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Rock-Tenn (NYSE:RKT)

Q2 2012 Earnings Call

April 26, 2012 9:00 am ET

Executives

Steven C. Voorhees - Chief Administrative Officer, Chief Financial Officer and Executive Vice President

James A. Rubright - Chairman, Chief Executive Officer and Member of Executive Committee

James B. Porter - President of Corrugated Packaging and Recycling

Analysts

George L. Staphos - BofA Merrill Lynch, Research Division

Phil M. Gresh - JP Morgan Chase & Co, Research Division

Mark Wilde - Deutsche Bank AG, Research Division

Chip A. Dillon - Vertical Research Partners Inc.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Kurt Schoen - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Albert T. Kabili - Crédit Suisse AG, Research Division

Philip Ng - Jefferies & Company, Inc., Research Division

Steven Chercover - D.A. Davidson & Co., Research Division

Joshua L. Zaret - Longbow Research LLC

Stephen Atkinson - BMO Capital Markets Canada

Anthony Pettinari - Citigroup Inc, Research Division

Operator

Good morning. My name is Shane. I will be the conference operator today. At this time, I would like to welcome everyone to the RockTenn Second Quarter Fiscal 2012 Earnings Conference Call. [Operator Instructions] As a reminder, slides are being presented today as a part of the conference call. These slides can be accessed at www.rocktenn.com under the Investors page. Ladies and gentlemen, this call is being recorded today, April 26, 2012. [Operator Instructions] Your speakers for today's call are Mr. James Rubright, Chairman and Chief Executive Officer; and Mr. Steve Voorhees, Chief Financial Officer. Mr. Voorhees, you may now begin.

Steven C. Voorhees

Thanks, Shane. Welcome to RockTenn's Second Quarter 2012 Earnings Conference Call. This is Steve Voorhees, Chief Financial Officer. I'm joined by RockTenn'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 discussed. We included a description of these risks and uncertainties in our filings with the Securities and Exchange Commission, including our 2011 [ph] Form 10-K and our Form 10-Q for the -- filed for the period ended December 31, 2011. During the call, we will refer to non-GAAP financial measures. We provided reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the appendix to the slide presentation, which is 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 status of our integration, as well as non-operating items in our financial statements. After our prepared comments, Jim and I will be available for questions. Jim?

James A. Rubright

Thanks, Steve. Good morning. Our adjusted earnings of $0.97 per share reflected continued excellent performance in our Consumer segment. That was more than offset by the lower earnings in our Corrugated segment caused by the continued price weakness in domestic box and export containerboard markets and the seasonal demand and pricing bottoms we believe we experienced in January and February. The weak market conditions we faced in the maintenance downtime we took in the quarter had the greatest impact on our Corrugated segment, where sequential quarter adjusted earnings were down $0.31 per share, and that more than offset the $0.10 per share in other earnings improvements.

While the improvements in the market conditions in March and April have been modest to okay, we performed much better in March than we did in January and February. Quarter's actual earnings improvement over our pre-announcement resulted from better performance during the month of March than we estimated that we pre-announced expected quarterly results. But March can be a very good and a picky month and for us it was this year.

In the face of the quarter's relatively weak market conditions, we continue to achieve strong cash generated from operations of $255 million. And as Steve will discuss, we executed several very favorable financings that significantly improved our overall financial structure. During the quarter, among other cash uses, we reduced net debt $62 million, contributed $40 million to our pension plans in excess of pension expense, and we paid dividends of $14 million. The proceeds from closed plant sales essentially offset cash restructuring costs, and we paid $19 million in redemption premiums and issuance costs to retire our 9.25% 2016 notes and the balance of $746 million on our acquisition-related term loan B.

Comparing Corrugated segment earnings in Q1 to -- in Q2 to Q1, lower pricing reduced earnings $10 million; volume including economic and major maintenance downtime reduced earnings $22 million; and the net impact of wood, fiber and energy increased earnings $8 million. We completed major maintenance outages at our Panama City, Florence and Jacksonville mills, which reduced containerboard output by about 52,000 tons. And we took approximately 120,000 tons of economic downtime, primarily at our Jacksonville recycled containerboard mill and at our La Tuque and West Point white top mills. We also permanently closed our Matane, Québec 176,000-ton-per-year recycled containerboard mill. It was a medium mill, and we took it down as required to balance our system capacity in the lighter capacity that we we're going to add to our Hodge and Hopewell mills through projects later this year. We expect it will take a very limited amount of white top economic downtime in the June quarter, no brown economic downtime, and it will draw down the containerboard inventories we built up in anticipation of the approximately 140,000 tons of major maintenance outage downtime that we expect to take in the June quarter. We also currently expect to run to capacity in the September quarter, and we see our primary challenge in it is meeting our overall system demand in our seasonally strongest period. Our overall corrugated converted product volume was up about 1% over the December quarter. Our strongest performers were our West Coast in Mexican operations and our recently acquired Corpak plants, and that acquisition is working out very well.

We continue to make progress restructuring our box plant system. We consolidated 2 more container plants in the quarter, bringing the total, since May 2012, to 9 plants. We've also completed some very detailed plants -- plans for plant performance improvements that will undertake in our box plant system that I believe will take somewhere between 18 to 24 months to complete. To that end, we are also significantly strengthening our dedicated box plant manufacturing improvement team with a number of people who recently became available and who have significant recent experience in successful box plant transformation activities. Although this is a long multi-step process, we're very optimistic about the results we'll achieve.

