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Rock-Tenn Company (NYSE:RKT)

Q3 2008 Earnings Call Transcript

July 29, 2008 9:00 am ET

Executives

John Spiegel – VP and Treasurer

Steven Voorhees – CFO

James Rubright – Chairman and CEO

Analysts

Claudia Hueston - JPMorgan

Joshua Zaret – Longbow Research

Christopher Chun - Deutsche Bank

Kevin Casey - Casey Capital

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 third quarter 2008 conference call. All lines have been placed on mute to prevent any background noise. As to the speakers remarks, there will be a question and answer period and to ask a question at that time, please press star one. As a reminder ladies and gentlemen, this call is being recorded today, July 29, 2008. Should anyone need any assistance, please star zero. Thank you.

Your speakers for today's call are Mr. John Spiegel, Vice President and Treasurer; Mr. Steven Voorhees, Chief Financial Officer and Mr. James Rubright, Chairman and Chief Executive Officer.

Mr. Spiegel, you may begin your conference.

John Spiegel

Thank you, Trey and a welcome to all for joining Rock-Tenn fiscal third quarter 2008 conference call. Joining me are Jim Rubright, CEO; and Steven Voorhees, CFO. During the course of the conference call, we may make statements that are not historical in nature and may involve forward looking statement, then the meeting of federal securities law.

For example, statements regarding our plans, expectations, estimates and beliefs related to future events for forward-looking statements which involved a number of risks and uncertainties. Many of which are beyond our control and that 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, 2007, and the Form 10-Q filed for the quarters ended December 31, 2007 and March 31, 2008.

During the call, we will be referring to non-GAAP financial measures. Reconciliation of these non-GAAP measures to the most directly comparable GAAP measures are contained in the third quarter press release which is available on Rock-Tenn's website at Rock-Tenn.com.

With that out of the way, I will turn the call over to Steve Voorhees.

Steve Voorhees

Thanks, John. During the June quarter, Rock-Tenn completed to close full quarter of operating results to Southern Container. Rock-Tenn's net sales from the June quarter $771 million, an increase of $180 million. Southern Container accounted for 156 million of the increase in sale. Rock-Tenn sales excluding the Southern Container increased 4% over the same quarter of last year. Rock-Tenn reported third quarter net income of $18.8 million or $0.49 per share. Rock-Tenn's suggested earnings were $0.70 per share, $0.06 or 9% more than the $0.64 per share reported in the third quarter of last year. Adjustments included $0.7 for the impact of the purchase accounting step up from the value of the seven containers inventory at the time of the acquisition.

As you may recall from our prior conference call, (inaudible) requires a step up to the value of the inventory who require to a level that in the case of finish goods, approximate the selling price of the inventory (inaudible). As we saw this inventory, we assign the step up value of the profit sales minimal profit on these sales. We do not record the profit as we would have normally recorded this inventory, have been valued the cost.

For cost, the step up produced income for the June quarter by $4 million or $0.07 after tax. We will not have similar charges from the seven container acquisition in future quarters. We recorded $3.7 million of restructuring cost consisting of acquisition integration cost of $1.7 million, and that amortization of acquisition-related deferred compensation expenses of $2.1 million.

We will refer to the $2.1 million as ESU expenses during the conference call in April. During the quarter, we successfully completed the capital project of the Solvay mill to expand the capacity of the paper machine number two. The project reduced our income by $3.8 million primarily due to the loss of 12,500 tons of production during the outage.

Finally, we incurred $1 million of operating losses at our folding carton plant in Chicopee, Massachusetts as I showed with the wind down of operations of that plant and the relocation of this business.

Turning back to the consolidated results for the quartet, non-allocated expenses increased by $1.7 million to $6.9 million in the quarter. Most of the increase was for expenses related to the major of financial systems upgrade that we implemented this quarter. The cost to move to this new state-of-the-art financial system reduced income by 1 million in the quarter. The total project cost including capitalized expenses was approximately 7 million.

At the time of the seven container acquisition, we fixed a portion of our bank debt for a period of four years at an average LIBOR rate of 3.11%. When interest rate increased, we terminated these fixed rate agreements and received $10.4 million in cash. We then entered into new fixed rate agreements for accountable time period at a higher average labral rate.

