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Executives

Steven Voorhees - CFO

James Rubright - Chairman and CEO

Analysts

Mark Connelly - Credit Suisse

Claudia Hueston - JP Morgan

Christopher Chun - Deutsche Bank

Steven Nissan - Mindflow Capital Investment

Kevin Casey - Casey Capital

Rock-Tenn Co. (RKT) F1Q08 (Qtr End 12/31/07) Earnings Call January 24, 2008 9:00 AM ET

Operator

Good morning. My name is Trey and I will be your conference operator today. At this time I would like to welcome everyone to the Rock-Tenn first quarter 2008 Earnings 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, ladies and gentlemen, this call is being recorded today, January 24th, 2008. (Operator Instructions). Thank you.

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

Steven Voorhees

Thanks Trey. Good morning. Welcome to Rock-Tenn's fiscal first quarter 2008 conference call. During the course of the conference call, we may make statements that are not historical in nature and may involve forward-looking statements within the meaning of federal securities laws. For example, statements regarding our plans, expectations, estimates and beliefs related to future events are forward-looking statements which involve a number of risks and uncertainties, many of which are beyond our control and could cause actual results to differ materially from those discussed.

Additional information regarding these risks and uncertainties is contained in the documents that we file with the Securities and Exchange Commission. These documents include the Company's Form 10-K filed for the year ended September 30, 2006. During the call we will be referring to non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are contained in the first quarter press release, which is available on Rock-Tenn's website at rocktenn.com.

Let's turn to Rock-Tenn's results for the quarter. Rock-Tenn's first quarter net sales were $596.3 million, up $62.4 million, or 11.7% when compared to last year's first quarter. Segment income of $48 million was $5.5 million higher than we reported in the same quarter of last year, an increase of 12.9%.

Rock-Tenn reported first quarter net income of $17.5 million, this is $0.46 per share. The $0.46 includes $3 million in pretax restructuring cost or $0.05 per share for the closure of Chicopee folding carton plant that is discussed in the press release and will be discussed in more detail by Jim in his comments.

During the December quarter of last year Rock-Tenn recorded $0.5 million or $0.01 per share of expense in restructuring charges. Realized prices for all paper board and pulp grade increased $41 per ton over last year's first quarter.

Turning to energy costs, energy costs were up $1.9 million in the quarter. Based on current market conditions the March quarter of this year will be in the range of $7.50 per MBTU. This is about $0.75 higher than the $6.76 per MBTU [non-exposing] price in the March quarter of last year.

We do not have any natural gas hedge positions on for the winter or this coming summer season. Rock-Tenn's cost of recycled fiber was $139 per ton in the quarter. This is up $49 per ton over the last year, an increase of approximately $12.5 million over the prior year quarter. That comes cost of recycled fiber in the first quarter of fiscal year 2008 was up only $2 per ton from the December quarter fiber cost of $137 per ton.

Markets for recycled fiber are down slightly from the December quarter, although higher than the last year. The January index for OCC in Chicago is $110 per ton, as compared to the average index of $93 per ton in the March quarter of 2007 and a $112 per ton in the December quarter of 2007.

Chemical cost, some of which changes in oil prices were up $ 2.6 million in our paperboard segment. That number compares cost in this quarter versus same quarter of last year. Freight costs were $300,000 higher than last year and 11.7% increase in net sales. This reflects a continuation from previous quarters of our process improvement programs regarding our transportation management.

Rock-Tenn did not buyback any shares during the quarter. Net cash provided by operating activities in the first quarter of fiscal 2008 was $22.3 million compared to $32.3 million in the prior year quarter. The decrease was primarily due to the reduction of non-debt current liabilities in the current year quarter.

The Company's credit agreement debt to EBITDA ratio was 2.57 times as of December 31, 2007, based on Credit Agreement EBITDA for the 12 months ending December 31, 2007 of $293 million. We have $35.6 million of cash on our balance sheet at the end of the quarter. An unusually high amount for us due to cash received at the end of quarter that was not applied to debt repayment.

The credit agreement debt to EBITDA ratio does not give us credit for cash on hand and would have been lower for cash was used to pay down debt at December 31.