As I mentioned, our Consumer segment business has performed very well with strong sales in folding cartons, partitions and merchandising displays. Our overall revenues were up sequentially $27 million or 4% over, for the Consumer business, the seasonally weakest December quarter. Consumer segment EBIT was up $4 million sequentially, as higher selling prices and volumes more than offset higher commodities and materials costs, and the $4 million costs that were required in mini-maintenance outage we completed at our Demopolis bleached paperboard mill in February 2012. Segment EBITDA margins of 16.8% were up 190 basis points over the prior year.

Our Recycled Fiber business continue to generate low single-digit EBITDA margins in the quarter. Those margins are lower than the prior years due to 2 factors: the first is the lower nominal pricing for recycled fiber this year; and the second, possibly more important, is the fact that the spread between export and domestic pricing is at historic lows, which compresses the margin opportunities we have in our export business. If Recycled pricing escalates to last year's peak levels, and if export margins return to historic norms, we would expect EBITDA margins in this business to improve by as much as 100 to 150 basis points.

Our outlook for the next quarter is for slightly higher adjusted earnings in the range of $1 a share, as our higher maintenance outage costs and downtime will generally offset the improving export demand and pricing. April domestic sales to-date show good seasonal improvement in box demand, and if this trend continues, it could provide some upside to our current outlook.

Steve will now address our results and our progress on integration.

Steven C. Voorhees

Thanks, Jim. Our trailing 12-month credit agreement EBITDA was about $1.25 billion, and free cash flow remained strong during the quarter at $72 million. We spent approximately $39 million more in capital expenditures than in the first quarter and the total of $202 million in fiscal year to-date. Our capital investments will increase our run rate basis over the next 2 quarters, for their total fiscal year estimate of $480 million to $500 million, as some of the larger capital projects began this quarter. We expect our run rate of capital expenditures to decline to $350 million by fiscal year 2014. We are very pleased that we completed the series of related financing transactions during the quarter. These transactions included the retiring of $300 million in 2016 notes. We are paying $746 million of our term loan B, funding the new $227 million term loan A2 obtained in December and issuing $350 million of 4.45% 2019 notes and $400 million of 4.9% 2022 notes. These transactions enabled the removal of security from our Senior Credit Facility, and along with the expiration of an interest rate swap, have reduced our annual interest expense from a rate of $128 million per year to $112 million. This is a $16 million reduction. At the end of March, our net debt was $3.4 billion, and our credit agreement debt-to-EBITDA ratio was 2.8x. Liquidity was $1 billion at the end of the quarter. Overall, our balance sheet and liquidity are in very good shape and are able to support our business.

We made substantial progress on the integration during the March quarter. During the quarter, we essentially completed the conversion of the legacy Smurfit operations from SAP financials to JD Edwards. We started using natural gas at the Stevenson mill in January. This project reduces our annual energy costs by over $10 million. We are capturing the benefits of integrating the supply chain of the larger corrugated packaging system and accumulating purchasing savings available to us.

At the end of the March quarter, we have achieved a run rate of synergies and performance improvements in excess of $150 million. In the current quarter, the benefits of these synergies and performance improvements have been more than offset by lower market pricing and lower mill volumes. We continue to expect to achieve our target of a total of $550 million in synergies and performance improvements as we capture the opportunities available to our combined organizations.

Turning to our key cost inputs, wood cost increased compared to the December quarter by nearly $1 per ton. This is in line with seasonal patterns and offset by the decline in recovered fiber prices of about $11 per ton in the quarter. We continue to benefit from the decline in natural gas prices. The 12-month NYMEX strip at the time of our last conference call was approximately $3 per MMBtu. Today, it is approximately $2.70 per MMBtu with current cash prices of about $2 into the pipeline in most areas of the country.

On the last call, we described the project with Solvay to convert financial gas from a coal-based third-party steam supply by the end of this fiscal year. We now expect the conversion to occur during the second half of fiscal 2013, in line with our updated expected timing of the permit and construction schedule.

Turning to our guidance for certain financial statistics. We've made a slight reduction to our depreciation and amortization for the year, from $550 million to $540 million, as spending will occur a little later in the year than we estimated. We expect corporate and interest expenses for the June quarter to be $26 million and $28 million, respectively. Our book tax rate for the March quarter was 38.6%. We currently expect our book tax rate in fiscal 2012 to be between 37% and 38%. Our cash tax rate will be substantially lower, as we use our available federal net operating losses and other tax credits on our books to reduce cash taxes. Our unused cash items aggregate to approximately $366 million and reduced federal cash taxes. In addition to these items, there's also an unrecorded federal net operating loss related to the potential taxability of the Smurfit-Stone black liquor tax credits claimed as an excise tax credit. If we are successful on this issue, the cash benefit of our unused tax items will increase by $227 million to $593 million. We also completed our calculation of the IRS Section 382, the one associated with the Smurfit acquisition, and have concluded that this will not limit our ability use the net operating losses in future years.

As we disclosed on our last conference call, we've conformed the accounting for major maintenance outages in the legacy Smurfit-Stone Mills through RockTenn's policy of recognizing the expense ratably over the period from the time incurred to the next scheduled outage. In the March quarter, we recognized $7 million in maintenance outage expense, more than the $5 million in the December quarter. This expense will increase as outages occur. We expect this expense to increase to $18 million and $20 million in each of the last 2 quarters of this year.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from George Staphos.

George L. Staphos - BofA Merrill Lynch, Research Division

First question on the integration efforts, synergies, performance improvements. You mentioned that you're pleased with your progress, if I heard you correctly. Are there any projects at this juncture that are trending better than expected either in terms of results or in terms of your process? And similarly, are there any projects that are maybe trending below expectations or maybe a little bit behind on in terms of implementing? And then I have a couple of follow-ons.