The $10.4 million gain will be amortized over the original term of the fixed rate agreements. We currently have approximately 70% of our debt at fixed rates. Capital expenditures for the quarter were $22.5 million, below depreciation and amortization of $39.2 million.

Our guidance for capital expenditures in fiscal year 2008 has been $90 million to $95 million, and for the fiscal year 2009, our guidance has been $80 million to $85 million. We expect actual capital expenditures for fiscal year 2008 to be at the lower end of that range, (inaudible) $90 million, and fiscal year 2009 capital expenditures to be in the range of $90 million to $95 million. This includes a $5 million increase for the spillover of capital from '08 to '09.

We have identified a number of project that will drive synergies and enhance the seven containers integration that will require an additional $5 million that we have included in the past month. Rock-Tenn's net cash provided by operating activities was $107 million in the quarter as compared to $72 million in the prior year quarter. This strong cash flow enabled us to pay down $89 million in debt during the quarter. Total debt was 1.765 [ph] billion at the end of June.

Our (inaudible) which deducts the cash on our balance sheet at the end of June was just under $1.7 billion. Rock-Tenn's full format credit agreement EBITDA for 12 months ending June 2008 was $440 million.

Using the $440 million and our debt levels at the end of June, our credit agreement debt to EBITDA ratio as of the end of the quarter was 3.92 tons as compared to the 4.2 tons when we closed the acquisition in early March. And this compares to our cabinet of 5 tons. We continue to expect to reduce our debt to EBITDA ratio to 3 tons by September 2010.

On January 15th, we announced a realignment of operating responsibilities. Our six coated paperboard mills now report to Michael Kiepura who has lead and will continue to lead our folding carton business.

Our five special paperboard mills now reports to Dick Steve [ph] and will continue to have responsibility for Rock-Tenn's RTS partition joint venture with Sonoco. Rock-Tenn's reporting segments will change to reflect this realignment. Before we vie up to recording segments, we will include the following, consumer packaging consisting of folding carton investments and six coated paperboard mills specially paperboard products including five specially paperboard mills, 16 converting locations, and our recycled paperboard procurement in trading activities, corrugated packaging including the Solvay and St. Paul containerboard mills, and our corrugated converting operations.

Fourth, our merchandizing displays business will continue to be reported as a segment. In September, we will report financial results along this realigned segments including three years of comparable financial information. General, James will now discuss our operating results in (inaudible).

James Rubright

Thank you, Steve. Strong sales performance in our consumer packaging display and corrugated packaging businesses and higher accretion to earnings from the Southern Container Acquisition prove this quarter's excellent results. Sales were up over the prior year 4.9% consumer packaging, 12% in display, and (inaudible) sales of corrugated packaging were up 16.5% all compared to the prior year.

Although higher prices contributed to the increased sales, our volume in each of our converting business were up. And in the case of consumer packaging in corrugated packaging where we have published industry data, our sales increases outpaced flat folding carton industry sales at 2.1% decline in industry box plant sales.

A higher sales contributed to the higher segment income in our consumer packaging business. Consumer packaging segment income was up 25.8% over the prior year and return on sales was 4.7%, which includes the business transition losses related to the closing of our Chicopee, Massachusetts plant which we took out in (inaudible).

We achieved this result due to the benefits we have attained from our operating improvements and our sale gained. Corrugated packaging margins were up as well including our legacy business and the Acquired Southern Container operations, although I can't quantify precisely the increase for you as we do not report the GAAP segment income for Southern Container for this pre-acquisition quarter.

Margins of our display business were down in quarter despite continued strong sales, as significantly higher input cost and sales mixed reduce margin. Return on sales of 9.8% for the quarter was disappointing as it was at the low end of our normal range but with still within the expected range for this business over time.

Turning to our paper mills, our mills were great throughout the quarter with new records total production at our coated and especially milled. Tons shipped, almost 236,000 tons are up 11,000 tons from the prior year, and are up 7,000 tons from the second quarter of this year.

Also to mention, sales increases in Southern Container box and graphics plant and containerboard mill's operating performance and superior cost position resulted in better than expected earnings accretion from the acquisition.

