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Executives

Roger Stone – Chairman and CEO

Andrea Tarbox – VP and CFO

Analysts

Ali Motamed – Boston Partners

Steve Chercover – D.A. Davidson

Michael French – Morgan Joseph

Jack Ripstein – Potrero Capital Research

Matt Sherwood [ph] – ZF Fund [ph]

Anabella [ph] – Elm Ridge Capital

Jerry Chan [ph] – William Harris Investors

Brad Goulagi [ph] – Latvilt Capital [ph]

Kevin Beck – Artisan Partners

KapStone Paper and Packaging Corporation (KPPC) Q2 2008 Earnings Call Transcript August 5, 2008 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2008 KapStone Paper and Packaging Corporation earnings conference call. My name is Erica, and I will be you coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator instructions)

Forward-looking statements, statements in this news release that are not historical are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can often be identified by words such as "may," "will," "should," "would,' "expect," "project," "anticipate,” "intend," "plan," "believe," "estimate," "potential," "outlook," or "continue." The negative of these terms or other similar expressions.

These statements reflect management's current views and are subject to risks, uncertainties and assumptions, many of which are beyond the company's control that could cause actual results to differ materially from those expressed or implied in these statements.

Factors that could cause actual results to differ materially include, but are not limited to. One, the ability of KapStone to successfully integrate SKB's [ph] operations and employees, and KapStone's ability to realize, anticipated synergies and cost savings; two, industry conditions including changes in costs, competition, changes in the company's product mix, and demand and pricing for the company's product; three, market and economic factors, including changes in pension and healthcare costs and natural disasters, such as hurricanes; four, results of legal proceedings and compliance costs, including unanticipated expenditures related to those cost of compliance with the environmental and other governmental regulations; five, the ability to achieve and effectively manage growth; six, the ability to pay the company's debt obligations; and seven, the ability to carry out the company's strategic initiatives and manage associated costs.

Further information on these and other risks and uncertainties is provided under Item 1A "Risk Factors" in the company's Annual Report on Form 10-K/A for the year ended December 31st 2007 and quarterly report on Form 10-Q, for the quarter ended June 30th 2008, which is incorporated herein by reference, and elsewhere in reports that the company files or furnishes with the SEC. These filings can be found on KapStone's Web site at www.kapstonepaper.com and the SEC's Web site at www.sec.gov.

Forward-looking statements include herein speak only as of the date hereof and the company disclaims any obligation to revise or update such statements to reflect events or circumstances after the date hereof or to reflect the occurrences of unanticipated events or circumstances.

I would now like to turn the presentation over to your host for today's call, Mr. Roger Stone, Chairman and CEO. You may proceed, sir.

Roger Stone

Thank you. And good morning. Wish to – when I hear a disclaimer like that I think I've got way a list [ph]. Everything we say is suspect. Anyway, good morning again. Thank you for joining us. As usual, Andrea Tarbox, our CFO, is with me on the call.

Yesterday after the market closed we released our second quarter earnings. We believe we had an excellent quarter. Andrea will give you an in-depth look at the numbers, and I will return with few comments, then we will try to deal with any questions you may have. Andrea?

Andrea Tarbox

Thank you, Roger. Good morning, everybody. We invested $150 million in our first acquisition at the beginning of 2007. Having completed 18 months of operations, we have already generated $73 million of operating cash flow. The second quarter of 2008 proves to be a very successful quarter, producing over $16 million of EBITDA despite the significant inflationary pressures on our input. Our outstanding operating efficiencies coupled with proactive price increases have led to a positive result.

Now, I will discuss our second quarter results and how our operations generated these cash flows. In 2008, we changed the timing of the annual maintenance outage to the third quarter from the second quarter in 2007. This change should be kept in mind if we discuss our results. The 9-day outage in the second quarter of 2007 negatively impacted operating income by approximately $4.6 million.

Basic earnings per share for our second quarter was $0.32, up $0.18 over the prior year as net income rose 139% to $8.3 million, up from $3.4 million. Improved operations contributed $0.08. The timing change of the annual outage added $0.11. And higher share count reduced EPS by $0.01. Our fully diluted EPS of $0.22 was up $0.13 over the prior year.