Capital expenditures for the quarter were $17.9 million, below Rock-Tenn's depreciation and amortization of $25.8 million. For fiscal year 2008, we expect Rock-Tenn's legacy capital expenditures to be in the range of $75 to $80 million and in the range of $90 to $95 million assuming that the Southern Container acquisition closes in March.

Rock-Tenn's effective tax rate for the first quarter of fiscal 2008 was approximately 32%, which is lower than the 35.5% effective rate, we expect for the full fiscal year and somewhat higher than the 29% rate in the first quarter of fiscal year 2007. We expect our annual pension expense to decrease to approximately 8 million down from 13.3 million in fiscal 2007. During fiscal 2008, we expect to contribute approximately 23 million to our five qualified defined benefit plans.

Rock-Tenn's financial results for the past 12 months reflect record results for our business. Rock-Tenn's credit agreement EBITDA was 293 million or 12% of sales. Segment income was 216 million. Net income was 84 million and EPS of $2.14 per diluted share before adding back restructuring and other costs of 7.2 million.

Jim will now discuss our operating results and outlook

James Rubright

Thank you, Steve, and thanks to all for joining our call. The first quarter 2008 was just another really good quarter across the board in all of our businesses. We started off with great sales in all four of our business segment. Sales in consumer products were up 8%, sales in paperboard were up 11%, merchandising displays up 35%, and corrugated packaging sales up 13% over the prior year quarter.

We have continued to recover price increases in all of our segments, which contributed largely to the sales increases, but we also had volume growth in all four segment. The volume growth was strongest in our merchandising display segment. In our paperboard division, we also had a shift in mix from recycled board to bleach board, which helped our margins and resulted in part from continuing improvements in the operating performance of our Demopolis bleach board mill. Our consumer packaging business performed very well in the quarter.

Sales growth, as I mentioned were strong, largely price recovery, volumetrically it was up about 2.5% from the prior year. The most significant factor about the quarter is that we achieved our 5% return on sales target, which we established, when we acquired Gulf States assets little more than two years ago, but we did it in the December quarter, which is seasonally by far the weakest quarter for our Folding Carton business.

The main factors that contribute to our success in achieving our margin goal are the results of two programs that we started about two-and-a-half years ago. One is operational excellence, which focuses on optimizing and standardizing our operating functions. And the second is an equipment utilization project, which essentially matches our existing business to the optimum operating environment for us Rock-Tenn. We have seen great improvements from both programs, both reducing costs and then creating open capacity that is itself very low cost.

In addition, we are continuing to realize benefits from the execution and delivery of synergies from the Gulf States acquisitions and we are also seeing the benefits of the application of capital that we made overtime in this business [from] cost reducing technologies across the board.

Finally in the December quarter, there were no significant LIFO charges, which we had been experiencing through the course of the last year, as our board price increases to-date with the exception of the most recent announcement they have been passed through the Folding Carton business. As Steve mentioned and which goes in the press release, we announced yesterday the closing of our Chicopee, Massachusetts Folding Carton plant.

We have been operating in the northeastern United States two Folding Carton plants that each have less than $30 million in sales, and then operate in general Folding Carton markets. We cannot just by reinvesting in both plants given the past capacity that you effectively create with new investments in printing technology given the fact that we have very large plants in eastern Canada and North Carolina both of which have open operating capacity that's been created by the operating initiatives I refer to above.

With respect to this plant closure, as Steve mentioned, we recorded about $3 million in restructuring expense in the last quarter and we will record about a $1.3 million in subsequent quarters as we [first incurred]. The actual out-of-pocket costs of the closing that we will incur will be about $1.5 million after-tax. However, due to the capital avoidance, we will experience from the redeployment of the vest assets from this closed plant and we expect that proceeds from the sale of the building will actually be cash positive, as a result of the closing about several million dollars that we will realize over the course of the next two years.

From an operating standpoint, we expect to realize approximately $2 million in increased operating income, as a result of the closure. Thus by continuing to consolidate our business into large very well equipped modern plants that are operating at high utilization rates, we are continuing to generate increasing return on sales and a positive turnover in implied capital costs in our Folding Carton business.