If it excluded special items we sited above in establishing adjustment earnings which we think is the best way to represent the ongoing earnings of the acquisition without the acquisition relay of charges in the Solvay capacity expansion which I will discuss. The acquisition of Southern Container had a $0.21 per share to our adjusted earnings for the quarter.

Our June 2008 expansion of the southern containerboard mill has exceeded our targeted capacity increase. And based on current production rates, the annual capacity of the mill is now 770,000 tons per year. Fully 50,000 tons more than we paid for and what we announced when we announced the acquisition in January of this year.

As we expected, I think I have advised you with connection to this jut down, we believe we have the additional tons sold out primarily from the increase internal consumption that we have at Rock-Tenn and from integrating Rock-Tenn's purchases, as well as from improvement in our combined portfolio and trace walks [ph].

Turning to the cost situation, much higher input cost particularly in our coated and specially milled reduced total statement income by 18.6 million or 31% per share over the prior year, and 6.4 million or $0.11 per share over Q2 '08. Specifically for the coated and specially milled, recycled fiber was up $21 per ton as Chicago OBM pricing averaged to $110 per ton in the quarter, and recycled fiber pricing increased $5 per ton over Q2 '08. Virgin fiber cost were also up $25 a ton over the prior year, and $17 per ton over Q2 '08.

Natural gas and other purchased energy costs were up $18 per ton, because NYMEX natural gas pricing average $10.92 per MMBTU for the quarter, and increased $5 per ton over Q2 '08.

Transportation costs, which you know are very material cost for Rock-Tenn, were up $7 per ton, as diesel fuel prices were up 57% over the prior year according to the US Energy Administration. And they increased $5 per ton over Q2 '08, and US Energy Administration's increase for that quarter was 24% over the immediately preceding quarter.

The chemical costs were also up $6 per ton over the prior year and $2 per ton over Q2 '08. Thus, we saw just a veritable storm of higher input cost across our business compared to both immediately preceding quarter and the year. And though we have realized price increases for coated and especially paper board during the quarter, the price increases were not enough to offset these cost input increases. However, as I will discuss in more detail, fiber and energy costs particularly have eased significantly from the averages we experienced in the just-completed June quarter.

Also, as we noted in our press release, there are a number of factors that appear to go very well for continued earnings and cash flow increases for Rock-Tenn over the balance of this year, and in the fiscal 2009. I will detail the most important ones that we see.

First, demand for paper board in consumer packaging remained solid, and our businesses have outperformed industry averages by gaining share and doing better with respect to price recovery of that our competitors.

Demand for corrugated packaging actually strengthened materially in the last few weeks with backlogs and new projects showing healthy gains. Thus, we believe the demand outlook across Rock-Tenn is very good.

Second, we have seen a number of recycled mill closures announced since our last conference call, which will remove overhanging capacity and keep industry operating rates up.

A total of 635,000 tons per year of recycled capacity of all grades have been announced to close since we had our last call. Particularly significant to us is the announced indefinite, whatever that means, closure which is scheduled for late August of this year of 180,000 ton per year coated recycled mill in Canada, and then 343,000 tons of uncoated recycled box board capacity including a small but significant mill located in Chattanooga, in Tennessee, where we also have an uncoated mill that serves independent (inaudible) manufacturers.

Third, recycled in virgin fiber cost and NYMEX natural gas pricing, our largest input cost together with transportation have all moved in our favor. For example, Chicago OBM pricing for OCC is now $90 per ton versus the June quarter average of $110 per ton. In Buffalo, OBM for OCC is also $13 per ton lower.

We currently consume an average of 1.9 million tons of various grades of recycled fiber, of which OCC is approximately 75%. In our virgin paperboard and market pulp production based on current pricing for fiber, we would also expect fiber cost to ease by $6 or $7 a ton for this quarter versus the immediately preceding quarter on our 430,000 annual tons of production of bleach paperboard and market pulp. Natural gases also eased materially, as I'm sure you've noticed.

The July actual natural gas price was $13.10 per MMbtu, but the August-September natural gas strip is approximately $9.20 per MMbtu, $3.00 less, and the annual natural gas and fuel oil equivalent purchases for us are about $9 million MMbtu per year, so again, a significant variance in cost.

Fourth, we expect to realize much higher pricing for paperboard and converted products in the coming months particularly corrugated packaging.