Total company net sales for the second quarter 2008 increased about 13% to $68.2 million from $60.2 million, on increased unbleached Kraft segment sales. Unbleached Kraft segment sales were up $8 million or 15% to $60.5 million compared to $52.5 million in 2007 as a result of 2007 higher prices and volume increases that partially resulted from the change in timing for the annual outage.

Average revenue per ton increased to $581 per ton, up $42 or 8% per ton, adding approximately $4.4 million to our sales. Our $40 per ton kraft paper price increase improved revenues by $1.8 million in the second quarter and will increase revenues $2.7 million per quarter thereafter. Volume of paper sold increased by 6,700 tons.

Looking ahead, both third and fourth quarters will benefit from additional price increases. On July 21st we announced a $50 per ton kraft paper price increase. We anticipated benefit of this increases $600,000 for the third quarter and $3.25 million for the fourth quarter.

Additionally, we will benefit from a $55 per ton increase on roll wrap and domestic linerboard grades which is currently being implemented. The third quarter benefit is expected to be approximately $600,000 and the fourth quarter benefit should be approximately $1.3 million. The impact on the last half of the 2008 from three price increases I discussed is anticipated to exceed $11 million.

It's important to note that the linerboard price increases will also be beneficial to our new Charleston operations, along with price increases they enacted in the second half of the year on kraft pack and saturating kraft. Finally, in the third quarter, we expect operating income to be negatively impacted by approximately $5.3 million due to the annual maintenance outage.

Revenue per tonnage bag sales increased 2% year-over-year on a 6% increase in volume. Increased price competition in two ply bag which comprised over 18% of our sales however, led to a decrease in average revenue per bag of $0.09.

Total company operating income increased $7.1 million to $13.2 million, up 115% over prior year's second quarter. Higher selling prices, the timing of the annual maintenance outage and productivity improvements increased unbleached kraft paper operating income to $15.9 million, up $8 million or 101% over the prior year.

The mill has run very well since the beginning of March. And for the second quarter, we achieved an operating margin of 26.3%, our highest rate since owning the mill. Production volume in the second quarter of 2008 increased 15%. A 11% due to the outage timing change and 4% from productivity improvement. Inflation of approximately $3.9 million on our energy, chemicals and freight costs partially offset our gain.

The dunnage bag operating income declined to $1.3 million, down $0.5 million or 30% from the previous year resulting primarily from lower selling prices of $2.2 million and inflation on raw materials of $0.2 million. Operating margin declined to 14% from 21%.

Selling, general, and administrative expenses of $4.6 million were up $0.3 million, or 6% over the prior year due to higher corporate charges of $0.3 million, including non-cash stock compensation costs, Charleston acquisition start-up costs and personnel ad additions.

Offsetting these costs was the elimination of the transitional support services from international paper, a $0.6 million. We ended our reliance on international paper for providing transitional support services on April 1st this year when our own ERP system was put into operations.

Our EBITDA for the second quarter of 2008 was $15.1 million, up $7 million or 77% from the prior year's quarter.

Cash generated from operations was $20.9 million. Accounts receivable balances increased on higher sales and slightly higher DSO. Our inventory level remains low despite the increased production.

We invested approximately $4.6 million year-to-date in capital expenditures including an additional $1.8 million for our ERP system which is now essentially complete, bringing total costs of the system to approximately $6 million. The majority of the remainder of the capital expenditures was spent on our unbleached kraft segment.

Our working capital was $79.6 million at June 30th 2008. And we paid down debt by $15 million prior to the Charleston acquisition. As you know, due to our acquisition on July 1st of the Charleston operations, we paid off the existing loans and entered into a new five-year senior secured credit facility of $515 million consisting of LIBOR-based term loans of $415 million and a $100 million revolving credit facility. In addition, $40 million of 8.3% senior notes were issued.

And at this point I'm going to turn it back to Roger.

Roger Stone

Thank you, Andrea. The integration of Charleston is off to a very good start, and we remain very positive about its contribution to building shareholder value. Even with Roanoke Rapids shutdown in July, July appears to have been a good month from an operations point of view.

Backlogs are healthy in all of our product lines. Pricing continues to be strong. Second half pricing over second quarter pricing levels will add about $15 million to $16 million, an additional revenue in the second half with the bulk of it coming in the fourth quarter.

