Apr 30, 2015
Executives
Steven C. Voorhees - Chief Executive Officer, Director and Member of Executive Committee Ward H.
Dickson - Chief Financial Officer and Executive Vice President James B. Porter - President of Paper Solutions Michael E.
Kiepura - President of Packaging Solutions
Analysts
Mark Adam Weintraub - The Buckingham Research Group Incorporated George L. Staphos - BofA Merrill Lynch, Research Division Mark Wilde - BMO Capital Markets Equity Research Chip A.
Dillon - Vertical Research Partners, LLC Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division Deborah Jones - Deutsche Bank AG, Research Division Anthony Pettinari - Citigroup Inc, Research Division Alex Ovshey - Goldman Sachs Group Inc., Research Division Philip Ng - Jefferies LLC, Research Division Christopher D.
Manuel - Wells Fargo Securities, LLC, Research Division Mark W. Connelly - CLSA Limited, Research Division
Operator
My name is Ajel. I will be your conference operator for today.
Conference will run for 1 hour and at the end, we will conduct a question-and-answer session. At this time, I would like to welcome everyone to the RockTenn Second Quarter Fiscal 2015 Earnings Conference Call.
[Operator Instructions] As a reminder, slides are being presented today as part of the conference call. These slides can be accessed at www.rocktenn.com under the Investors page.
Ladies and gentlemen, this call is being recorded today, April 30. [Operator Instructions] Your speakers for today's call are Mr.
Steve Voorhees, Chief Executive Officer; and Mr. Ward Dickson, Executive Vice President and Chief Financial Officer.
Mr. Voorhees, you may begin your conference.
Steven C. Voorhees
Thank you very much. Welcome to our call.
This the Steve Voorhees, Chief Executive Officer, and I'm joined this morning by Ward Dickson, Chief Financial Officer; Jim Porter, President of our Paper Solutions business; and Mike Kiepura, President of our Packaging Solutions business. During the course of the call, we will make forward-looking statements involving our plans, expectations, estimates and beliefs related to future events.
These statements may involve a number of risks and uncertainties that could cause actual results to differ materially from those that we discuss during the call. We described these risks and uncertainties in our filings with SEC.
These include our most recent 10-K for the fiscal year ending September 30, 2014, and 10-Q for the quarter ending December 31, 2014. We will also refer to non-GAAP financial measures during the call.
We've provided reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in the appendix of the slide presentation. The slide presentation is available on our website.
I'm going to start by discussing our operating results, and then Ward will discuss our balance sheet, pension and various financial measures. I will complete our prepared remarks with comments on the status of the merger of MWV and the outlook.
Then Ward, Jim, Mike and I will be available for your questions. The RockTenn team continued to deliver solid operating results in the March quarter.
Adjusted earnings of $0.85 per share were 35% higher than last year's adjusted earnings of $0.63 per share. This improvement was driven by strong results in our Corrugated Packaging segment, where segment income increased 28% over last year.
This increase was a result of strong external demand in corrugated and solid commercial execution and operational improvement in our mills and box plant system. Additionally, we benefited from lower commodity cost.
We were negatively affected by the combination of a substantial electrical failure at our Panama City mill and severe weather in February. These negative factors reduced earnings by $0.09 per share.
We've seen our box shipments trend positively over the prior year shipments on a per day basis since the second half of September of 2014. This trend continued during the December and March quarters for both RockTenn and the overall industry.
RockTenn's March quarter box shipments increased 5.4% on an equivalent per day basis and actual shipments increased 3.7%, both of these are as compared to the prior year. There was 1 less shipping day in the quarter this year versus last year, and both numbers significantly exceeded the comparable industry numbers.
We also saw very good end market demand in our folding carton business, where volumes were up 1.1% compared to the prior-year quarter. Performance in our Merchandising Displays business is not meeting our expectations.
Segment income for the quarter was $12 million less than last quarter. I will speak to our Displays segment in more detail later in these prepared remarks.