James A. Rubright

Let's say we're net probably about where we thought we would be. I think we've concluded that the performance improvements we expected to get out of our mill system are taking a little more time than we had anticipated and will require some capital, so that's part of the delay. But on the other side, looking down the road, as I've indicated, we think we've got greater opportunities than we thought on the box plant side, and we've got very detailed plans there to execute, and been part of it is an issue of just staffing up to able to execute the plans and then training and execution of people in the plant. So I think we're probably going to see this move out into our fiscal 2014 year. But in the end, I think we will meet our targets comfortably.

George L. Staphos - BofA Merrill Lynch, Research Division

Okay. So Jim, on the mill side, just to be clear, maybe the implementation is taking a little bit longer relative to what your expectation would've been on the last conference call.

James A. Rubright

Well, yes, I think that's as accurate as I can be.

George L. Staphos - BofA Merrill Lynch, Research Division

Okay. In terms of the measure in talent that you're adding in Corrugated, have you made any changes within the existing organization within Corrugated and the box network, or are these purely adds? And in general, how is the organization yields, Smurfit versus the old RockTenn, how is that meshing together at the juncture?

James A. Rubright

We're doing both. We're certainly taking advantage of the opportunity to upgrade staffing throughout the system where we can, and we're adding significantly to the expertise of our corporate resources, which we think we need to do. George, if you go back and look at the time we acquired Smurfit, they've closed 55 box plants, and their data would suggest that they had taken the average box plant costs to basically system average for the industry. Well, average cost doesn't win, and average cost is not acceptable to us. And so it's -- we've had to basically do the work associated with strengthening the team across the board to be able to significantly move that number down, which we are in the process of doing and believe we will continue to do. I think culturally, the organizations have come together very well. Jim and I, Jim Porter is here with me, we're out all the time, and I think people are very, very supportive of the transaction and where we want to go. We just have to get the skill levels up and support them with the right capital and processes.

George L. Staphos - BofA Merrill Lynch, Research Division

Last question, and I'll turn it over. By the fourth quarter, you expect to be running to capacity. You'll also be certainly reasonably complete on your projects maybe. You said those are going to take into the beginning of fiscal '14. But will you be in a position, over the next few quarters, to make the next structural changes to your capacity footprint, or is that -- do you anticipate not needing to make any additional changes other than Matane?

James A. Rubright

First, with respect to the projects, there are 2 that relate to increasing the linerboard product line or capacity of our system. One is at the Hodge mill, and Hodge goes down basically very soon and through May. Then the second one is an increase in capacity at our Hopewell, Virginia mill. That occurs during the fourth calendar quarter of this year. As you know, startups will then take sometime, so we expect that production to ramp up in the periods after that. We also have a significant amount of process changes at our Stevenson virgin medium mill. That will be into the next year's outage season, as well as a pretty significant de-bottling of the cost structure at our Florence mill, starting with major improvements that will basically rebuild the wood yard. So these projects are going to take -- these are going to unfold over the next at least 6 months to 9 months. So you will see step changes in the capacity and cost structure and then, as I've indicated at the time that those things incur, we'll make judgments regarding what the market demand for our capacity is.

Operator

And our next question comes from Phil Gresh.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

So just I wanted to ask, if it's possible, if you could give any color around what the fourth quarter might look like. Coming off the third, you have a significant reduction in downtime. It sounds like the repair costs are kind of flattish. You should have some synergies perhaps kicking in. There's going to be some seasonal strength, so looks like it could be up pretty meaningfully, and -- so I was wondering what kind of color you could give us there.

James A. Rubright

Well I think you've just done it. The fourth quarter should be a very, very solid quarter for us, significantly better than the last couple that you've seen. Pricing environment and export pricing environment are not as favorable as they would've been in the September quarter of last year, so a lot of the work that we've done, a lot of the cost improvements are going to be offset by the market developments. But we expect a very strong fourth quarter, and then building off of that as we go through the seasonal period of the following year.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

And as you exit this year, where do you think the synergies and performance improvement run rate will be? I think you're tracking above 150 at this stage. Any kind of ballpark you can give us for that as you're exiting this fiscal year?

James A. Rubright

The major buckets for us, as I've indicated, are in the near-term capital-associated projects in our mill system. So you're going to see them ramp up over the next 6 to 9 months, and I'm not really trying to quantify them, but it's a material amount of money in the aggregate. We've indicated that Hodge and Hopewell are projects that have -- that appear to have 35%, 40% returns just based on cost takeout in the mills. So in general, the aggregate capital on those projects is well over $150 million. So that should come on in the next 6 to 9 months, similar really pretty strong return off of the $40 million at Florence and so forth. So you're going to see that -- those returns come on over the next 6 to 9 months. The box plant improvement program is going to be a longer-term plan. We've got the initial closures, and those closures are in the $150 million that we've mentioned. By the end of this calendar year, we'll do 3 more natural gas conversion projects in large mills, and those, at current gas price levels, are going to add another $40 million a year in run rate of improvements, and we've included -- that's all included in the bucket of performance improvements that we've indicated. The next major administrative steps are IT and accounting-relating opportunities that we have. But -- although we've converted from JD Edwards to -- to JD Edwards from SAP in the financial systems, the major transformation effort is going to be in the box plant systems, where we've said we're currently at 6 legacy Smurfit procure-to-pay systems, all of those are going to be replaced with Kiwi, and that is about a 12-month project which we're kicking off today. We had to get the financial systems at the home office on the JD Edwards to do that in a logical way. That's a year project, so there's -- as we've indicated, it's a pretty long tail before we begin to realize a number of administrative and IT savings that fall out of the acquisition, but that's just the pace at which we are able to achieve them. The other thing that we'll continue to ramp up, I think we've got another $30 million or $40 million we're going to get out of procurement savings, and I think you can see that coming over the next 6 to 9 months. Steve, wouldn't you agree that that's the right schedule for that?