When we compare year-end pricing of this year to the beginning of the year, you should note that kraft paper pricing will increased about $90 a ton. Domestic linerboard about $55 a ton. Saturating kraft over $40 a ton. And kraft pack by over $50 a ton. It appears that export linerboard prices maybe beginning to move. In any case, we will be increasing our domestic sales of linerboard beginning in the fourth quarter. This mix change will be improving our pricing by approximately $65 a ton in the tons switched from export.

Historically, saturating kraft prices are negotiated to change at the start of each year. And although I emphasize that we have not announced any price increases of saturating kraft it's reasonable to anticipate some price improvements in the first quarter. I've gone through all of this because it's important to understand the rollup, the effect of a rollup in pricing in order to evaluate future performance.

We are incurring substantial purchase costs increases in energy, chemicals and freight, and modest increases in just about everything else. Compared to many of our competitors, we have a favorable energy and fiber profile, and because of this our improved pricing should compare favorably at the bottom-line with the industry. We also believe we will be successful in improving our productivity and reducing our operating costs.

Finally, the environmentalists war with the plastic bag seems to be accelerating and this can only be good for paper. So if sound optimistic about KapStone's future is because I am and that should not be a surprise to anyone who knows me. Now, we'll be glad to take your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Ali Motamed from Boston Partners. You may proceed.

Ali Motamed – Boston Partners

Hi. I was wondering you guys were very positive on the cogen facility as part of this acquisition. I was hoping you could maybe take a little, little bit of time to explain it a little bit better and help us understand what kind of incremental benefit that provides you, maybe if you could quantify a little bit to so that we could really see what kind of advantage you have as part of that facility especially relative to competitors. Thank you.

Roger Stone

Well, that mill, because of the Cogen, has low energy costs compared to most comparisons I've seen in the linerboard. It burns coal, and I guess the good news s it has one year to go on its coal contract so the recent up-and-down pressures in the coal market should have little effect, although its transportation costs will rise as all transportation costs do. It's a very healthy number. I don't think I want to quantify that, but – any more than I have and anymore than we did in documents. That Charleston is a mill where we think there's lots of opportunity to use very good assets and to decrease operating costs. And so I would just wait on that question.

Ali Motamed – Boston Partners

Thanks.

Operator

Your next question comes from the line of Steve Chercover from D.A. Davidson. You may proceed.

Steve Chercover – D.A. Davidson

Thanks. Good morning.

Roger Stone

Hi, Steve.

Steve Chercover – D.A. Davidson

I apologize if I might have missed a little bit; I got on a wee bit late. But first of all, have there been any surprises, positive or negative, in the month that you've owned Charleston?

Roger Stone

Yes. I think there have been surprises, mostly good. Some of the overhead costs that were allocated to the mill, and there were a lot allocated by West Virginia. And we estimated what we thought we could save on a standalone basis, and we underestimated that savings – that the savings are even greater.

Steve Chercover – D.A. Davidson

Great. And with respect to your ERP system, is it scalable and is it sufficient at this stage to rapidly assimilate and handle Charleston?

Andrea Tarbox

Yes. As you know this acquisition took quite a while for us. So actually when we were evaluating the ERPs we were already thinking ahead. And knew that we needed a scalable system. So yes it is scalable, and it will be – it will function for us, Charleston.

Steve Chercover – D.A. Davidson

Thanks, Andrea. And final question, if I understand part of your strategy – I think you're trying to move away from some of your kraft paper production and back into container board. Do the victories of the environmentalists banning paper bags make you reconsider that strategy?

Roger Stone

We have plenty of paper capacity left in Charleston where we've been running linerboard, and we would prefer to run all Kraft paper there. So, it's very good for us in that regard. The linerboard will be switched obviously to Charleston. Charleston, not including the productivity improvements in the mix, Charleston has a big stake in the export market. As I indicated in my remarks, switching some of that to the domestic market obviously has a great financial advantage, so we win two ways. And Charleston is perfectly capable of making heavyweight sack Kraft as well.

Steve Chercover – D.A. Davidson

Are there any studies that indicate what potential, if we migrate back towards paper bags –I assume there's going to be so many usable sacks that, if you are smart enough to remember them which I never do, that it's not going to be back like 70s, but is this just the tip of the iceberg in terms of the reversions of paper bags?