Since our last quarter call, published transaction pricing for containerboard is up $55 per ton. Our total containerboard capacity is 955,000 tons per year. Published transaction pricing for bleach paperboard is up $40 since our last analyst call. Our annual capacity for bleach paperboard is a little over 330,000 tons per year.

The pricing outlook for 100,000 tons of bleached southern softwood craft pulp continues to look good. In addition to previous announcements related to these increases, we have announced additional price increases of $65 on bleached paperboard and $50 per ton on uncoated and coated recycled paperboard. Our total uncoated and coated recycled board capacity is 851,000 tons per year.

We actually have some additional capacity on our Seven Hills joint venture with the gypsum pacing machine in our very small Aurora book board mill, but there – in Aurora, we only sell converted pricing, so paperboard pricing index is not relevant. And in Seven Hills, as you know, it is a total agreement effectively and affects three of those prices. And that's why the 851,000 tons is the number that I've used because those are the ones that we will select market pricing in our effective value increases.

So, as we track through that, we would expect higher paperboard and containerboard pricing over the September and December quarters and then with our most recent announcements, we would expect continued recovery of higher pricing on coated and uncoated paperboard in the calendar 2009.

Finally, as we discussed, in June 2008, we brought on additional capacity in our Solvay containerboard mill. This capacity adds 50,000 tons of production over the next 12 months. In addition, we are beginning to realize the synergies that we have forecast with the southern container acquisition, although as I've mentioned before, we are just beginning to bring those synergies on. So we really expect to increase the annual contribution from that acquisition by about $15 million as a result of those synergies.

On the subject of synergies, we have begun executing our business integration plan within the last 30 days and as I discussed in connection with that, we are actually downward integrating the legacy Rock-Tenn operations into the larger and lower cost Southern Container operation.

As a part of that integration, Southern Container will give up its historic identity in the marketplace and will go to market as Rock-Tenn. And we are going to be much more consistent with our other business units in eliminating a number of the trade names we've operated on because we believed we will benefit significantly from capitalizing on the brand equity for quality and service that is signified by the Rock-Tenn brand in the marketplace.

In that connection, we freshened and modernized the look of our brand, which you may have noticed appearing at the head note of our earnings release.

When we take the current environment of good demand, continued capacity rationalization and paperboard grades that are highly material to us, strengthening demand for containerboard and particularly corrugated packaging at our box plants, which I think is very important on the subject to passing through at the box plant level the published containerboard price increases together with our volume increases at the Solvay containerboard mill, we think this represents all in all a very positive outlook for Rock-Tenn.

That concludes the prepared comments that Steve and I had. And at this time, we would open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) The first question does come from Claudia Hueston of JP Morgan. You may ask your question.

Claudia Hueston - JPMorgan

Thanks very much, good morning.

James Rubright

Good morning Claudia.

Claudia Hueston - JPMorgan

Did I hear you right that Southern was $0.21 to earnings in the quarter and then I just wondered if you could talk about how we should think about the accretion on an annualized basis, so are you comfortable with that as sort of a run rate?

James Rubright

Yes, I am. The mill does not take a prolonged annual outage as the Demopolis virgin mill does. It does take outages during the year, so you multiply 21 by 4. You might shave a couple cents of it for maintenance outages, but I think it is a run rate. When we announce that we were doing the shutdown to increase the capacity of the mill, we predicted about $0.05 of operating losses which is really lost production and expenses that you would otherwise have devoted to productive offer activities. And I think that if you're trying to go to the underlining earnings of the mill, you have to essentially treat that as a capital expense associated with the project and that's why we adjusted it out.

So, yes, I think that's right, but it does not reflect the synergies because the business integration with respect to the reduction and staffing and associated business improvements from aligning our business with the Southern Container business model we just began in basically in July and August. And then as we've also discussed, the administrative synergies are awaiting a major system integration which we are in the process of designing. As Steve mentioned, we upgraded Rock-Tenn's financial systems materially in the last quarter and we had to do ours first before we could do theirs. So I don't think you are seeing significant synergies. We have integrated some purchases, but the substantial majority of the synergies are ahead and we have them identified and I feel very confident that we will be able to recognize them.