Our adjusted EPS of $0.85 is higher than the updated guidance range we provided at the end of March. While I like the fact that our performance exceeded these expectations, I would prefer that we not see this amount of difference between our actual and estimated results, particularly this late in the quarter.
We regularly update our forecast each month and, in this circumstance, we faced a series of negative events during February and the first half of March. These negative events included weather impacts to our natural gas service at 4 of our large mills, where service was unexpectedly curtailed; the electrical issue at Panama City; and a discernible decline in demand for promotional displays.
The cumulative impact of these events caused us to reduce our expectations, and with those facts, I felt compelled to update our guidance. While we were reducing our expectations, we benefited from a number of positive factors during the last week of March, including strong demand and operational performance in excess of our expectations across all of our businesses, particularly in our mills.
The roughly $0.10 difference between our reported results in the top end of the revised guidance range to about 1/3 better mill and plant performance, 1/3 stronger sales and 1/3 forecast conservatism. Net sales of $2.5 billion, were 3% higher than last year's March quarter.
The Tacoma Mill acquisition, which was completed in May of last year, and the strong box plant performance contributed to the revenue increase. RockTenn's Credit Agreement EBITDA of $1.6 billion for the last 12 months was $66 million or 4% higher than last year's quarter.
We generated strong free cash flow of $1.11 per share. We will absolutely maintain our focus on strong free cash flow generation after the merger is complete.
We ended the March quarter with leverage of 1.74x, and our balance sheet is in great shape as we get closer to completing our merger with MWV. Demand for Corrugated Packaging continued to be solid this quarter, with higher industry production of domestic and export containerboard in this quarter as compared to last year's March quarter.
Industry box shipments in the March quarter were also higher than last year's March quarter by 3.4% on a per day basis as reported by the Fiber Box Association. The improved domestic and export containerboard volumes and box shipments resulted in healthy industry containerboard mill operating rates of 95.5% for the quarter.
Demand for RockTenn's corrugated products was strong, with export and domestic containerboard production improving more than the industry in the March quarter as compared to the prior year quarter. Export demand improved significantly, as our exports shipments of 286,000 tons in the quarter were up 19,000 tons or 7% from the prior year quarter, largely as a result of 3 factors.
First, we added new customers. Second, we experienced improved demand in Latin America.
And third, we added additional mill export volumes from our Tacoma Mill. Sequentially, export containerboard volumes increased by 10,000 tons or about 4%.
As compared to the December quarter of this fiscal year, export containerboard pricing was slightly lower by about $5 per ton as a result of changes in mix and the strengthening dollar. Our regional export mix was similar to last quarter, with approximately 60% of our export shipments to Latin America, 20% to the Middle East and 10% each to Europe and Asia.
RockTenn's box shipments also surpassed the industry's year-over-year improvement. Starting in mid-September 2014, we began to see our box shipments trend positively over the prior year shipments on a per day basis.
The increased box shipments were due to healthy industry box demand as well as the progress that we've been making in our product quality, service and improving the customer experience. Box demand continued to strengthen in the March quarter.
Our growth exceeded industry box demand, with our box shipments improving by 5.4% on a per day basis compared to last year's March quarter. There was no benefit from the Tacoma Mill acquisition on these strong box numbers, as the Tacoma Mill operated no box plants.
RockTenn's Corrugated segment mill operating rate for the quarter was 92.6%. If we exclude the 80,000 tons of maintenance downtime we took during the quarter, our operating rate was 96.5%.
Our April box volumes are also very strong month-to-date, as they are up over 4% on a per day basis as compared to last year. Both Aprils have the same number of shipping days.
Containerboard and box trends are reflected in our financial results for the quarter. Corrugated Packaging segment sales of $1.73 billion, increased from $1.65 billion in the prior year March quarter, an increase of 5%.
Corrugated Packaging segment EBITDA margin for the March quarter was 17.3%, this is up 210 basis points from the prior year quarter. Our focus on operational improvements continues to drive positive results.