Roger Stone

Now, dreaming a little bit – yes, if it happens. I started promoting that 15 years ago and so – it hasn't happened, but clearly there is a lot of momentum there. Yes. I think, before the entrance of the T-shirt plastic bag, for the most part that bag consumption, probably supermarket bags, was about a 4 million ton plus business. And that's with a much smaller population. Today, with a larger population, it's about a 600,000 ton business. That's where plastic has taken over. So if that market regains, it's very good not only for the kraft paper makers, it's good for the linerboard guys, particularly those who can make lightweight linerboard or if they can make the heavyweight in the grocery sack area. So it's very positive. It's the old story. If you bring your cloth bag, which I think is terrific and people should do that. You're always going to be a bag short or two. In other words, some people may be smart enough to just fill up the cloth bag that they bring if they bring it. So if this thing happens and momentum continues, yes, it should impact kraft paper demand which will help both the linerboard and the kraft paper businesses. But it's a big political issue today and is big political issue with some states and there are lots of laws being passed, and there are supermarket chains are saying they are not going to issue plastic bags any more. And again, they will sell cloth bags, and they will encourage you to use the cloth bags and they will have paper. So I don't see how it can help grow Kraft paper demand. The issue is by how much and that would be how fast the spurt environmentalist perber [ph] moves across the United States – and Canada by the way.

Steve Chercover – D.A. Davidson

Thank you.

Roger Stone

Welcome.

Operator

Your next question comes from the line of Michael French from Morgan Joseph. You may proceed.

Michael French – Morgan Joseph

Good morning, everyone.

Roger Stone

Good morning.

Andrea Tarbox

Good morning, Mike.

Michael French – Morgan Joseph

Congratulations on a really strong quarter.

Roger Stone

Thank you.

Michael French – Morgan Joseph

The first question I have is on a – this is kind of a two quarter on CapEx. Given that the ERP is down and you won't need to spend any more there, at current levels, you're still generating strong cash flow. The first part of the question would be whether the magnitude of CapEx can stay where it is. And the second part of the question has to do with where it would be deployed. Among other things, last quarter, we talked about energy saving initiatives and the good returns you're seeing there, and the possibility you might deploy more capital into that area. So the question is going forward, how should we think about CapEx in terms of magnitude and where it's deployed?

Roger Stone

We are – obviously sound energy projects, we believe we have some for example, the Roanoke Rapids mill – will be pursued but always evaluated on payback and good – and high standards of return. And we believe we have a number of very good projects at Charleston, to reduce costs and increase reliability. So – but our capital expenditures combined company, projected a pretty modest (inaudible) Do you remember what those are?

Andrea Tarbox

We are about $11 million, $12 million for this year.

Roger Stone

No, no, that should not – so have been $12 million at Roanoke Rapids – Charleston.

Andrea Tarbox

Charleston, I think we were looking at a run rate of $20 million, 22 million a year.

Roger Stone

A year annual. 20 plus a year at Charleston, sorry correction.

Michael French – Morgan Joseph

All right. Thank you. The next question on the dunnage bag, on the price decrease there, would guess that it has something to do with price sensitivity in the transportation. Is it just that what's causing out or some other factor?

Roger Stone

Number one, the trucking industry, LTLs loads are down, shipping is down, LTL which affects it. We have been able to grow units, but – and therefore our mix has changed with two ply units and therefore, on the overall price that lowers the price. Then we've had substantial cost increases in film and, happily to say in paper as well. We feel about the business. We returned picking up volume that we've had we've added new customers, we think margins will return. It's still a very nice niche business. It's just really is – at the present it's nice execution to be.

Michael French – Morgan Joseph

I will ask you to comment a little more on the 4% that you were able to achieve in the productivity increases. Is there much more room to go? Exactly what's kind of things were you doing to get there?

Roger Stone

The big things were reliability and are also compared against period or periods last year where we ran – the mill ran ruggedly. We had some issues. We had some downtime with a fire, and (inaudible) other issues on keeping that (inaudible) so we will – the mill is very good and working on what we call reliability. And keeping pushing those bottlenecks ahead of them and having good uptime. So I think we can creep that productivity at Roanoke Rapids. I believe we have huge productivity opportunities in Charleston. And we are going to concentrate a great deal of our time at that.