Steven C. Voorhees

Yes.

James A. Rubright

There have been some other bits and pieces of synergies, but I think I've given you the best guidance I can on what we foresee.

Phil M. Gresh - JP Morgan Chase & Co, Research Division

That's helpful. One last question. There is a -- there are a couple of mill closures over in Europe, particularly one on the craft liner side. Have you seen any impact on your export business already from that, and do you expect that to have an impact in the coming quarters?

James A. Rubright

We do, actually, and we are seeing a little bit of improvement in the European markets. Europe strengthened for us, and we increased our participation in European -- our exporting to Europe. It's a relatively small market for us, but we definitely saw some improvement. The Middle East continues to be probably the weakest market in -- that we export to. As long as I am continuing -- some pretty strong competition in Latin America, our largest market, but we are seeing improving pricing. And for craft liner, China, actually, was improving modestly for us.

Operator

And our next question comes from Mark Wilde.

Mark Wilde - Deutsche Bank AG, Research Division

Jim, Steve, a couple of questions about -- around pricing. First of all, can you just give us a sense of sort of the recovery that you're seeing in export pricing maybe from the second quarter average to where we are today or where we were at the end of the second quarter?

James A. Rubright

I'm not going to be very specific there, Mark, for competitive reasons, and they are reasons you're aware of. But we're seeing modest but continuing improvement in export markets. And as I've indicated, I think the Middle East is the most challenged, but it's relatively small for us. And we're seeing -- we are seeing -- we did realize and we expect to continue to realize higher prices, particularly in Latin America, which is our biggest market. But that's as much detail as I feel I can go into.

Mark Wilde - Deutsche Bank AG, Research Division

Yes. And then you also -- you've singled out some pressure in box pricing. Has there been any change there from what we've seen over the last 2 years, which has been this kind of slow gradual erosion in box prices?

James A. Rubright

I think it's too early to tell because we've come through a seasonally weak period. And as I indicated, our April box sales have been up significantly over the prior year. But that's happened in the last 3 weeks, and there's a lot, I think, going on in the marketplace. But it's really too early to see whether there's a trend developing with respect to pricing.

Mark Wilde - Deutsche Bank AG, Research Division

Okay. And then you -- just 2 others on price. You mentioned in the release, SBS pricing being down a bit, and then finally, the -- that West Coast medium announcement that you had out there didn't seem to get reflected in the trades this last week.

James A. Rubright

That's correct, it did not.

Mark Wilde - Deutsche Bank AG, Research Division

And the SBS pricing, is that kind of across the SBS business or more in some grades than others?

James A. Rubright

Well, it certainly affects our folding grades. And as you know, there we have contracts. So over time, you will see that get reflected in the contractual-based SBS tons and also pretty much immediately in the spot turns.

Mark Wilde - Deutsche Bank AG, Research Division

Okay. And on the cost side, Jim, do guys have any outlook on where you think OCC might be moving over the next few months?

James A. Rubright

Absolutely. We would say that it's flat for the next month, trending up $15 to $20 for the remainder of the year. But you'll recall, last quarter, I expressed some skepticism at our forecast that by the end, that would be trending up now to last year's historic highs. So I guess I'm most comfortable saying that right now, we're essentially in the trading range with weak export demand. And until something occurs to change the current paradigm, I see relatively flat pricing going forward. But that's a personal view, where the most I've got comfortable saying I have a low degree of confidence in my ability to forecast OCC pricing.

Mark Wilde - Deutsche Bank AG, Research Division

Yes. And would you say that the kind of limited rebound that we've seen so far is a result of kind of weakness on the export side as opposed to anything in the domestic side?

James A. Rubright

You mean rebound pricing down?

Mark Wilde - Deutsche Bank AG, Research Division

No, I mean, rebound pricing up. I mean that we started to see prices bounce in January and February, and now it seems like it just kind of flattened out. And I'm just trying to get a sense of is this mainly the result of weaker Chinese demand or are there other issues here?

James A. Rubright

Well, if you go back a couple of months, you get into seasonal generation issues, where you hit a period where fiber is historically relatively high based on low generation, and you saw a little bit of an increase. But I think China's export demand has pretty much followed the general economic trends that we're all seeing at the slowing in China, and it has had a fairly long-term effect on the fiber market. And that's what I'm saying. Until that market place changes, I think you're in a trading range with potentially -- some domestic supply lowering price or at least balancing the seasonal uptick in mill demand. So there's -- I just don't see a lot is going to knock it significantly out of the trading range that it's in until something spectacular happens.

Operator

Our next question comes from Chip Dillon.

Chip A. Dillon - Vertical Research Partners Inc.

First question, and I apologize if these were asked, just on the -- on your view toward sort of the next leg of growth, that it seems like this is from discussing a lot of the challenges in assimilating Smurfit-Stone, which obviously is a big transformative deal, that maybe you would feel more comfortable not being active now, or do you feel -- still feel that would not be a factor, that you could -- whether it's an opportunistic -- a few facility acquisition or even something larger? Is that something you feel you could handle at least from an operational standpoint now?