Corrugated productivity improved by 1% over the March quarter of 2014. The benefits of the EVOL installations have driven flexo folder gluer performance to record levels.
For the quarter, flexo folder gluer's performance increased 19% as compared to the prior-year quarter and was up 6% sequentially. Die cutter productivity also set a record with 5% improvement over the March quarter of 2014.
Additionally, our container plant labor efficiency, as measured by square feet produced per labor hour, increased by 3% over last year. During the March quarter, we continued to execute our long-term EVOL flexo folder gluer strategy in our box plants.
We added 1 machine at our Dayton, New Jersey plant. Through the end of March, we have installed 12 of total 30 EVOLs that we plan to install in fiscal year '17.
In April, we installed an EVOL in our Montgomery, Alabama plant, and we will install another one later in the quarter in our Lancaster, Pennsylvania plant. These investments are greatly enhancing the capabilities and productivity of our box plant system.
Our Corrugated Packaging team delivered excellent performance this quarter. I'm very pleased with our results that reflect both improving industry demand and the progress we're making on our commercial and operational excellence initiatives.
During the March quarter, the CRB market gained strength and the SBS market remained in balance. CRB industry backlogs, as of the week ending April 15, stood at 144,000 tons, 23% higher than last year's backlogs.
RockTenn's CRB backlogs are about 3 weeks. SBS industry operating rates were at 95%, with industry backlogs of approximately 4.5 weeks.
RockTenn's most recent SBS backlogs are at about 8 weeks. RockTenn's SBS and pulp volumes were lower than the prior-year quarter as a result of the March major maintenance outage at Demopolis.
This was 1 month earlier than last year. Minor and major outages alternate every year.
Industry folding carton volumes were down in the March quarter by 2.8% compared to the prior year quarter. As mentioned earlier, our folding carton volumes were up 1.1% for the same period, driving our growth compared to the industry.
The RockTenn team performed extraordinarily well, with net sales of $320 million. This represents a record March quarter for the division.
The promotional displays business has been impacted by the changing purchasing patterns of large retailers and consumer packaged goods companies looking to reduce their overall cost structure. Some large retailers are reducing the number of promotional displays in order to cut costs.
Consumer packaged goods companies are actively evaluating their supply chains to reduce cost and, in some cases, they're investing to reconfigure their distribution systems. These changes had a direct impact on our results in the quarter.
Merchandising Displays segment sales were flat as compared to the prior year quarter. The 2 acquisitions we made last year contributed $17 million in sales over the prior year quarter, and our sales of permanent displays increased by $3 million.
Our sales of temporary displays declined by $21 million from the prior year quarter. We have had significant amounts of new contracted business, which have required investments in people and infrastructure, both to support the new business as well as future growth opportunities.
Due to the changing market conditions and our previous investments to support the growth, we expect profitability in this segment to be about $25 million in fiscal year '15. In light of the changing customer demand, we're adjusting our cost structure and expect improved results in fiscal year '16.
Merchandising Displays adds significant value to our enterprise. Displays innovation and relationships helped both our container and folding carton businesses with new business opportunities.
Displays purchases from our Corrugated Packaging and Consumer Packaging businesses also benefit RockTenn overall. Lower recycled fiber prices, soft demand in China and the West Coast port labor disputes drove the negative year-over-year results in our recycling business.
We believe the resolution of the West Coast labor disputes and the potential for stronger Chinese demand later in the year will translate into stronger results. Our Recycling business provides secure, cost-effective access to recycled fiber.
This provides a competitive advantage for our mill system and also provides market intelligence for our overall business. The Recycling team does this very well.
I'll turn it over to Ward, who will now discuss various financial aspects of our business. Ward?
Ward H. Dickson
Thank you, Steve. This quarter's selling price and mix were unfavorable to the March quarter of last year.
This decline is primarily driven by the Corrugated segment. 2/3 of this decline is related to the adverse impact of the strengthening U.S.
dollar on export containerboard pricing and box shipments into Canada and Mexico. The remainder of the decline is largely due to customer mix changes in corrugated box.