Michael French – Morgan Joseph

And the final question from me in terms of the capacity you're looking at on the 440 tons. Has anything changed in terms of the outlook there?

Roger Stone

If we run more paper, we will have less capacity at Roanoke Rapids, but we will have more profits, so that's what it's all about. The – we see substantial – by operating efficiencies capacity (inaudible) by mix changes, operating improvements for Charleston.

Michael French – Morgan Joseph

I hate to go back on my words so soon, this is one more. This is a small question. I noticed that financial relations board is working with you now. What can we expect out of this relationship?

Andrea Tarbox

Well, we decided our focus at first was getting the acquisition and stuff, and we decided now that we were of the size and whatever that that we really should start focusing on the investor relations aspect. So they are helping out as far as contacting, buy, sell side, analysts, helping us get the news out about the company, which we think has been one of the probably best kept secret. And we like to start sharing our success with others out there and they seem to be in a great position to help us do that. So one of the things that we have talked about was a having an investor day conference. They are going to help us in organizing that. And just basically helping us get out there so that more potential investors know about us.

Roger Stone

Yes, at this fall we – on that conference, hope to have an investor conference probably in October at the Charleston mill. Everybody seems to want to see it. And we are happy and delighted to do that. And I think that the reason as you know, we think we have a very good story to tell. So we hired somebody to help us tell them.

Andrea Tarbox

I think one of the things you will see that we certainly notice. When we got added to the Russell 2000, Russell 3000 index, how our volume has increased dramatically over the past month or so, and there is increased liquidity there and stuff. So I think it's a good time to start, getting out there and telling the story.

Michael French – Morgan Joseph

Well, that definitely sounds like a good idea. Thank you and good luck.

Roger Stone

Thank you.

Operator

Your next question comes from the line of Jack Ripstein from Potrero. You may proceed.

Jack Ripstein – Potrero Capital Research

Hi, good morning. Thanks for taking my call. With respect to the outage it sounds like the Q2 outage is done and so you back up and running. Any surprises on coming back up to full speed?

Roger Stone

Actually, the outage is done, and it's always nice to appear to come in on plan and on time. And that's always a surprise when you take a break in the left. So we are back running and doing fine. Thank you.

Jack Ripstein – Potrero Capital Research

And is there a plan – what's the schedule maintenance schedule for Charleston that to offset – I'm assuming you're having offset schedule there.

Roger Stone

Charleston has had major outages in the first half of this year. Charleston has extra recovery boiler capacity. So they only go down to a cold mill every three years on schedule. And we are looking to see how we can extend that. So they always have steam and power to run the mill when they do the appropriate maintenance on their boilers and recovery boilers. That the fact they have excess which makes it for me unusual I never had a paper mill in that excess recovery boiler capacity. Therefore, didn't go down once a year. But Charleston has that capability. So – we have a lot of boilers there, we have a lot of other things that require maintenance in a big mill. But it's – we will announce when we were planning the shutdowns but at the moment there are no cold shutdowns planned for this year, anyway. And frankly, thinking about the schedule I don't think next year either at the Charleston. But Roanoke Rapids will indeed go down. We are trying to move that shortage – they shutdown back further into the year for planning purposes it's more usual and so on. So, but it will have the same kind of downtime somewhere next year probably towards the end of the third quarter.

Jack Ripstein – Potrero Capital Research

And then last one, when you guys announced the acquisition, and talked about the operating metric, et cetera, do you guys see kind of the same – you gave I wouldn't call it guidance, but a backwards view. Is there any forward view or something that has changed or is different that wouldn't allow us to use the similar assumptions that provided at the time of the announcement?

Roger Stone

We are very optimist – we are not going to forecast. The question as you know question comes up we have said that the Charleston acquisition is accretive and will be accretive this year and we have said we believe it has great potential. That's about as far as we are going to go.

Andrea Tarbox

But you heard on the price increases that Roger does that.

Roger Stone

Yes, and it's in the mix breakdown, yes, we can swing those machines and so but you have all the grades there. And so – and the company has roughly a 1,300,000 tons. So you can – do your own forecasting.