Turning to Paperboard, although Paperboard volumes were up slightly in the quarter over the last year operating income to the segment was down approximately $2 million from the prior year.

Main driver was that the recycled fiber costs increased somewhat more than price recovery, more recycle grades, but particularly in our uncoated recycle grades.

Operating rates across the division for uncoated grades were low and they were consistent with industry trends, where we're seeing weakness in operating rates which we've discussed.

In addition, the annual outage at our Demopolis bleachboard mill was very well executed as was the startup, although the scope of the work that we undertook this year in the outage was much greater than the scope of the work in 2006. So the operating results in the 2007 quarter compared to 2006 tend to mask the significant year-over-year operating improvements we've achieved at this mill.

In addition, as we noted in the press release during the quarter, we received about $1.7 million in recovery of previously expensed environmental costs, which were largely offset by about $1.3 million in operating losses in our Dallas mill, where we experienced significant disruptions from some dryer failures and a subsequent major dryer section rebuild.

These disruptions accelerate the timing of the scheduled dryer rebuild at the mill and we also expanded its scope. Bright spot is we believe that we'll see some handsome payback from the rebuild both in reduced cost and added volume. And we've been seeing the benefits of those in the early weeks of January.

Our display segment had a 35% sales increase in the December quarter over the prior year as I mentioned. Those were especially strong late in the quarter as well as we had a very strong month of December. Here we continued to see strong demand for promotional displays as well as the benefits continued growth in our customer platform.

Our margins in the quarter were reduced somewhat by a less favorable overall mix and also by the startup of a new assemble facility that's related to the on boarding of a significant amount of new business from one of our largest customers. But we expect to see improvement in the margins that we generate from this incremental business over the course of the next few quarters.

With good sales growth in our corrugated packing segment, sales were up 13% in quarter over the prior year quarter. With good demands, we have bookings for corrugated sheets and those for corrugators, and we've good packaging sales in our converting plants.

Income of segments was up 22% based on mix and better asset utilization. When we close the acquisition of Southern Container, which we expect to do in the current quarter, we begin including the results for our St. Paul corrugated medium mill in our corrugated sector.

St Paul medium mill ran further in the last quarter as it has from last several years taken only holiday contractual downtime. Demand for corrugated medium in North America continues to be very strong and capacity remains very tight.

Looking forward to the balance of the year, demand continues to be good across all four of our business segments. Critically important for us is demand for paperboard. Our backlogs to bleachboard and clay-coated recycled boards are [off time]. All the industry today assures that North American bleached uncoated recycle mills can up strongly after the holiday downtime with initially very high operating rates.

Equally important to this paperboard division results are the status and price initiatives and then summarize the activity that is public. First, we see published $30 increase on NBSK pulp that we will recover on January 1, 2008 on our 100,000 tons of annual productions with southern bleached softwood kraft pulp.

Second, the three largest bleachboard producers and Rock-Tenn have each announced a $40 per ton increase for bleachboard folding grades to be effective in late February. Continued high operating rates and strong demands, as well as continued strong exports have led to favorable operating conditions for bleachboard.

Lastly, all of the major uncoated recycled board manufactures have announced the $40 per ton increase on most grades of uncoated recycled board.

Our two primary market mills for uncoated recycled board are located in Cincinnati, Ohio and Chattanooga, Tennessee. They have about a 150,000 tones per year of annual capacity. Operating rates in uncoated sector in North America, like these two that serve primarily tube and core, and other industrial applications have been relatively weak in 2007, the 80% range suggesting weak operating results in this sector.

As the fiber costs increases as Steve discussed are particularly affecting this lower margin segment for the URB market and are driving its price increase.

I would note that we operate three other unquoted mills. Ones that are very small mills focused exclusively on solid fiber book covers and the other two are sold out. One is a mill that supplies our interior packaging and partition joint venture and the other one is sold out by contract to Gypsum Wallboard, manufacturer that's a JV partner in the mill.