In modeling our business, Claudia, they probably will not all show up in the containerboard segment because there will be an administrative component to those savings that will show up across Rock-Tenn. And we very likely will reallocate the home office in administrative costs. For purposes of this year, particularly because of the way the Southern Container employee compensation programs were established, we didn't change the allocation of cost to Southern Container. We held them steady from the administrative cost they would have incurred. And in fact that made sense because of the transition of the administrative assistance I referred to.

So if we in fact change our allocations, what we will do is to make that clear. We will give an update and publish the report so that it will be out there and we will be glad to sit down and explain to you how we have modeled that, so then you'll be able to predict how this cost roll across the segment, but then it will be formalized before we are in a position to do that.

Claudia Hueston - JPMorgan

Okay, thanks that's very helpful. And then just looking at the paperboard business, the bleach board and pulp volumes were a little bit lower than I had expected. Don't know if you have any caller on that, (inaudible) year-over-year?

James Rubright

We do, we report ship tons, not tons produced.

Claudia Hueston - JPMorgan

Okay.

James Rubright

And so there can be noise in the shipment date, more than production. In fact, the mills run at essentially – the bleach board mill was sold out, so it really was a function of when the ton shipped, not when they were produced.

Claudia Hueston - JPMorgan

Okay.

Steve Voorhees

In the coated mills, we took a few days of market downtime, but not anything that was really significant and I think that we will be cleaned up by the closure that we have referred to.

Claudia Hueston - JPMorgan

Okay, that's helpful. And then just finally, could you just give a little bit more color on the displaced business and sort of maybe parse out what was cost and what was maybe mix related and just a little bit more color on what the cost pressures are in that business?

James Rubright

Yes. Well, I think the majority of the difference in earnings was mix related and they are subject to a lot of the same production cost that are corrugated box plant would be subject to, because you've got the transportation costing cost (inaudible) cost and the like. They tend to pass through their cost pretty well and that's why I think that the majority the effect was mixed, as I have to look at it and review the sort of the detail under those numbers. But I kind of been to the point, if you are turning the dials up on Rock-Tenn's businesses, don't turn all of them up and then turn alliance up too.

Claudia Hueston - JPMorgan

Okay.

James Rubright

That business turns to -- that is going to be a somewhat countercyclical business. So I think that you need to kind of take an average of a number of running quarters in order to really predict the annual run rate at alliance. It's a very competitive business. And as you know, we have a large competitor out there who's indicated that the business has maybe gotten a little tougher too. So, I think that, if I were modeling that business, I'd put it in something like an 11%, 11.5% return on sales. Try to make a guess with respect to sales going forward, but recognizing that if the economy picks up, probably you might see a little dialing back and customer utilization of this place. So I'd moderate that business somewhat.

Claudia Hueston - JPMorgan

Okay great that's really helpful. Thanks so much guys.

Operator

Joshua Zaret of Longbow Research, you may ask your question.

Joshua Zaret – Longbow Research

Thank you. I guess, if I heard correctly on demand for corrugated packaging, I think you said it strengthened significantly in the last few weeks. I would just like to follow up on that because the June numbers were pretty bad, and so I'm wondering is that because of the unplanned schedule maintenance and it relates to you as a company, or just the industry?

Steven Vorhees

That is the right question to ask. What I was referring to was demand for corrugated packaging in our box plants and graphics plant. So our plant activity is up in our backlog were up. I think our backlogs for corrugated packaging were up about 7% over the last couple of weeks and our pipeline of new projects was healthy to us. So we are seeing good demand from our customers for finish goods. We are 2% of the industry and we're focus on the Northeast, Mid-Atlantic, and Southeast. So it maybe a regional look, and it may be our companies look. I don't have visibility across the industry so I think -- for the answer to your question, I'd be listening very careful to the -- carefully to the others who announced, but I will tell you that we feel that demand has definitely strengthened.

Joshua Zaret – Longbow Research

Okay. As long as you bring up, I mean the regional thing, with Solvay, there are not a lot of containerboard mills up in the Northeast. So I'm kind of wondering, when you look out past 2010, your balance sheet is restored and you start looking to expansion. How important is that mill? Is there room for expansion there and would that be the first place you look within the company in terms of putting a new machine? How do you think about that now?