Jack Ripstein – Potrero Capital Research

Okay. But nothing in the EBITDA profile looking backwards has changed going forward other than – you have taken price increases that I am assuming you are offsetting the costs increases?

Roger Stone

We – I think I tried to say is because we have good energy profiles, and because we have good fiber profiles, that we – our price increases should more than come across. I'm very disappointed. So we believe there is substantial incremental contribution to the price increases.

Andrea Tarbox

I think one thing that Roger mentioned in his commentary was that as we are being able to see more of the detailed some of the charges and allocations that have been coming from Mead, et cetera. We are having some pleasant surprises as far as what those costs might be going forward. And so our projection – we think we are conservative when we adjusted earnings last year.

Roger Stone

Right. I tried not to – I tried to leave an impression that. The price increases more than offset the cost increases.

Jack Ripstein – Potrero Capital Research

Okay. Well, I appreciate that reiteration. Thank you.

Operator

Your next question comes from the line of Matt Sherwood [ph] from ZF Fund [ph]. You may proceed.

Matt Sherwood – ZF Fund

Hi, guys. Strong quarter. Just had a couple quick questions. First, it look like just if you back out all of the noise from Q2 to Q2 it looks like the cost per tons up about $25 a ton. Is there any reason to believe that the year-on-year increase in costs is going to get worse in the second half? Or is that about where it's going to be?

Roger Stone

With the oil prices leveling off – but it would appear that the pressure on freight and transportation should level off and on that basis. Coal is an issue at Roanoke Rapids, contract is up at the end of the year, and we have opinions both ways. Coal has certainly risen in price and its transportation has risen, but where we are going to be on that is we're still working on that. I don't really want to comment. But so, yes, I think we have incurred the bulk of the price increases – we might get some moderation in transportation is my hope, but we have incurred them. And second quarter levels probably not a bad place to look for the cost, for the cost levels.

Matt Sherwood – ZF Fund

And there is no reason to believe that the escalation in costs would be worse at Charleston since in fact, you are probably more, your energy profile is a little bit better there.

Roger Stone

There is no reason to believe that – their coal minus transportation coal, okay, is in good shape for all the exterior so we are lucky there, because they do burn a lot of coal. They had a lot of chemical escalation as had both mills, but there is no reason to believe that. I think relatively speaking per ton cost increases on those are reasonably similar.

Matt Sherwood – ZF Fund

Great. Then just one question. While you gave the guidance – when you did the acquisition that you did about 412 tons of kraftliner at Charleston. Did you ever give a breakdown between export versus domestic?

Roger Stone

No, I didn't. But – they have to make sure export position relative to their mix, and we are changing that profile as we speak, for obvious reasons, more profitable to run domestic.

Matt Sherwood – ZF Fund

Did you give us sort of broad brush, it doesn't have to be exact, but like greater than 50%, greater than 25%?

Roger Stone

Of the linerboard production?

Matt Sherwood – ZF Fund

Yes, that goes to export.

Roger Stone

Less than 50%.

Matt Sherwood – ZF Fund

Okay. And then the last question is saturating kraft, you're seeing the only price action was essentially plus $40 a ton at the beginning of the year this year.

Roger Stone

No. The – there was an increase at the beginning of the year, and we have been able in many of our contracts most to get some of our costs escalation through. But in terms historically at saturating kraft, you negotiate and prices generally go up in January or the first quarter to most accounts when we were in those discussion phases now. Whether those old patterns will remain like once a year kind of thing or will it change like other paper products, is also yet to be determined, but so what I gave you is what we got at the beginning of the year and what we've gotten through cost recovery and we believe we've got the cost recovery this year. It is our belief – I guess what I said in my remarks, we have not announced our price increase, but it's reasonable to assume that the saturating kraft would go up in the first quarter.

Matt Sherwood – ZF Fund

Great. Well, congrats on a good quarter, and it looks like good stuff to look forward to.

Roger Stone

Thank you.

Operator

Your next question comes from the line of Anabella [ph] from Elm Ridge Capital. You may proceed.

Anabella – Elm Ridge Capital

Good morning.

Roger Stone

Her question must be answered.