Domestic box pricing was stable during the quarter. Export containerboard pricing declined by $35 per ton year-over-year, with most of that decline occurring last summer and fall when the currency impacts were quite rapid.
Export markets have stabilized and volumes continue to be strong and export prices only declined by $5 per ton on a sequential basis. We experienced a favorable cost environment this quarter and had net cost deflation of approximately $45 million as compared to last year.
Energy prices, driven by a 40% reduction in natural gas, generated a $40 million benefit. Declines in fiber cost, primarily recycled fiber, contributed approximately $30 million benefit.
These benefits were partially offset by higher wage, benefits and other cost inflation. We generated $22 million in cost-savings and productivity improvements this quarter over the prior year and have good momentum as we enter into our merger with MWV.
Nonrecurring items in the quarter included the impact of the Panama City electrical outage, the La Tuque labor disruption and the Demopolis scheduled maintenance outage which occurred in the June quarter last year. We continued to generate strong free cash flow at a level of $159 million or $1.11 per share during the quarter.
Over the last 12 months, we have generated free cash flow of $845 million or $5.86 per share. At the end of March, our net debt was approximately $2.75 billion.
Our LTM Credit Agreement EBITDA was $1.6 billion and our leverage ratio was 1.74x. At March 31, we had used all but $5 million of our U.S.
federal and foreign net operating losses. We still have approximately $56 million of various state net operating losses and other state credits available for use in future years.
We also have significant remaining U.S. federal cellulosic biofuel, alternative minimum tax and other federal tax credits that can be used to offset a total of $188 million of U.S.
cash taxes. We expect to use these during fiscal years 2015 and 2016.
The June quarter should be the last quarter we make any substantial pension contributions into our U.S. plans.
Immediately after the merger, we will merge the overfunded MWV plans with the RockTenn plans. In terms of our CapEx guidance.
We expect that the RockTenn 2015 capital expenditures will continue to be in the range of $500 million to $550 million. Maintenance downtime in the March quarter of 93,000 tons was slightly higher than last year's downtime of 73,000 tons.
The majority of this maintenance downtime is in our Corrugated segment. The June quarter is our heaviest maintenance outage quarter, as we plans to take maintenance downtime of 116,000 tons at several of our key mills.
At the end of March, our containerboard system inventory was 40,000 tons higher than 1 year ago. We have increased our inventory levels to better support our customers.
Our inventory will peak in May at 10,000 tons higher than March and then should decline from there by 50,000 tons by the end of September. Now I will turn it back over to Steve, who will discuss our outlook.
Steven C. Voorhees
Thanks, Ward. I'm pleased with our results this quarter and the strides we are making across our businesses in improving operating efficiency and offering customer-focused solutions.
Our Corrugated Packaging business is performing very well. Box volumes are growing and box pricing continues to be stable.
Domestic containerboard market conditions are solid, and strengthening seasonally. Export market volumes continue to be strong and pricing is reasonable, considering the currency situation.
Our mills and box plants are operating well. Folding carton demand is also solid and we're seeing strengthening in SBS and CRB markets and backlogs.
Merger integration activity is going very well. We're on track to complete the merger in June.
Our integration teams are working to ensure we can hit the ground running on day 1, that we achieve and drive to exceed our synergy targets. As we work together, we continue to identify new opportunities.
I plan to give a more detailed summary of our synergy and performance improvement opportunities as well as our road map to achieve them on our July earnings call. Our new company will have a great business platform, strong cash flows and a solid balance sheet.
Our capital allocation will center around a normalized leverage ratio of 2.25x to 2.5x. On day 1, our leverage ratio should be at approximately 2x, excluding the benefit of future synergies.