Steven Vorhees

I think, we think about all of the things that you've mentioned -- we were very attracted to the containerboard business based on what we viewed as a change in the fundamentals. That economic premise looks really good four months into it and we think there's opportunity there both through acquisitions and continue the Southern business model of successful expansion. There is room for another machine on the site in Syracuse so we will definitely evaluate that.

In our St. Paul site, we have the ability I think to significantly improve both the cost and the productive capacity on that site and we have great access to fiber and just a superb workforce in a community that recognizes the value of having that mill where it is. So, we are definitely going to look at the possibilities of doing something in that region. But the fact that you've noted which is if we have a locational advantage in New York State based on the scarcity of productive capacity there really translates into the strength of the swap position that we have through that mill and because of course it's new and makes a very high quality product that swaps.

Joshua Zaret – Longbow Research

Great. And one last set of questions, on the cost side or fiber cost being down so much, is that a function of weather, or is there something else going on there?

Steven Vorhees

No, it's a function of February. If you just model recycled fiber pricing over time, there is a February increase that is observable in most instances and it is the amelioration of the February price point.

Joshua Zaret – Longbow Research

Okay, that was for recycle, but what about now for virgin, is that a weather thing or --?

Steven Vorhees

No, I think that it is really a fuel oil related phenomenon. The cost pressures on truckers are the same cost pressures that are experiencing -- being experienced by the people who go into the woods and go get trees, where fuel oils and material costs, and the marginal producers there are under a lot of pressure.

Joshua Zaret – Longbow Research

Got you, that's very helpful. Thank you.

Operator

(Operator instructions) Our next question does come from Christopher Chun of Deutsche Bank. You may ask your question.

Christopher Chun - Deutsche Bank

Yeah, thanks. Good morning Guys.

James Rubright

Hi, Chris.

Christopher Chun - Deutsche Bank

First of all, can you remind us how much pension expense will be for this fiscal year and how that compares to your cash funding?

James Rubright

Yes, Steve is referring to that right now.

Steven Voorhees

Approximately $5 million.

James Rubright

Pension expenses, $5 million.

Steven Voorhees

Yes.

Christopher Chun - Deutsche Bank

What about the cash funding?

James Rubright

Hold on a second.

Steven Voorhees

It is $5 million.

James Rubright

And what is pension funding, I thought it was –

Steven Voorhees

It was $16 million, I'm not sure.

Christopher Chun - Deutsche Bank

Okay. And how -- do you have a sense of how that it will look in '09?

James Rubright

I think it's going to go up a little bit, but it's not going to be material. The funding is going to go up probably closer to $20 million.

Christopher Chun - Deutsche Bank

Okay.

James Rubright

Then the expense, Steve, do you have a forecast of expense?

Steven Voorhees

I think about 11.

Christopher Chun - Deutsche Bank

Okay. Can you explain why the expense would go up somewhat?

Steven Voorhees

It is the investment results for this year, just have not been. They have been under the assumed right return that we have. (inaudible) they're going to be just little investment of financial markets have declined.

Christopher Chun - Deutsche Bank

Okay. And then in terms of all your input cost, Jim, you discussed a number of factors in terms of how they were quite high for last quarter, but they've moderated since then. If you put them all together, can you give us a sense of sort of -- I don't know, either an absolute number on a per ton basis or something of order of magnitude of how much they might have moderated continue to last quarter's average?

James Rubright

I can, but I have to add it all up. I went through it item by item in the call.

Christopher Chun - Deutsche Bank

Right.

James Rubright

If you don't mind, just call us back after the call and we will add it up and we'll discuss through it.

Christopher Chun - Deutsche Bank

Yeah, okay. And then how about on that pricing side? You have a couple of price hikes on paperboard grades out there. Can you talk about how you expect them to roll through this quarter and how much of a lag there will be into the coming quarters?

James Rubright

Sure, because of the anti-trust rules that apply to us, I can't really predict or talk about how we will execute. I can speak, however, from the extent to which our volumes have contractual limitations and so forth and then what the normal experience we've had regarding price increases from publication in DPW. The big one that we'll start with is the $55 increase on containerboard and in our corrugated packaging business, we are less restricted regarding price movement contractually than we are in folding carton business.

