show up by the fiscal ‘14, and how much though would you expect to show up in fiscal ‘13? Certainly the energy project, the $50 million there presumably would all be in fiscal ‘13, but how about of the other $350 million, how much of it, would half of that potentially be showing up by fiscal ‘13 or is it more backend than that?

Steve Voorhees

No, I think you’ll see a pretty significant slug. I mean, I said we got about $140 million in capital in Hodge and Hopewell and we’ll spend that and have those projects completed by the end of first fiscal quarter of ’13. And so, those are basically minimum 40% return projects. So that’s, let’s do the math, over $50 million just from those two projects alone and the energy projects are $40 million. So that’s $90 million.

And then, there is a significant slug that’s going to come out of box plant rationalization and realignment where we’re optimizing the footprint of the box plants, optimizing staffing, basically doing pretty significant equipment realignments in the plants and those are going to really pretty significant benefits, but that’s like sort of like an 18 month timeframe to get through a lot of what we contemplate 18 months from now.

There is a very significant slug of synergies and performance improvements that will be in place midyear 2013, fiscal 2013, once we get all the systems projects done. And that’s the part a little frustrating because, you do the JD Edwards conversion, but you really haven’t done enough until you convert the box plants to really optimize the administrative functioning of the corporation.

So mid-fiscal 2013 you should see a lot, and as I’ve indicated a fair amount of that is going to come out of performance improvements and increased capacity in the containerboard mill system, and so you should be starting to see significant cost reductions through productivity improvements by the middle of 2013 basically off of the 2012, early 2013 capital, maintenance capital expenditures.

Mark Weintraub - Buckingham Research

Okay. And you highlighted kind of legacy performance issues. I was trying to understand was -- were there any surprises, I mean were they the quality and/or productivity issues a little bit more pronounced in the last quarter than you were hoping to be at and what type of impact, if any, is the fact that you do have these very active capital projects underway potentially having on productivity, while the projects are underway?

Jim Rubright

Well, first, with respect to our expectations at the time we did the acquisition relative to what we found in the mill system, I think it was pretty consistent with what we had expected and I’ve said there is probably $150 million in 2012 and 2013 that really is to address capital maintenance issues that will have effects on the productivity and product quality, which again is very important to rationalizing the functioning of the system. So I would say our expectations there were consistent.

I am disappointed that we haven’t been able to ramp up the production as fast as I thought possible and there are a couple of factors that work there. Number one is as we’ve discussed we essentially replaced under Mike Exner’s leadership the entire leadership of the containerboard mill system and they’re in the process of also realigning their staffing to essentially put in place the people that can make the kind of sort of significant productivity and quality improvements in our mill system that we think are possible there. So you have to put all of that in place before you can really start and so while we’re seeing improvements, we’re not seeing at the pace that I think all of us would be happy to have seen.

And then, a lot of it just takes capital and you got to ultimately determine exactly where the greatest and priority projects are, and then you got to engineer them and employ them and a lot of it has to be done in outages. So, I would expect a lot of the stuff, if we pick a mill that’s going to have a third quarter 2012 outage. You are just waiting until then to fix a problem that needs to be fixed, there is nothing you can do about it. So, I think that’s a frustration. Now, whether it’s a difference between what we expected or not I don’t know, I just know I have a lot more granular knowledge of it that I would have without spending six months working with the system.

Mark Weintraub - Buckingham Research

And just one clarification on what you’re just saying. You talked about not ramping up production as fast as you were hoping, was it that or more quality because presumably -- I mean you chose to take some economic downtime given what’s going on in the export market. And so, it didn’t seem like you needed to produce more products?

Jim Rubright

Well, just stop. We’ve got a cost curve and we’ve got low cost mills and got high cost mills. If I can increase the production at a low cost mill, I can reduce the production at a high cost mill. Lot of those high cost mills are recycled where the cost of outages is zero. You can turnoff a recycle containerboard machine and then turn it back on. So, the fact is that if we had been able to ramp-up sooner productivity increases in our lowest cost assets further reducing their costs, we would have been able to produce the overall production cost in the mill, and in fact that’s large part of what we see going forward. So I think that that’s issue.

With respect to productivity the capital is really going to do two things. It’s the one, I’ve just discussed, which is incur increased productivity in very well cost assets. But secondly, there are a lot of inefficiencies in the way this system operates because of inconsistent quality in production and the mill system. So those are kinds of things I said we got to address, in some cases through capital and that capital deployment will occur over the balance of this year. And a good bit of it because of the way we schedule the capital out into 2013.

Operator

Your next question comes from Philip Ng, Jefferies. Your line is open.