Now, converting businesses, demand for all of our converting products appears to continue to be good. Looking at the segments individually, consumer segment demand early in January is ahead of last year. We see very strong demand for merchandising display, where it is just a continuation of the growing demand in the sales patterns we similarly have experienced over most of last year.

Our corrugated segment began the year with higher demand in the last year, particularly in our corrugators, which are generally good indicators of market conditions. Of course given the recent announcements of the acquisitions in Southern Container, this product category will assume much greater significance to us. Southern Containers has also reported good demand through the end of December and have been offset at this quarter.

There is a strong demand for our converted products and our paperboards that goes in to those converting products. It's attributable, in fact, that on an overall basis, our businesses are focused on two paper and tissue, health, beauty and cosmetics, and consumer non-durables and all of those sectors continue to be very resilient in the current economic environment.

Thus, we believe that the overall outlook for our business appears to be good with continuing prospects for the generation of strong cash flow that you have seen from us. Those were my prepared remarks and Steve and I are now welcome your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Mark Connelly of Credit Suisse. You may ask your question.

Mark Connelly - Credit Suisse

Thank you. Just two things. If we look over the last couple of years at both your coated board and your bleachboard businesses, there is a lot of stability in the volume numbers that you're showing. I wonder if you can give us any sense of what's happening underneath that in terms of the customer base, the relative size of accounts and whether there is any shift among those categories that you've talked about x Demopolis obviously. I'm just trying to get a sense of what's really happening out there because certainly the economy isn't as stable as what you are reporting?

And my second question was just on the energy costs. I was wondering if you could give us a little bit of sense of the energy costs in the quarter, and also how that mix of energy will change once you close Southern.

Steven Voorhees

Sure. I'll answer the first half and answer the second half. There is tremendous stability in the customer base both in the coated recycled mills and the bleachboard mill.

James Rubright

There has been very, very strong continuity; about half of it is internal and there is some mix in and out of North Folding Carton business. But that's a relatively stable customer. I'd say a very stable customer base and the same is true both in CRB and bleachboard.

I acknowledge there has been a lot of movement in the sector, as you see I've referred to, but it hasn't really affected us. I think it is a tribute to the job that our people do in serving their customers and creating customer loyalty, so that at a market clearing price we're going to retain our customer base. We've got extremely low costs of quality in the division.

So, the movement we've made, Mark, has primarily been on the margins looking to improve trends and looking to improve shifting. So, we're either working with our customer base or on the margin changing customers to increase margins and maximize the opportunity in half of our mills. But, I'd say on the whole, the stability has been very high. Steve, if you'd address the energy question.

Steven Voorhees

Mark, our energy usage pretty [southern] is about 9.5 Bcf per year; that's natural gas and fuel that would exclude electricity and so speaking primarily to boiler fuel.

Mark Connelly - Credit Suisse

Right.

Steven Voorhees

But, that mix is more. We had a steam contract at our St. Paul mill, which we reported last summer. The contract ended and we're now burning our natural gas and fuel at the St. Paul mill. Southern Container also has a steam contract, a long-term steam contract with our steam host, which is located adjacent to the Solvay mill. That steam is generated by coal and so, in fact, that represents a significant cost of damage for that mill. They do consume a small amount of natural gas and oil at their converting plants and the order of magnitude volumes about another half of Bcf.

Mark Connelly - Credit Suisse

Okay, okay. So, it doesn't sound like we're going to see any big swing, a real substantive swing in the overall mix of energy that you are purchasing?

James Rubright

Well, what -- I think the way I'd express it is that there is a big mix in the stack that are going to coal base rather than natural gas base energy at the..

Mark Connelly - Credit Suisse

Right for the steam, that's right.

James Rubright

Solvay mill and, but it's not a long-term contract with the price adjustor that's primarily based on CPI and a percentage of the delta in coal cost.

Mark Connelly - Credit Suisse

Right.

James Rubright

We actually have -- we're significantly increasing the overall stability and dampening the volatility of Rock-Tenn’s overall energy cost mix.

Mark Connelly - Credit Suisse

Okay, okay. Thanks very much; that’s helpful.

Operator

Claudia Hueston of JP Morgan. You may ask your question.