Our leverage ratio is higher than both companies' current levels because we will be funding approximately $750 million at closing to repurchase the necessary RockTenn shares to reduce RockTenn's ownership interest of the new company to below 50%, and we will also use these funds for -- to pay deal-related transaction costs. With the strength of our balance sheet and underlying cash flows, we will have a balanced capital allocation strategy that will allow us to pay an attractive dividend; continue to invest in our business; take advantage of accretive business opportunities, including acquisitions; and return capital to our shareholders through share repurchases.
We've considered postmerger dividend strategy. While that's a decision for the new board, I have some thoughts I will share with you now.
We've had many conversations with shareholders over the last 3 months. As we always do, we listen.
Our dividend policy should reflect that as a large-cap company with strong cash flows, we should pay an attractive dividend when compared to large-cap indices. When setting the dividend, we'll take into account the impact of the planned spin of Specialty Chemicals on our financial statements and also on our total market capitalization.
I remain confident in the opportunities in front of us. This combination is a terrific opportunity to leverage the best of each company to create significant value for our customers and shareholders.
As we expect to close on the merger this quarter, it's difficult to provide our guidance with respect to the reported results for the new company. The reported results will be a blend of both companies' results during the quarter.
If you're looking for help in your modeling, I would guide you to RockTenn's adjusted EPS for the June quarter on a stand-alone basis being about 20% higher than the $0.85 we earned in the March quarter. Now with that, Jim, Mike, Ward and I are now ready to take your questions.
Operator
[Operator Instructions] Our first question is coming from the line of Mr. Mark Weintraub of Buckingham Research Group.
Mark Adam Weintraub - The Buckingham Research Group Incorporated
I was hoping maybe to get a little bit more color, if possible, on the guidance for RockTenn-specific earnings. You had mentioned about 20% higher.
And is -- any bridges that you could provide for us, what the big drivers to the plus side and minus side would be?
Steven C. Voorhees
Mark, we're moving to, I think, seasonally stronger demand and I think we've got -- it's almost a continuation of the factors that we saw this quarter.
Mark Adam Weintraub - The Buckingham Research Group Incorporated
Okay. And I guess, I want to just follow up on it.
On Slide 10, you noted $22 million of nonrecurring when -- versus the prior year. I believe that would be the Panama City.
Does that also include -- what else would be included in that $22 million? And do we get that as we go from the current quarter to the June quarter?
Steven C. Voorhees
Mark, Ward will respond to that.
Ward H. Dickson
So Mark, you're right. In the -- included in the $22 million was 3 primary drivers.
We had the impact at Panama City, La Tuque, the timing of the Demopolis outage, which is really, on a year-over-year basis, it's the timing of the quarterly profile of that outage. We also had the gain of the MRO benefit that we highlighted in the press release.
So those are truly -- other than the timing of Demopolis on a year-over-year basis, those are truly nonrecurring items.
Mark Adam Weintraub - The Buckingham Research Group Incorporated
Okay. And I guess -- so then, we'll also have -- as you think about going to the next quarter, maybe one of the offsets is that we're -- given that there's going to be more maintenance downtime.
I guess that's the other factor included...
Ward H. Dickson
That's right.
Operator
The next question is coming from the line of Mr. George Staphos from Bank of America.
George L. Staphos - BofA Merrill Lynch, Research Division
I appreciate the presentation and the details. I recognize that July you'll probably give an update on synergies and other factors in terms of road map with MWV, but can you comment at all in terms of your confidence in the synergy targets that you initially pointed to with your colleagues at MWV?
Where are you finding the sources of the most confidence if, in fact, that's the correct statement? Any thoughts here would be appreciated, and then I had a quick follow-on on containerboard inventories.
Steven C. Voorhees
I'd just -- the number we put out was $300 million for the synergies. We've done a substantial amount of work.
I think we have talked about opportunities. I think we're finding in the paper business there's probably more opportunities that we have inside the mill system.
It's not so substantial that I would change the $300 million. And I think I would point out, when we get to July, I want to put in context both that $300 million but also in context the other productivity improvements that we have, so that you, as an analyst, can track our overall performance as a company.