Philip Ng - Jefferies

So, I want to get your thought on just the rationale, I mean behavior of some of your competitors, it sounds like you guys took a pretty disciplined approach in managing capacity on the export side. And then your big competitors act accordingly as well?

Jim Rubright

I am really not going to comment beyond what I said with respect to that.

Philip Ng - Jefferies

Okay, that’s fine. And then, just help me understand the table that you have on page 10, you guys breakout the pricing, it sounds like the drag on seasonal mix should reverse itself in Q2. Are you seeing any further deterioration in the box price side?

Jim Rubright

The seasonal mix, as I -- I think I mentioned -- I will try to make this clear we will reverse over the course of Q2. So the full benefit of it you will see in Q3.

Philip Ng - Jefferies

Okay.

Jim Rubright

Not in Q2. And then, I’m sorry, can you ask me the second part of your question again please.

Philip Ng - Jefferies

What about box prices, have you seen price to deteriorate further from what you saw in the previous quarter?

Jim Rubright

No. I would just continue to say its relatively competitive marketplace out there right now, and that’s just what we see.

Philip Ng - Jefferies

Okay, that’s helpful. And this is the last question, just the maintenance expense part I mean I think that you said the steady-state number is going to be $17 million to $19 million on a per quarter basis, is that incremental or is that just a run rate going forward?

Steve Voorhees

That’s the run rate. So, in other words, we will ramp up to that run rate as we do a full year of maintenance outages, and then that full year of maintenance outages on a mill-by-mill basis has been amortized over the course of the 12 months till the next outage. So, once you get to your full run rate then that is essentially steady-state run rate. And, whether its $17 million, $19 million, or $15 million, I don’t know because we know we got relatively major maintenance outages this year compared to historical practices, and I think there is possibility that ramps downs slightly to something could be in the $15 million to $17 million range, but it’s sense if you use $17 million quarter for 2013, that would be about as good as an estimate as we can make.

Operator

Your next question comes from Al Kabili, Credit Suisse. Your line is open.

Al Kabili - Credit Suisse

Yeah, thanks. Just a quick question on the inventory build, and I think you’re building a little bit more inventory in this past quarter and going forward, does that suggest that you may have to take a little bit more downtime in this quarter, economic downtime, as conditions stay the same? Help me out with that one please thank you.

Jim Rubright

Well, we’re building through this quarter and we expect we are building more than we said we would, but that has nothing to do with market demand, domestic, or export its really a function of our view with respect to what the system requirements will be based on the sales we’ve achieved in our box plant system for Q3 -- Q2 and Q3 in connection with the audit, Q3 and Q4. But it’s also a view with respect to the ending balance we want to have when we come out of the busy season, which is the September quarter. So that’s its just unrelated to the market. Its really the export market not the domestic market that’s really the determinant of how much downtime we end up taking, and frankly that’s not something we can predict with great certainty at this point because we are in a market that seems to be changing.

Al Kabili - Credit Suisse

Okay. On the legacy Rock-Tenn business, it seemed like the last time OCC prices fell and demand is sluggish, that the business held up a little better than what we're seeing right now. I was wondering, Jim, if you can you just give us a little bit of perspective on that, if anything has changed in that regard in terms of dynamics maybe with the Smurfit assets that you've added?

Jim Rubright

Well, yeah, I think you are referring to the 2008, 2009 recession and the business performed marvelously then because you had just a precipitous fall in recycled fiber pricing that ultimately bottomed at $40 a ton whereas the margin -- the market bottomed at a higher level. Also the New England and Buffalo indexes did not decline as much as Chicago and the southeast. So, the relative benefit in the northeast where the Solvay Mill which is 800,000 tons of capacity resides did not benefit as much. We are going to pull the number right now but Matt, what did you have for the difference. The northeast was down $25 whereas the southeast and southwest were down $45. so, you just didn’t have a proportionate benefit with respect to the northeastern recycle capacity we have.

Al Kabili - Credit Suisse

Last question, Jim, what are you seeing right now in the box board markets? I guess any thoughts on SBS prices falling, CRB holding steady with despite OCC falling any risks there, one. And then you mentioned, you talked backlogs were going to start to build again, and are you seeing anything there gets you more optimistic or is that is just the seasonality impact there?'

Jim Rubright

I'm glad you asked. I think in the general holding market, CRB, coated recycled board is fine, and then we are seeing backlogs build there. and so, with the exception of the specialty mill I mentioned I think that’s fine and I don’t see any reason why based on operating rates you'd see any change in pricing.