Claudia Hueston - JP Morgan

Hi, thanks a lot. Good morning.

James Rubright

Good morning

Claudia Hueston - JP Morgan

I was encouraged to see the margin improvement in the Folding Carton business. And I just wondered if you could maybe talk a little bit about how sustainable you see that 5% sort of return on sales level? And then, do you think there is another leg up for margin improvement in that business, and, if so, how you are going to get there?

James Rubright

With respect to the first half, I think that the overall cost position of the business is much better than it would have been 24 months ago. So, I think I'd expect to see better margins over time than you'd have seen at the outset of the period for the average of the period, yes.

And the returns are really not volume driven or market driven. These are real benefits of cost reduction and optimizing the business platform. So, I think they are sustainable in that sense. However, the business is highly sensitive to marginal volumes and we had good sales.

As we've noted in the quarter, sales were up over the prior sequential quarter and in our December quarter they are flat to the previous September quarter. So, we had strong sales. So, that is definitely going to effect margins. So, if you have the strong sales quarters, it kind of shows up in the margin outlines.

And do I think we are out of gas in terms of the ability to improve the productivity of those plants? No, I don’t. I think the environment in which we have strong paperboard pricing, which we've had for now at least 24 months, generally favors the ability of the converting businesses to recover price increases. So, I think that has contributed to the benefits that you're seeing and as long as the paperboard markets stay tight, I think that will help the converters, Rock-Tenn included.

Claudia Hueston - JP Morgan

All right. That's really helpful. And then, I just wondered if you had any thoughts on recycled fiber in terms of where you sort of expect those costs to go over the course of 2008.

James Rubright

Yeah, Steve, go ahead.

Steve Voorhees

I think right now we're -- interesting market domestic prices are the spread between domestic prices and export prices is larger than it has been. And I think most people have sound memory. So, there is upward pressure. There are new mills coming online in China. We understand there is about 4.5 million tons of capacity coming around and they are in the course of the year.

Over the past fiscal year for us the average OCC price was $93. I think we had expected that to increase. And I think as we get over the next few months, we're going to see where that settles out. If we had to estimate, we would see an increase of maybe $10 to $15 on an annual basis year-over-year; it would be where that would settle out.

Claudia Hueston - JP Morgan

Okay. Thanks. That's really helpful.

Operator

(Operator Instructions) Our next question comes from Christopher Chun of Deutsche Bank. You may ask your question.

Christopher Chun - Deutsche Bank

Yeah. Thanks. Good morning.

James Rubright

Morning, Chris.

Christopher Chun - Deutsche Bank

Hey, Jim, just following up on your discussion of the price hike initiatives that are in the market, you've talked about pulp and bleached and uncoated, is there anything going on in the coated recycled side?

James Rubright

Nothing has been announced there, Chris.

Christopher Chun - Deutsche Bank

Yeah. Okay. And then on container board, did this last quarter fully reflect the small price hike or is there anything still left?

James Rubright

That price hike was announced for October, so we began getting it early in the quarter, but we didn't have the full benefit of it. So, with respect to our corrugated medium mill, I believe there is a little bit that you saw primarily most of that increase in the mill.

In the converting business, we are recovering early in the quarter, but again, it's pretty earlier in the quarter. So I don't have -- I can't give precise fraction. But I think that we did see the effect of that in the converting business as well.

Christopher Chun - Deutsche Bank

Okay. And then in terms of the $40 ton uncoated recycled hike, can you talk about over what time frame you expect to recover that?

James Rubright

Well, that's just a difficult subject to discuss for both competitive and any trust reason. So I am really not going to attempt to do that. Typically, as you know there is anywhere from three to six months period of time over which you recover price increases generally, either because of contractual limitations, market movements or just negotiations with your customers. But I can't comment specifically on this one.

Christopher Chun - Deutsche Bank

Okay. And is that the typically three to six months lag similar for the bleached paperboard as well or is that different?