And that's the intent. I'm just -- the mechanics of doing that now, it's a little bit premature to provide that level of specificity at this point.
George L. Staphos - BofA Merrill Lynch, Research Division
Steve, we understand that and that's helpful. I guess my other question would be, you cited the inventory levels -- I don't have my notes that I took down here, but you're I think 30,000, 40,000 tons up from a year ago, and then inventories are going to drop 50,000 tons or so through September.
Are inventories where you wanted them to be? Again, thank you for the detail in actually describing what they are currently.
Are they where you wanted them to be? Are they tighter than you want or they may be a little bit heavier than you would've wanted, given the demand outlook?
Steven C. Voorhees
So George, Jim Porter is going to respond to that.
James B. Porter
I think we're pretty pleased with where our inventories are. We are constantly focused, primarily, on trying to satisfy our customers' requirements with products on time and doing so in a way that delivers them with low-cost freight and the best logistics that we can.
And what we've learned is, our system functions better with a somewhat higher inventory level than certainly where we began some years ago. And as we look forward to the very heavy shutdown period that we have coming up or our seasonal maintenance requirements at our large mills, we need this inventory to carry us over.
And I think we're really just right on track.
Operator
Our next question is coming the line of Mr. Mark Wilde from BMO Capital Markets.
Mark Wilde - BMO Capital Markets Equity Research
Steve, just any updates on kind of thoughts coming out of the combination in terms of the balance sheet. You're only about 1.75x levered right now -- Mead similarly, MeadWestvaco is in pretty good shape.
So just any updated thoughts on that.
Steven C. Voorhees
Yes, our target leverage ratio will be 2.25x to 2.5x. I think that's where we start.
RockTenn's leverage ratio was 2x on unfunded pension plans, so that increment is appropriate. We're going to come out of the box at 2x because of the repurchase of the RockTenn shares and also the funding of transaction costs.
I think from there, we'll I think operate with a balanced capital allocation program that, I think, served us well. Where we seek opportunities to grow and if we have good investment opportunities, we invest in our businesses.
And to the extent we don't, we feel very comfortable returning that cash to shareholders, with either a dividend and/or share repurchases.
Mark Wilde - BMO Capital Markets Equity Research
Okay. And if I could, just for a follow-on, Steve, can you just update us on kind of major capital projects within kind of legacy RockTenn?
I know that you have made some more moves down at Florence. I don't know whether what you've announced down there to this point is kind of the full drill for Florence going forward?
Steven C. Voorhees
I think current capital projects like -- help me out, Jim, we have on the Stevenson project...
James B. Porter
Exactly, the pulp mill improvement initiatives at Stevenson to change our cooking process, which is approximately $47 million. We have a large recovery -- or excuse me, power boiler project at Demopolis.
You mentioned Florence, we completed our large wood yard project down there that has dramatically improved our capabilities in the back-end of our operations. And then there's just the continuing runway of investments that improve our efficiency and quality across the portfolio.
Steven C. Voorhees
I think just, Mark, in addition to that, we're putting a biomass boiler at Demopolis. And I think we talked about our EVOLs.
I think, going forward, we have done a substantial amount of work on our mill system. And I think with the combination, we're effectively updating that because we're going to have a larger mill system and we're going to have, I think, additional opportunities.
And that's the type of work that I think we're doing now. In addition, we're also looking at our box system for kind of, call it, the next phase of capital investment.
Mark Wilde - BMO Capital Markets Equity Research
Yes, okay. And it looks like, from the outside, you're getting -- you're combining with a pretty well-capitalized mill system.
Steven C. Voorhees
I would agree with that.
Operator
[Operator Instructions] And the next question will be coming from the line of Mr. Chip Dillon with Vertical Research Partners.
Chip A. Dillon - Vertical Research Partners, LLC
As you think about the merger as it closes, the thing that's really fascinating I think to a lot of folks is we now finally have pretty much all the paperboard substrates under one roof. And as we've seen in the corrugated world in the last, actually 30 years, but really intensively in the last several, is the vertical integration with the box system.