James A. Rubright

Well, yes. I mean, I think if you look at the resources that's required to analyze an effect of a significant transaction, those of us who would be involved at the front end are available to do so. I think we've gotten -- we got great resources in the mill system. We've effectively realigned the leadership there and are stable and improving. Similarly on the box plant system, I think that's where our largest challenges are, but we've got a lot of people in a very large box system. So to integrate assets there would be fine. We've done very well, and I indicated with our acquisition of Corpak, so I would say we're open for opportunities.

Chip A. Dillon - Vertical Research Partners Inc.

Got you. And on a second matter. I know in the past, I seem to recall that you all were pretty vocal, at least in terms of issuing press releases, when there were price changes, especially on the consumer packaging side, and have you thought about changing that sort of practice and -- or at least as it regards to the containerboard side of the business?

James A. Rubright

Well, we have changed that practice. We've stopped issuing those press releases. We now advice our customers directly regarding our pricing through letters and individual communications rather than a general industry-wide communication.

Chip A. Dillon - Vertical Research Partners Inc.

Got you. And could you share with us sort of what made you change your view about that?

James A. Rubright

Our belief is that it's a better course of action for us to follow.

Chip A. Dillon - Vertical Research Partners Inc.

Got you. And then the last question. If I think about it broadly, when you get through with the Hopewell startup, I believe that's the last big mill project, I believe you'll be pretty much left with just the box plant. I know this -- that's a lot of work, don't mean to say just, but the box plant initiatives. But is it fair to say that once you get past Hopewell, that we should start to see a dramatic slowdown in activity in terms of what you need to do to get to the synergies that you expect the $550 million?

James A. Rubright

No, I don't think that's correct at all. We think that there's significant opportunities to increase the productive capacity of our existing craft liner system. I think if you go back a couple of calls, what we indicated is we don't think those assets really are performing at what we would think of it be in the industry standard rates given the capabilities of those mills. And the issues are many, whether it's deferred maintenance, training, staffing, strategic capital. We think there's opportunities to significantly increase the productive capacity of our craft mill system by as much as 250,000 tons, which I think it will take us -- we had indicated before that we thought it'd take us till the end of fiscal '13. Now it might take us a little bit longer than that. It's been slower than we thought, getting traction, but certainly, if you just benchmark what those assets should be capable of producing versus what they are, that opportunity, we believe, is there and have not changed our view on that.

Chip A. Dillon - Vertical Research Partners Inc.

And that's above and beyond the Hodge and Hopewell projects?

James A. Rubright

Yes.

Operator

And our next question comes from Mark Weintraub.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Just to clarify on that last point, so Hodge and Hopewell is about 300,000 tons or so in terms of incremental capability. And then beyond that, there's another 250,000 tons. Is that about right?

James A. Rubright

Yes, the initial target for us was slightly over 600,000 tons of craft liner production increase, which -- although some of that is me and based on performance improvements. But we have broke down -- we exited the craft bag market, and that increased our craft liner by 120,000 tons. We've already realized that. It's at Hodge, and it also allowed us to close 1 small craft paper machine in Hodge. The project that we're about to undertake will increase capacity -- the numbers slipped from my head, but it's another -- yes, another 107,000 tons, I think, of craft liner at Hodge, and that also reduced as the mill from a 3- to a 2-machine mill. Hopewell adds another 100,000 -- I think, 120,000 or 130,000 tons capacity. So those are the big chunks right there. But that then leaves, as I mentioned, about 250,000 to possibly more of capacity that we believe we will add through essentially our performance improvements at the remaining craft mills.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Okay. And that was included in the additional 250,000 or whatever is included in the $550 million. And I guess the timing on when you would do that is relatively open-ended at this point.

James A. Rubright

Well, as I said, I think our initial belief was we could have the vast majority of all this completed by the end of fiscal '13, that's September of 2013. I would revise that now to suggest it's going to run into 2014, both because of what we see in terms of the ability to move the box plant system and the pace at which we've been able to achieve improvements in the craft mills.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Okay. And you indicated that fiscal 2014 you thought CapEx would be trending back to about a $350 million-type level. And so can you give us a sense on 2013, is it roughly where you'd expect it to be?

James A. Rubright

We -- our trend was $480 million to $500 million. $400 million in 2013 and $350 million as sort of a sustaining rate in '14 and the out years. This summer is when we will really refine our estimates with respect to '13 capital, so I don't have an update there. To a certain extent, it's going to be depending upon this pace at which we are able to execute the projects that we've got on the plate for the remainder of this year because we do carry out a significant amount of capital. And we also have a very continuing updating capital process at RockTenn, probably different than most companies. So we're continually revising and updating our capital plans. So I would say that in July, I should be able to give you a better picture of '13 capital. But today, I don't have information better than the $400 million that we have been estimating.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Okay. And then lastly, you just noted that your -- that the box business in the first 3 weeks of April has looked to be up significantly. And I think you suggested maybe there were some industry dynamics maybe related to some other consolidation activity. Would that be the explanation, or is it do you think that the industry itself is picking up quite significantly?

James A. Rubright

I think that what I can see from our sales is a month-over-month improvement I think I misspoke too because the improvement that I referred to was really April over March in box cut-up, and I don't -- and the data, year-over-year, I don't have in front of me. But I'd just be speculating if I try to explain why.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Okay. Fair enough. And so that may in part also be seasonal, April picking up over March?

James A. Rubright

Yes, and it was delayed because we would have expected to see it sooner, but we are seeing it now.