James Rubright

Well, some of it's going to get -- initially you spot transactions, your contractual -- where you don't have contractual limits you're going to get relatively, quickly, immediately. So I don't want to suggest that it’s -- you know it's an average flow over three to six months. That's not right. But, what I am saying is until you ultimately get finished recovering all that you're going to get; it can take three to six months. The bleachboard is similar -- really depends upon the individual contracting state of the individual mill.

Christopher Chun - Deutsche Bank

Okay. And then in terms of your display business, it was up significantly year-over-year but I noticed that it was down a bit sequentially. Can you talk about through the normal seasonality that affects that business?

James Rubright

I can, and if you take that business overtime, the December quarter usually is the weakest quarter except when it's not. And, that's essentially what is happening. December in a way, in 2006 and 2007 were weak quarters seasonally, significantly weak. And that's true probably in three of the prior four years, but there was one year in which we had strong sales. 2008 continued the strong sales momentum that we saw in the fourth quarter.

I'm speculating, my belief is, though, that given weakness in the economy, consumer products companies have turned on the -- I am just speaking with respect to product promotions in order to maintain sales volumes. Because my belief is that this business is somewhat counter cyclical to the rest of our businesses and that is there is less need to promote in the healthiest environments, where the consumer products companies issue is production and supply as opposed to growth demand.

But the fact that it was down slightly from the prior quarters didn't trouble us because it was a tremendous sales rate for our December quarter.

Christopher Chun - Deutsche Bank

Okay. And, finally, Jim, you talked about how this quarter was affected by the fact that the average at Demopolis involved more work this year compared to last year. Can you tell us, sort of, what the incremental impact from that was?

James Rubright

It will. I have been speculating, it's very hard to take that in parts and we might try to do a little bit more work on it. But, I think it's in the range of a couple of million dollars because we had about a 2.5 times as many people in the mill at the peak of the average work as we did the prior year. And, saying so significantly greater scope and what that's going to mean is higher maintenance expense, higher maintenance non-capitalized costs and then sort of greater disruption costs.

But, the fact is I don't have a proxy to compare the analogy of this scope, under this management team against to really define what the additional operating expense or maintenance expense was and then compared to last year. My belief, however, is that the quarter, you can't really compare 2007 with 2008 apples-to-apples because of the scope of the work. And, therefore, while the mills operating results improved it was significantly greater improvement masked by the scope of the outage.

Christopher Chun - Deutsche Bank

All right. And going forward, would you expect future outages to look more like the '08 version or the '07 version?

James Rubright

Well, somewhere in the middle. They are not going to necessarily look like either because this is the year when we went into recovery boiler. So, this is going to be a large scale and you are not going to do that every year. So, this is going to be somewhere in the middle of it.

Christopher Chun - Deutsche Bank

Yes, okay. Thanks for your help.

Operator

[Steven Nissan] of Mindflow Capital Investment. You may ask your ask your question.

Steven Nissan - Mindflow Capital Investment

Yeah, a couple of questions; Good job, Jim. You always seem to do well in this very challenging environment.

James Rubright

Thank you.

Steven Nissan - Mindflow Capital Investment

A couple of questions regarding your operation initiatives; Can you tell us about how you guys are really going to improve on your operational initiatives in terms of Lean CPM Six Sigma to overall improve on throughout?

James Rubright

Well, we can talk for a long time about that if you wanted to really.

Steven Nissan - Mindflow Capital Investment

No, I'll talk for forever. Maybe you give us.

James Rubright

Over the last, I guess, from the time I've been here we have trained well over 200 people in Lean Six Sigma. We've over twenty Six Sigma Black Belts, who are fulltime devoted to process improvement and Six Sigma projects in the company. We've got a substantial number and I don't know the exact number of part time Black Belt.

And so, if I just try to count the number of projects that we were doing I don't -- tell you, it would be very difficult to do. But an average Black Belt is probably going to do two or three projects a year that are significant in terms of their potential impact of part time Black Belt pretty much as a commitment to do one project a year.

So, you've a massive effort throughout the company applying Six Sigma and Lean technologies to the business and the process of generating the projects for those people is very detailed at the business unit level. So, you have an enormous opportunity said and you've a lot of people who essentially have a methodology that if we are familiar with the methodology it works very well in identifying opportunities to improve operating results and then uses essentially day-to-day decision making in designer [experiment] capacities to isolate ways -- to isolate new process and develop improvements.