And my perception is, when you look at paperboard, there's a lot less vertical integration, that most of the folding carton work is done by smaller private companies. Do you think that there's an opportunity for you to increase your -- or is it a desire to for--, integrate further down into converting over time, now that you have sort of the ability to self supply all these different substrates?
Steven C. Voorhees
I think it's premature to come to that conclusion. I met with about 30 of our sales managers last night and I think they're going to market.
I've met with customers and I think our customers and our salespeople are very enthusiastic about the prospect of going to market with that. And I think we're -- we sell a lot of paper to converters and we value those relationships.
We also sell converted product to our customers, and we value those relationships. So I think it's hard to say that we would look at one or the other as having a -- at this point, a better -- and just being a better opportunity for us.
Chip A. Dillon - Vertical Research Partners, LLC
Okay. And then just -- well, second to the last question, if you could talk a little bit about the potential, as you see this strong growth in the box business, to -- or should I say, the tension between continuing with the export strategy versus pulling tons out of the export market back into the U.S.
It would seem like given the differential in pricing, you're certainly, in the near-term, better off pulling board back in. On the other hand, you have to manage customer relationships overseas as well.
And how do you think about that?
James B. Porter
This is Jim Porter. I think we've shared previously that we've -- we look at our business through really the 3 channels that we operate in.
One, is our internal converted product channels, where we serve all of our domestic end-use customers. Secondly, our domestic independent customers.
And thirdly, our international customers. And we've really built a very deep and rich relationship across the world with these customers, and so we value them all extremely much.
However, we do look at the integrated profitability of each of those particular channels. And when we're making decisions about where we optimize our mix of business, we would shift volumes between those channels where the opportunities create the most cash flow.
So that's how we think about it and we operate daily on that basis.
Operator
Our next question is coming from the line of Mr. Adam Josephson from KeyBanc.
Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division
Jim, just one more for you on containerboard. You mentioned your domestic prices were stable sequentially, despite the fact that medium prices came down in February.
I mean, can you talk about whether you saw or expect to see any impact from that medium price reduction? And given your view that conditions are fairly healthy, why medium prices came down in February?
James B. Porter
Okay. So I'm generally pretty bullish, frankly, about all our markets, and I think we're going into a period of seasonal strengthening.
The medium thing, I'm really not clear why pulp was down. We didn't see a market shift.
It did. And clearly in those situations where we have relationships that are tied to the index, it moves.
But it's not going to impact our earnings significantly and we clearly do not see a degradation in those markets. To the contrary, we see demand strengthening and the market's firm.
As you look internationally, demand is also quite solid and, for the last number of months, we've seen really pretty flat pricing environments across those markets. There certainly has been a currency-related bias and so on a year-over-year basis, as we look at the -- where the euro has fallen that the -- any softening in our export prices has been nowhere near that magnitude.
So it's really a tribute to the strength of our markets. And I feel pretty good about things.
Adam J. Josephson - KeyBanc Capital Markets Inc., Research Division
And just one more on box shipments for you and for the industry. Obviously, they were pretty healthy in the first quarter for you.
Are you surprised by the extent to which shipments have held up? Obviously, the U.S.
-- the GDP number came in yesterday was not very good. The economy is just not looking all that hot, yet you're seeing pretty healthy demand.
Are you at all surprised by the rate of growth that you're experiencing or that the industry is experiencing, given that you would think boxes would be a pretty good barometer of what's happening more broadly?
Steven C. Voorhees
I think, just the GDP number did come out as disappointing. I think if you go behind the scenes on that, it's -- drilling activity is down, oil and gas industry is down.
I think the Long Beach situation had an impact. We're not really affected by those directly.
In fact, we're probably helped with that because of the reduced oil prices. What we've seen it's put more money in people's pockets to be able to -- in order to spend on things.
And we make nondurable goods. And I think box demand going up higher than the economy, what we've experienced over the past, call it, 6 months, that's not surprising to me.