Operator

And our next question comes from Mark Connelly.

Kurt Schoen - Credit Agricole Securities (USA) Inc., Research Division

This is Kurt Schoen in for Mark. So you noted in the release that consumer packaging benefited from higher display sales. Were these higher sales more a result of the market share gain from acquisition or more due to seasonality? And do you expect more competition going forward given the higher margins?

James A. Rubright

The increase in sales was a function of customer demand in the period, and it relates to the promotional activities of the customer base itself. Those aren't necessarily seasonal, and they're based on decisions that our household name consumer product company customer base makes, so I don't have a reason for the increase better than customer decisions and customer demand. The display business has always been competitive. On the other hand, we have now, with the acquisition of Smurfit, putting together, I think the 2 largest display platforms in North America, tremendous capacities that we're bringing to the marketplace. And we're -- we think that we will grow relative to the competition based on the opportunities in front of us and the capabilities we bring to that marketplace.

Kurt Schoen - Credit Agricole Securities (USA) Inc., Research Division

All right. And then the second question is you guys noted that the West was a little stronger for containerboard. What was the reason for that?

James A. Rubright

I didn't say for containerboard. I said the places where we're having the greatest success in the marketplace and our operations are performing the best were the West Mexico and the recent acquisition.

Operator

And our next question comes from Al Kabili.

Albert T. Kabili - Crédit Suisse AG, Research Division

Jim, I was wondering if you could maybe elaborate a little bit on -- I think you mentioned you're as confident as you've ever been on the magnitude of the performance improvements, but the timing of -- is maybe slipping a little bit versus your original hope or expectations. I was wondering if you could elaborate a little bit on that, number 1 . And then number 2, does any of that have any risk to the capital required to achieve these improvements?

James A. Rubright

Yes, I don't know that my view has changed a lot over the last 6 months. I'm trying to recall what we said in the last conference call. There I was -- I think I forecasted that we had felt a lot better about the opportunity set in the box plant system, and we were in the process of really developing some plans. Now those plans are much more concrete than they were, so I've got better visibility. I think I know exactly what our opportunity set would be and how we'll execute it. I also indicated that I think that I was aware then that the pace of mill improvements was slower than we had initially anticipated. And so I think that the net of those kind of balanced out to the same number, but the process is taking us a little longer than I thought. And I guess that's my view.

Albert T. Kabili - Crédit Suisse AG, Research Division

Okay. And to clarify, though, from a CapEx perspective and a capital perspective, it -- your -- the expectation there hasn't changed, it's more of a timing.

James A. Rubright

Yes. I think that I see more opportunities to deploy capital in the box plant system in small amounts, but lots of small projects than I would have. So if capital were going to go up, it would probably go up on strategic capital deployed in the box plant system because we really do have a lot of opportunities there. I don't have a change of view on the capital in the mill system.

Albert T. Kabili - Crédit Suisse AG, Research Division

Okay, that's really helpful. And then just switching to the Consumer segment. You mentioned the backlogs improving there. Is that do you see that as end market strength you're seeing driving that or is that more seasonal factors from what you can tell right now?

James A. Rubright

I don't recall saying that we had seen backlogs strengthen in the Consumer business. In fact, SBS and CRB backlogs have been stable at relatively low levels for the last period of months. I don't know how many. And SBS operating rates have been in the low 90s, while we have been okay in the CRB business, and the only mill we've been taking downtime is in Stroudsburg, which is a very specialty CRB mill. Those markets I don't think have strengthened, so I'm not sure what you were referring to but...

Albert T. Kabili - Crédit Suisse AG, Research Division

Okay, that makes more sense. For some reason, I looked at it as on --

James A. Rubright

Steve has shown the [indiscernible] majority of [indiscernible]

Albert T. Kabili - Crédit Suisse AG, Research Division

On Slide 12 on your 3Q outlook in the presentation, it said SBS and CRB backlogs...

James A. Rubright

[indiscernible] in CRB, we expect seasonal strengthening. You really hit June, for example, is typically a pretty strong month as people roll up into the July sort of vacation period from closure period, temporarily consumer products plant closure in July, and then September is our strongest period, so I think what we're saying is we anticipate seeing backlogs improve and demand improve in those grades, but I can't say that we're seeing it today, so I'm sorry for the confusion.

Albert T. Kabili - Crédit Suisse AG, Research Division

Okay. Now that's helpful. And then last question is I know you mentioned the strength and the display sales. I mean, it looks like, just from the production data, your recycled paperboard overall seems to be outperforming the market, and I was wondering, your thoughts on how sustainable that might be.

James A. Rubright

Sure. We had a fairly long period of outperformance in the folding carton and CRB marketplace. I think we've got terrific people, was very dedicated to their customers and very strong customer relationships, both with independence, and we serve with CRB and with our major consumer product and local account folding carton customers. So I think there's a lot of momentum there, and that momentum ought to be sticky, but they are relative weaker markets today than they were a year ago, so certainly, they're competitive.

Operator

Our next question comes from Phil Ng.

Philip Ng - Jefferies & Company, Inc., Research Division

Sorry I've joined the call a little late, so if you guys mentioned this, I apologize. But just on the export market, you've seen demand bounce back a bit. How much of that do you credit as real demand, or is that more of a function of restocking, potentially some pre-buying?

James A. Rubright

How would I know that? Right? These are export markets where we're exporting into seasonally strengthening agricultural markets in Latin America, Europe. As we've indicated, we've seen [indiscernible] capacity closures and an improvement in the demand situation. We're simply responding to the market signals that we're getting, and the market signals are driven by whatever the market is driving. I apologize for not really trying to answer that question, but I don't have a view.