Operator

Ms. Ana, your line is open. Your next question comes from the line of Jerry Chan from William Harris Investors. You may proceed.

Jerry Chan – William Harris Investors

Good morning, everybody. And add my congratulations.

Roger Stone

Thank you, Jerry.

Jerry Chan – William Harris Investors

What's the demand like in the saturated? How was it, say, in the quarter before you bought it?

Roger Stone

Demand in saturating kraft has been remarkably good and very strong. Backlogs are very, very strong. That is surprising, given where some of the end users business is not good. Now, it's a major export product as well as we found lot more uses than just high pressure laminates for it. The backlog in saturating kraft is our biggest backlog.

Jerry Chan – William Harris Investors

Is that normal? I don't know –

Roger Stone

I don't know. Because I am very happy with (inaudible). Hello?

Jerry Chan – William Harris Investors

I'm here. I don't know. Someone else was on the line for a minute.

Roger Stone

I am very happy with our backlogs on all our products. But saturating is largest. And some of that happens when people are worried about getting supply, they tend to double up on orders and it tends to get in the backlog, somehow they think if they order more, they will get less and therefore they will get what they want. I don't know that's the case in saturating kraft. But our people think it's real. That demand is real and reflects the need for the product. And there are only two other major producers in the product line locally, and that's International Paper in the U.S. and a Scandinavian Company.

Jerry Chan – William Harris Investors

The liner you talked about before the change that's all coming out of Charleston, and that's a switch from export to domestic, just based on I guess demand here on prices (inaudible) which is coming?

Roger Stone

Yes. We didn't have a lot of linerboard to sell at Roanoke Rapids. And so – and we believe we have the capability of selling a lot more linerboard to domestic users. We – the management here has a history of being able to do that. So we believe that we can still service the export market, but the mix will go heavily towards domestic for shareholder value reasons.

Jerry Chan – William Harris Investors

Someone had asked me a few months ago – I don't know to what extent we are in a recession or slowdown I don't know, but I hear a lot of complaints about it. I would have very surprised to hear price increases not just by you, by others, kraft has gone – liner boxes at a time like this.

Roger Stone

Well, box demand is not strong. It's weaker. A great deal of this is cost push, and low inventories. It's the industry balancing supply with demand. And cost – people who do not have our kind of cost profile and desperately need those price increases, and is coming, but it is unique, but I must tell you which sort of unrelented. So it's – I guess maybe it's a sign of inflationary times.

Jerry Chan – William Harris Investors

All right. Thank you.

Operator

(Operator instructions) Your next question comes from the line of Brad Goulagi [ph] from Latvilt Capital [ph]. You may proceed.

Brad Goulagi – Latvilt Capital

Hi, good morning, everyone.

Roger Stone

Hi.

Brad Goulagi – Latvilt Capital

Could you just talk a little bit about the – and this is dovetailing on the previous comment, but if you could just talk a little bit about the end product demand growth we are seeing in the second quarter. Whether or not that was primarily from the agriculture side, from cement end producers, where are you seeing that volume growth coming from the kraft business?

Roger Stone

Well, the multiwall business which would be agricultural, also construction-based and chemical-based, was very good in the quarter. Our multiwall customers all had increased demand and volume. But we had pretty good demand across all our product line. Some of that is because some people have closed in the business, therefore demand switched around, some people have stopped making grades that they were inefficient in making them because they can get business for grades they are efficient to making them. So there is unusual move around. But the single largest customer we have which is the multiwall producer – not just multiwall paper, but things we sell to multiwall producers, is having a good year, having a very good year.

Brad Goulagi – Latvilt Capital

Great. And do you expect the business, the Charleston business – is that going to be targeted towards the particular end user or is it going to be similar to what the existing multiwall and kraft business targets?

Roger Stone

Well, we want a broad customer base. We do have a fair amount of concentration with the major multiwall manufacturers. We think we make a good sheet they do too would. And so we are certainly going to stay with that. But we have a broad base and within the weeks that we want to supply we think we will have just good demand. Whether – unless the environmentalist war moves along a lot faster with plastic, we will still be running some linerboard grades for a while in Roanoke Rapids.

Brad Goulagi – Latvilt Capital

Great. Thank you. Congratulations on the quarter.

Roger Stone

Thank you.