In fact, fully two thirds of our business is unrestricted and so we have the ability to move that when the market moves and that should – we should expect if the market moves in August as we expect, two thirds of that business would be unrestricted which respect to our ability to move it. The remaining third begins to have either delays where you got a two to three month delay or in some cases the cap bottom provision where you might get 60% of an increase or 60% of a decrease. So, there's a third of the business on which you will either be partially delayed or you won't get the full amount of the increase, but you should see a very substantial realization of that $55 on the assumption and we're making that assumption that it does move through the marketplace relatively quickly.

Now, bleach board, the publication of that increase was basically 20 and 20 over the last couple of months and that will pass through the marketplace relatively rapidly on the open tons, but again you have somewhat of a greater exposure to contractual limitation there than you do on containerboard and corrugated packaging. But again, over the next three to six months, I think you'll see us recover fully what we'll recover and likely weighted towards the first three months. With respect to coated recycle board, there we would be contractually the most limited in terms of our recovery. So, typically, we have said that a price increase takes really three to nine months to move through our system with a normal distribution that probably has a peek about six months out.

Christopher Chun - Deutsche Bank

Okay. And then what's the breakdown between open tons and contractual in waste and CRD?

James Rubright

I don't have that precisely, but I think at least 50% of our total tons on both grades would have some contractual provision that would specify a time period in which that increase would be recovered and that would have some delay.

Christopher Chun - Deutsche Bank

Okay. And then lastly if I might, Steve, you touched on this in your prepared comments, but I was wondering about you're debt and your infrastructure. Can you remind us, what's fixed and what's variable and if it's -- what the variable is high to and also how much of that comes from the Southern deal?

Steven Voorhees

We have about $1.7 billion in net debt. About $1 billion of that is due to the Southern transaction. The breakdown of fixed is we have public notes outstanding of $550 million, and then we have a term loan under our senior credit facility, which – that is what we have hedged, debt balance is currently $550 million. We took on $120 million some odd of debt unresolved that bound outstanding, those are fixed, and so that adds up to the fixed debt that we have, which is about --

Jim Rubright

70% of the total debt.

Steven Voorhees

Right. And the balance is primarily tied to LIBOR, the floating piece.

Christopher Chun - Deutsche Bank

Okay. So, LIBOR doesn't move around for you much, it's the interest expense that we saw in the quarter, a good run rate for the future?

Steven Voorhees

Yes.

Christopher Chun - Deutsche Bank

Okay, thanks for your help guys.

Operator

(Operator instructions) Our next question does come from Kevin Casey of Casey Capital. You may ask your question.

Kevin Casey - Casey Capital

I'm not sure if you guys talked about this, but have you talked about next year's CapEx and depreciation?

James Rubright

Hi Kevin, Steve did, but I'll just go over it briefly. We had basically said this year, the number was going to be 90 to 95. As we look at the timing of the expenditures, we think we are at the low end of that range because about $5 million is going to push into next year. Next year we had said 80 to 85, so we're up in that 85 to 90. And then we've identified some integration and synergy capital that we think is really highly justified and is part of out overall $15 million of annual synergy run rate and that looks like about $5 million for us. Some of it is systems related and some of it is related to plan closure and so forth. So we're saying 90 to 95 for 2009.

Kevin Casey - Casey Capital

And then can you talk about, now with the more – the bigger debt burden kind of buying back stock versus paying off debt?

Jim Rubright

Yes, and I didn't follow through on depreciation but depreciation is about $155 million. So you're going to see $60 million of difference between CapEx and depreciation. On our bias on buying back stock, we think that the optimal capital structure for us has between 2.5 to 3 times of debt to EBITDA. So, our target is to aggressively reduce debt to three times debt to EBITDA, and at that point, stick your head up and take a look at what you should do. Our belief is that we will – it will be appropriate for us to increase the dividend run rate and we are looking at that. The timing of that will be tied to continued reduction in debt, but the majority of the short term effects would be in the form of stock purchases where you have really good ability to dial up or dial down the amount that you do.

Kevin Casey - Casey Capital

Alright, thanks. Congratulations on another great acquisition.

Jim Rubright

Good, thank you, Kevin.

Operator

At this time, we show no further questions.

Steven Voorhees

Yes, thank you very much for your participation on this call.

Operator

Today's conference has ended. You may disconnect at this time.

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