Philip Ng - Jefferies & Company, Inc., Research Division

But you're seeing it could flow-through into the April so far, I guess, is that fair?

James A. Rubright

Yes, we're speaking about current conditions.

Philip Ng - Jefferies & Company, Inc., Research Division

Okay, that's helpful. And then the box market, that market has been pretty competitive. But between you and one of your major competitor, you guys are taking some capacity out. Do you feel like, from a demand-supply perspective, things are pretty well-balanced now?

James A. Rubright

I'm not sure what segment of the markets you're referring to. I think the containerboard mill operating range, they've been running around 95%, haven't they? And so if you think of the average containerboard operating rate in North America for a pretty significant period of time is 95%. Would I like 97%? Yes. But 95% is not bad. There's lots of capacity in conversion capacity in North America.

Philip Ng - Jefferies & Company, Inc., Research Division

Okay, that's helpful. And then just lastly, display business was quite strong, and I know promotional activity was -- you saw a pretty good flow-through in the current -- in the past quarter. Are you seeing that same type of momentum in the current quarter?

James A. Rubright

I think it's more normal trends that we see now. We think that the second half of the March quarter saw a lot of promotional activity. So it's going to cool somewhat if the current trends continue.

Philip Ng - Jefferies & Company, Inc., Research Division

And that ticks back up in the summer, right, if I'm correct?

James A. Rubright

It ticks back up when it picks up. It is not easily predictable.

Operator

And our next question comes from Steve Chercover.

Steven Chercover - D.A. Davidson & Co., Research Division

You anticipated one of my questions on the benefit of your next 3 gas conversions. I think you said $40 million under current prices. So is there a level of natural gas where the benefits go away? And can you flex your fuel source if that's the case?

James A. Rubright

Steve, the current MMBtu equivalent oil/natural gas prices at $3 multiplied by almost 7, 7.5, so you get the $18 to $20 would be the equivalent MMBtu conversation for oil. So when we take oil out of a mill and substitute natural gas, that's the gap, and that gap has to narrow in order to eliminate the natural gas advantages. It's a pretty big advantage.

Steven Chercover - D.A. Davidson & Co., Research Division

Yes. And you do --you guys know a thing or 2 about gas so -- my other question was just with respect to the maintenance expense delta. So it's going to be up $11 million over Q2, if I read the slides correctly, and then economic down will be significantly lower. So if we just think of the opportunity costs, Q3 ought to be at least as good if not better. Is that fair?

James A. Rubright

Well I think we said we thought it would be about the same, slightly better. If we see this continuing upticks in the demand, it could be upside from what we forecast. But right now, we've said we think it's all going to net out to something like $1 a share.

Operator

And our next question comes from Josh Zaret.

Joshua L. Zaret - Longbow Research LLC

Can you tell us how much you built your containerboard well stock-up your inventories in advance, ahead of the downtime got started, I guess, in February?

James A. Rubright

We can, but somebody is going to have to hand me the number.

Joshua L. Zaret - Longbow Research LLC

And then as well how much do you plan to pull down in the third quarter?

James A. Rubright

Josh, we have about 150,000 tons of buildup, as you referred to it, coming into this quarter, and we'll run that off. So we will take our inventories back to our target level, which is a little over 4 weeks -- Jim, 4 or 3, something like that?

James B. Porter

That's correct.

James A. Rubright

We'll run our system at something like a low point of 4.3 or 4.4. It's a little higher than historic norms, but we've really done a lot of work optimizing roll stock supply into our box plants, and that's where we think we hit an optimum operating level.

Joshua L. Zaret - Longbow Research LLC

And when -- by what month would you expect that 150,000 to be worked down, would it be June, September...?

James A. Rubright

We're going to run it down through June.

Joshua L. Zaret - Longbow Research LLC

Through June. Great. Okay, that's good. Second question. There's a lot of consolidation going and rationalization going on in the containerboard industry. Talk about customer turnover in terms of the number of supplies your customers want. Have you been in -- have you lost customers? Have you been able to retain them? Just give us some color on that.

James A. Rubright

Well, I think that our -- over the last 12 months, the customer churn or attrition in our system is higher than we would like, and a lot of that is associated with the disruption associated with the very significant structural changes Smurfit had instituted in the periods prior to the acquisition. And that has a lingering effect, and it's currently a matter of major focus for us. Certainly, consolidation provides opportunities. Many customers will seek more than one supplier, so that put some churn in the marketplace, and whenever everybody is materially changing their operations, that can also result in some customer dissatisfaction and churn. So we think there's a lot of movement in the marketplace right now, but at RockTenn, we have a lot of improvement we can achieve by improving our customer experience.

Joshua L. Zaret - Longbow Research LLC

Okay, great. And then the final question. You talk about the competitive box market. Would it be fair to say that the greatest competition is in the Northeast? And if that's correct, what would you attribute that to?

James A. Rubright

I don't know that I can say where the competition is the greatest. We're certainly facing intense competition in the Northeast because there are a number of strong competitors there, including a number of quite strong independents, and it's less of a seasonal agricultural market, say for example, in the West. I didn't go into this point, but we've done a lot of work on sort of what our box plant system ought to work, the kinds of people we should have and what detailed sort of execution plans we should have. And I would say we're farthest advanced there by far in the West, and that's the region that's most successful. So do I conclude that it's the people achieving the success in the model for the rest of the system or is it less competitive? I think it's really the former, and that template is what we're basically bringing through across our box plant. It'd be nice if we could it all at once, but we haven't been able to do that. But I would attribute it more to the success of people than I would to the relative competitiveness of the market or certainly, the assets we've got in the market.