Operator

(Operator instructions) Your next question comes from the line of Kevin Beck from Artisan Partners. You may proceed.

Kevin Beck – Artisan Partners

Thank you. Just two quick questions. One on the volume that Roanoke – I'm wondered if you could talk a little bit about your strategy there, if you go back to the first and third quarters of last year, you're running at 107,000 108,000, and it slowed down quite a bi this year, so, I am curious relative to your 430 to 440 targets, what you're doing there?

Roger Stone

We're running a less linerboard. And so I think that would be the major thing. We're not going to – to add 440, we have to run a fair amount of linerboard. We don't see that happening. So – because we make much more profit on the mix that we can – that we're serving. So I think if you can look at the productivity in the second quarter as typical of the productivity we hope to maintain ignoring the shutdown time –

Kevin Beck – Artisan Partners

And so are these volume levels for the mix about where you would expect them kind of going forward or do you see you want to – ?

Roger Stone

Yes. I am very pleased with the way the mill is running. When I haven't been I have said so on this call. Very pleased with the way the mill is running. And I think – yes, we would hope to maintain that we would hope actually to add more paper and reduce it slightly. That would be – and add more profit.

Kevin Beck – Artisan Partners

Fair enough. And then the second question is kind of for you, Andrea, if you look at some of the pro formas or the 8-Ks related to Charleston business, obviously, the allocation of costs is a little messy. Is there any more transparency I guess you can give us on the third quarter and what to expect – I believe there is about 20-some million of costs on an annual basis that was allocated in the pro formas or about $7.5 million a quarter that – does that go away on – did that go away on day one of July 1? Or is there some transition costs that we should expect and that gets phased in over time?

Andrea Tarbox

Okay. There is about – I think on that we should about $23 million of overhead allocations. And of the $23 million I think it was our expectation at the time I think about probably $19 million or so would probably go away. There will be some one-time costs that you will see and we report as one-time costs, particularly in the third quarter as we move forward, but as we continue to look at the costs that are at Charleston, we said, we have been more favorably surprised than negatively. So I can't give you an exact number at this point, but the expectation is that of the $23 million large percent of it will go away although you should expect to see some one-time costs that will be hitting in the third quarter.

Kevin Beck – Artisan Partners

And then are most of those gone by the fourth quarter and we start to see that run rate?

Roger Stone

The one-time costs, yes, what you will see just like you saw with our past acquisition is we will have a running TSA, transitional services charge, that will be excessive compared to when we can finally take over and get our ERP implemented there. So those costs – I wouldn't consider them one-time costs, but the costs related to being on the transitional support services will be higher until we are transitioned and we are hoping for – depending on what the services is being rendered sometime nine months a year, to be completely off their transitional support services.

Kevin Beck – Artisan Partners

So just to clarify if you go back to the time of the acquisition, the presentation, you had reported I guess, $81 million of it what you call adjusted EBITDA for the Charleston mill, which assumes all of those costs are taken out. What you're saying is, is that it could take nine months to get to, to that run rate of costs, is that fair?

Andrea Tarbox

No, no, no, that $81 million is what we saw as sort of an ongoing – at that point if you want to take that was a good phase. With our best estimate of what it would look like after those excessive costs have been eliminated.

Roger Stone

But after the one-time costs is eliminated, but I think the transition services costs was in –

Andrea Tarbox

Right. The transition service costs is in that $81 million.

Kevin Beck – Artisan Partners

Okay. Fair enough. And what you're saying and I guess or what Roger mentioned is, is that because of the price increases we should see that number grow this year, we will see leverage I guess of the positive operating leverage on that number?

Roger Stone

We certainly think as we move into next year we should have a lot of benefit from both operations and pricing.

Kevin Beck – Artisan Partners

Fair enough. Great. Thank you so much.

Roger Stone

Welcome.

Operator

This concludes the question-and-answer portion of the call. I would like now to hand it over to Mr. Stone for closing remarks.

Roger Stone

Well, I didn't have any closing remarks. Thank you very much for joining us. We had a great quarter and we are looking forward to a great future. Thanks for calling in. Bye.

Operator

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. And have a wonderful day.

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Source: KapStone Paper and Packaging Corporation Q2 2008 Earnings Call Transcript

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