SBS, I was disappointed. We were a large seller to independents and we had not seen price deterioration in the prices we were selling and the balance is ultimately integrated with customer contract. So, our pricing was stable but I think because of the operating rates and the down time that people had announced, not us, but others in the industry, that probably influenced the index better. So, when you change the index by $20 a ton I mean, ultimately that’s going to show up in our spot sales and then ultimately over time pass through into our contracts if it isn’t reversed.

On the other hand, we're seeing a seasonal rebuilding of demand for SBS. So, actually our backlogs are strengthening, and I think the most recent operating rates I saw also indicated some return of operating rates in the system but we do have one major player who's got announcing pretty significant down time, but again, I don’t know the end-markets that are weak. Our demand for folding SBS is fine.

Al Kabili - Credit Suisse

And then just follow -- last question for Steve, tax rate. 37% to 38% I think you guided to is a little bit higher than order have been trending. Is that -- can you just help with the -- is that the full year tax rate we should be thinking about? What are some of the drivers there?

Steve Voorhees

It is a full year tax rate and there is a number of factors that caused I think the inquiries from the guidance we gave last quarter, but it is the full year books tax rate.

Operator

Your next question comes from Steve Chercover, D.A. Davidson. Your line is open.

Steve Chercover - D.A. Davidson

First of all, could you help us, I think your down time and I can see on the board was 80,000 tons as opposed to the 40,000-odd that you’ve guided. How much of it was economic and how much of it was the West Point Mill, the delta between the original guidance?

Steve Voorhees

Well, let me just pull it out and give it to you. So, of the 81,000 tons we had West Point was 11,000. We had maintenance down time of about 45,000 and the rest was economic.

Steve Chercover - D.A. Davidson

Thanks for that clarification. Now, I'm no IT specialist but obviously the Smurfit system fro SAP to JD Edwards is much bigger than converting your system to theirs. So, is there something wrong with SAP or is just two limited in terms of the flexibility?

Steve Voorhees

SAP is a very good system. It's very expensive to operate, maintain and staff and it provides a degree of complexity that really isn’t necessary to operate our business. Our JD Edwards implementation is very efficient, provides the information we want. We've integrated it much more deeply into organization with respect to enterprise asset management integration with the financial systems or the operating assets much more deeply than Smurfit have been able to do with respect to SAP installation.

And the other reason is cost. I mean, we expect to take out $25 million in total IT cost on a run rate basis, essentially none of that that we've experience today. so, it’s a very detailed cost benefit analysis that drives us to promulgate the Rock-Tenn systems.

Steve Chercover - D.A. Davidson

Final quick question. with the stock down at 8.5%, do you contemplate maybe managing expectations any differently going forward?

Steve Voorhees

We try to do the best we can to give people in some visibility into the components of our revenue and expense and to comment as candidly as we can with respect to business conditions and people then can model our business, as they choose to do so. We have not believed it to be our interest to try to get specific earnings per share guidance.

Operator

Your next question comes from Bill Hoffman, RBC Capital Markets. Your line is open.

Bill Hoffman - RBC Capital Markets

Just have two quick questions. Folks, you went through the energy projects, and I just want to if you can explain a little bit more about the Solvay project, how that actually works from a cash standpoint?

Jim Rubright

Our agreement, we are not able to get into the details, but I think our plan would be to follow for a format to use natural gas at the Solvay location and then that would in turn cause the contract to be terminated, and then we would put natural gas boilers in places rapidly as possible. And I think the overall comment that the cash would over time finance a good portion of the natural gas package boilers about all I can say.

Bill Hoffman - RBC Capital Markets

Okay. Then, I'm assuming there is some contract format with that coal system.

Jim Rubright

Exactly.

Bill Hoffman - RBC Capital Markets

Okay. Thanks. And then, the other question is just with regards to pension liability, have you had to recalibrate the total pension liability at this point and time that you gave guidance proofs for the payments for this year, with the total liability is.

Jim Rubright

I think it’s not significantly changed from what we would have recorded in September.

Bill Hoffman - RBC Capital Markets

Okay. And, that was about $1.4 billion I think.

Jim Rubright

Right.

Bill Hoffman - RBC Capital Markets

Now, do you have to recalibrate it here as you get in the 2012?

Jim Rubright

No, not for a financial statement purposes, we do look at it because we manage the overall assets and liabilities actively. But, from a financial recording standpoint we just value it once a year.

Operator

(Operator Instructions).

At this time, there are no further questions. I will turn the call back to you for closing remarks.

Jim Rubright

Thank you for your participation on the call.

Operator

This does conclude today’s conference. Thank you for attending. You may disconnect at this time.

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