Operator

Our next question comes from Stephen Atkinson.

Stephen Atkinson - BMO Capital Markets Canada

In terms of the $550 million, as you say, profit improvement program, can you tell me where you are right now, the run rate?

James A. Rubright

Yes, Steve indicated that we're comfortable that we've achieved $150 million. We believe we're somewhat in excess of that, but that's a range of where we are right now.

Stephen Atkinson - BMO Capital Markets Canada

Okay. And so that in terms of timing, then really just looking at trying to complete it by 2014 rather than '13.

James A. Rubright

I think the middle of 2014 is what we said, and that that's 24 months from today, and I think we -- a reasonable expectation, yes.

Stephen Atkinson - BMO Capital Markets Canada

Okay, I understand that. Sorry, I missed as on the call I can hear it. So when we're looking at the capacity additions and now you recognize and respect that you're on the firm according to demand, are any of the capacity additions or benefit or increased sales included in the $550 million?

James A. Rubright

Yes.

Stephen Atkinson - BMO Capital Markets Canada

Oh, okay. So that would assume a certain increase in the ability to sell?

James A. Rubright

Well, I'm not sure I answered your question as well as I could have. What we have always said is that the -- certainly with respect to the Hodge and Hopewell projects, the savings that we're forecasting and therefore, the economics that we built in or simply cost structure savings at those mills, we're taking that much cost out of the finished product. With respect to the balance of the capacity, we're not making -- we have an open-ended assumption, and that is if the market is there for us to sell that at compensatory rates, we will do so. And if the market is not there, we won't. How we then restructure our system will depend upon where the market is at the time.

Stephen Atkinson - BMO Capital Markets Canada

Sure. So the premise is that if there was export demand, then obviously, you could run at a higher rate. That's really where I was headed.

James A. Rubright

Yes, exactly.

Stephen Atkinson - BMO Capital Markets Canada

And what are your percent of exports right now? Are you able to tell me that?

James A. Rubright

Yes, we increased our exports in the quarter over the prior -- in the early preceding quarter, and I think we were at around 14% of our total containerboard capacity we export.

Stephen Atkinson - BMO Capital Markets Canada

Okay. And finally, what is the degree of box plant integration or integration with your box plants?

James A. Rubright

It's about 70%.

Stephen Atkinson - BMO Capital Markets Canada

Okay. And you're -- well, obviously, you have the facility to increase that if you want to. It's really just growth in customers. Am I reading that right?

James A. Rubright

Yes, we have capacity in our box plant system, and its success in the marketplace that will increase that degree of integration. We also would consider acquisitions that would further that integration if the acquisitions bring us good assets and a good -- stable customer base.

Operator

And our next question comes from Anthony Pettinari.

Anthony Pettinari - Citigroup Inc, Research Division

In containerboard, you referenced bottoming export markets in the quarter and some improvement heading into 3Q. And just following up on Mark's question and understanding you can't comment on specific pricing actions, can you just remind us what the sort of typical lag you see between price negotiation and realization historically, what that historically is in the export markets?

James A. Rubright

It's relatively rapid regarding what to get because the export pricing is ultimately either spot or 1 month or 2 months out, so it's relatively immediate. But that doesn't mean just because you announced a pricing increase you'd actually immediately get X. You may, over a period of months, be in the process of executing that increase. But it's not a situation where you have long-term contracts that significantly impact your ability to recover what the market will allow.

Anthony Pettinari - Citigroup Inc, Research Division

Okay, that's helpful. And then just on the box board side, we've been hearing about offshore capacity that's coming online or expected to come online next year. Have you seen or do you anticipate any pressure of domestic competitors kind of diverting tonnage from the export market to the domestic market? Kind of realizing that you guys don't really export SBS, but have you seen that dynamic in the domestic market at all?

James A. Rubright

No, we haven't. I'm not sure what drives the domestic market anyway, but as I've indicated, the markets have been relatively weaker than they were 1.5 to 2 years ago, but our demand has been relatively stable because we are so focused on the folding carton markets, which as I've indicated, have been relatively stable.

Anthony Pettinari - Citigroup Inc, Research Division

And then maybe just final question. Have you seen CUK kind of gain any market share from CRB or SBS in your business? Is that dynamic sort of impacted you at all?

James A. Rubright

There was a long-term trend where that was the case, that they sort of got to the markets that was a natural fit for CUK. And I'd say for a fairly long period of time, there's been a balance of movement in and out, but I don't think it's been material.

Operator

[Operator Instructions] Our next question comes from Mr. Staphos.

George L. Staphos - BofA Merrill Lynch, Research Division

One quick one, and I'll fill [ph] in the call. Could you comment on what you think your current liner versus medium mixes in your capacity, are you happy with it, and do you -- when we're done with these products, how would you see that balance shifting between liner and medium? Related question, it seems like as a region, North America is tightest in medium yet you're starting to see more medium mill closures versus linerboard. Just wondering why you thought that was the case, perhaps, our export strength longer term.

James A. Rubright

Our system is medium long, if you just simply looked at our overall balance, and the projects that we're doing at Hodge and Hopewell increased our craft liner capacity. But at the end of that, we still end up medium low. I think we're in better balance, but not perfect.

Operator

[Operator Instructions]

James A. Rubright

All right. Thank you very much for joining our call.

Operator

Thank you for participating in today's conference call. This time, you may disconnect.

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