But in addition to that, the big thing we've done in the Folding Carton business that we're doing that sort of an ongoing project is what I referred to as capacity utilization. Rock-Tenn has been a very environmental, a very entrepreneurial oriented company and we've operated on a pretty disaggregated basis. But, particularly after the Gulf States transaction, we concluded that we really needed to operate the Folding Carton system, as one Folding Carton system and change the overall market approach.

And, as a result, we're essentially re-pricing every piece of business from the largest, working our way ultimately, we will be down to the smallest piece of business determining exactly where that should run from an operating efficiency standpoint and then going to the -- trouble is actually putting it in that environment, which significantly reduces your cost, pretty significantly increases open capacity because you're creating, you're changing the efficiency with respect to the stuff that it runs.

But, to do that you need to change the mentality or the culture of the people because it's a significant culturalship all of which is in place and is really paying dividends. So as much as Six Sigma, I think it’s the different operating model that we've got in Folder Carton business, but that we're also looking at with respect to the other operations.

Steven Nissan - Mindflow Capital Investment

Right; in your manufacturing operations, how important are OEE and RONA to you and is that something that's critical to your business to measure your returns on your investment?

James Rubright

OEE, which if you are familiar with ROE, is really our Overall Equipment Effectiveness, and there is a new way of looking at our operations new to the way we've done it. We've got it from one of our customers and it's really worked well. But essentially you measure the performance of every piece of the equipment against perfection if that machine could run at a stated run speed then you multiply that time with 24 hours and 365 days and we would measure on months so it's a number of days and months or so. Okay, that's a 100%.

What was your percent, how many sheets came out at the other end of the printer? And what it has done is changed peoples' aspiration of what's really possible. So, they are no longer saying well, I run 8000 sheets and somebody else ran [8200] therefore 8200 is the goal. The goal is maybe 20,000 right and you start attacking problems with a different perspective.

So, in terms of the -- I think very significant operating improvements that we've made it's been critical because we've struggled with ways to make. But I'd think of as quantum changes in operating efficiencies overtime and this one is really working. So, I think it's critical that the results that we're producing, I couldn't be happier with the team that said this is the way we're going to do that and having successfully implemented it and just spreading across the company.

Steven Nissan - Mindflow Capital Investment

Now, as you are talking about, obviously you guys are right on track. But what are you doing to accelerate these initiatives? What types of systems implementation are you putting in place going forward to make sure you stay the leader in the industry?

Steven Voorhees

Well, I'd be happy to talk in more detail about that after this phone call. But I think it's been more detailed than I would with respect to the broad investor that we have here.

Steven Nissan - Mindflow Capital Investment

Okay. And then a final question for you. As we go into a very challenging economy, possible recession for mid of '08, how do you -- Jim, as I see your Rock-Tenn, plan to stay a leader in the industry, improve shareholder value and just overall with this costs and make everyone happy that they are investors in your company.

James Rubright

Well, our strategy has been to; number one, focus on a combination of very high customer satisfaction and very high quality and very low cost. And we'll continue that discipline and focus. The question about, do we see a recession coming, I don't know whether there is a recession coming in or not. I believe because of the mix of our business in food, which is probably 62% or two-thirds of the food and beverage of the overall business mix of Rock-Tenn.

And, then consumer non-durable mix of our businesses, we are likely to have greater resiliency than many sectors of the economy in times of economic downturn. So, I frankly believe that we're well positioned relative to American industry generally to do well in this environment.

Steven Nissan - Mindflow Capital Investment

Good. Thank you very much. Continued success down the road.

James Rubright

Thank you.

Operator

[David Gutterman of Bowen Research], you may ask your question. (Operator Instructions).

Our next question comes from Kevin Casey at Casey Capital. You may ask your question.

Kevin Casey - Casey Capital

Hi, guys. A question kind of on that last one about recession maybe, maybe not. Can you talk about have you changed the way you think about managing cash and cash flow, your different priorities for that? And then, can you just remind us what will be the length of the priorities.

James Rubright

Sure, Kevin. The answer is we have not made any change. First of all, we don't reductions in our volumes; the volume growth in our business is continued. And, as I indicated, through January our business has actually looked very good, but we operate our businesses with the view of generating cash.

As we've talked about in the past, we essentially make every decision based on today's present value of the future expected cash flows of that decision over the long-term, so we don't manage our business with short-term, whether we are in a recessionary environment or growth environment, our decisions are ultimately made on the base driven by the same basic principal. And, that is to not respond to short-term factors.

In our case, the priority for the application of cash since the cost base application has been to reduce debt, after we met the needs of our business, as you know our commitment is to investment in our assets investing our business. And I think we've done that. Particularly, we did it through the last downturn in year 2000 period of time and I think those decisions are should be consistent in applying technology, and the businesses are paying dividends today.

But, we are maintaining our assets great. We have the most cost effective assets in the marketplace to attack our business. It's never going to use our excess cash flow. [We will say] there has been significant amount overtime to reduce debt. The acquisition of Southern Container puts us in a position where our debt level goes back up.

There is something like 4.1 times debt to EBITDA, which is historically at the range we said is acceptable, but a range in which we would be highly focused on that reduction. So I think you will see us over the course of the next two years very focused on executing that acquisition as we did Gulf States, executing the business plans of that business and then taking that cash and applying it to debt reduction.

Kevin Casey - Casey Capital

Okay. And then the follow-up, and it actually has been asked anyway, can you talk about having the most cost competitive facilities, do you think you, like, I mean obviously there are tons of facilities but do you think your overall portfolio facilities is more competitive than the competition?

James Rubright

Well, I do, yes. If you look at our performance over the last 24 months and then we've our peer group. I just take the other people, who are in our business, look at the performance of the other companies, for example, that are in the Folding Carton business. I'll have to believe that our people and our assets are generating returns that our performance over that cycle is better than the competition. So, something is got to be driving those results and those returns.

In addition, we've got industry, principal assets or mills then you've got industry cost cuts that you can pretty well compare where you stand versus all of you competitors from a cost standpoint. And I'd tell you that Demopolis is a very low cost mill, maybe the lowest cost bleachboard mill in the United States and is focused on folding grades, which is exactly where we want it.

So, that is, I think, our Battle Creek, Michigan mill is one of the two lowest cost recycled board mills in America. It's a large mill. St. Paul has very well cost. Our other mills, two of them are very driven towards market niches, where they have good costs with competitive advantage. So, I think they are fine.

I think our URB mills in Cincinnati and Chattanooga since they have remained good earning assets and what I think is a pretty troubled environment and that business are probably very low cost. The Solvay mill, which we are acquiring, we've done a lot of work on the cost structure of that mill and the reason we have identified that acquisition it is just where we want to go in our markets with the lowest cost assets that you can apply to the business.

And, I think, people recognized that the Solvay is extremely low cost and the box plant system that Southern Container has is extremely well capitalized and very low cost. So, yes, I'm of the view this will bring superior assets to our markets.

Kevin Casey - Casey Capital

And, do you also think you are getting more competitive everyday with the cost initiatives?

James Rubright

Yes. The Battle Creek mill expansion that we did, we did last September, for example. We took the mill down and we said we're going to take a little pay in quarter, as a result of that it has created capacity at the very high end of our expectations with very low capital costs, which has significantly reduced the operating cost for that mill, which is one example.

But, I can go through with you many of the things that we think have improved the cost structure of Rock-Tenn. Other people are doing similar things; we're not the only person out there taking costs out. We are on a treadmill that's running pretty fast. But, are we responding? I think yes, and I think we start with bringing a very good asset base to the marketplace.

Kevin Casey - Casey Capital

All right, it sounds great, thanks. Congratulations.

James Rubright

Thank you, Kevin.

Operator

At this time, we show no further questions.

Steven Voorhees

Thank you, operator. Thank you all for being on our call.

Operator

Today's call has concluded. Thank you.

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Source: Rock-Tenn F1Q08 (Qtr End 12/31/07) Earnings Call Transcript
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