The spread, I'm not a good enough judge to know whether the spread is greater or less than I would've expected because I really would not have had an expectation for that.
Operator
[Operator Instructions] The next question will be coming from the line of Ms. Debbie Jones from Deutsche Bank.
Deborah Jones - Deutsche Bank AG, Research Division
I realize there are a lot of moving parts in Merchandising Displays. I'd like to get a sense of what opportunities you have to improve profitability in this segment.
Do you think you can get back to that, call it, maybe a $15 million quarterly run rate in 2016 or is that a 2017 event? And how might the -- can you comment on the mix of new business and how that will compare to your existing business?
Steven C. Voorhees
I don't want to set an expectation of what we would do in fiscal year '16. I think I'd commented that we do have a bunch of moving parts.
I am feeling confident that we're going to get the business aligned to where it can be -- it can continue to be very profitable and an important part of our business. We're on the front end of the changes in the, I'd say, the retail environment and the way the CPGs are responding to it.
And so we're -- just right now, we're bearing the brunt of that. I think long term, it's going to be very helpful because we're going to be in a position to understand what's happening in the retail market and for our consumer packaged goods companies.
So we're -- I think we're going to be able to have a very strong business, and that's going to fit in very well with packaging solutions business of the merged company.
Deborah Jones - Deutsche Bank AG, Research Division
And my second question, on the Recycling business, you mentioned the expectation for maybe stronger Chinese demand later in the year. I know we've seen this in -- potentially on trader reports, but are you seeing anything that gives you encouragement on this from your vantage point?
James B. Porter
Debbie, Jim Porter. China, wow, I don't know.
Short answer. We all know a bit about China and clearly, they've been through a softening period.
They still make a lot of paper over there. I think the port phenomenon really has dramatically shifted where that fiber had come from to supply their needs.
And while they have been down over the last couple of years compared to where they were a few years prior to that, really have no line of sight as to what their true demand structure is going to do. But we do believe that, with the port situation easing, that a more normalized flow from North America to China will resume, which we would believe would create an upward bias to pricing.
But going beyond that, really, would be a long shot call.
Operator
Our next question will be coming from the line of Mr. George Staphos of Bank of America.
George L. Staphos - BofA Merrill Lynch, Research Division
When we look at the investments that you're making in the corrugated network, and certainly we're seeing improvement in earnings for RockTenn, and that's a good thing, how do you balance the need to go with EVOLs and more productive die cutters with the risk that you ultimately over capitalize and/or create more capacity than you'd like in the converting business. Recognizing that converting is different than mills, you don't run to an operating rate per se, but tell us how you manage that risk, if you see it as a risk at all?
And then the other question I had, just on fixed cost. Doing some very quick calculations, it seems like your fixed cost inflation is currently running at around $100 million or so based on the fiscal 2Q result that's not different than what you've seen in the past.
What can you do, if anything, to maintain that level, perhaps drop it or should we assume a 2% or 3% rate of inflation on fixed cost going forward?
Steven C. Voorhees
I think just with respect to box plant system, I think our company has a philosophy of matching our -- what we produce with market demand, and that's what we've done in container. Just in circumstances where we've put in EVOLs, we have typically taken out 2 to 4 older pieces of equipment.
There are a couple of circumstances where we will keep maybe one of those machines in the corner, in the event demand goes up. But the economics of the EVOLs, in addition to providing just a more efficient piece of equipment, those economics are accompanied by a cost reduction when we put them in.
So I think that's responsive to your first question. The second question, I need -- we either need to go offline, because I'm not tracking the $100 million.
Do you...
Ward H. Dickson
Well, the biggest component of our noncommodity inflation is wage inflation, and we have a -- and that's in a -- we experienced a 2% to 3% wage and benefit cost inflation every year. That can easily be $60 million to $75 million a year of inflation that we have to fight.
It is part of the culture inside of RockTenn that we drive cost reduction targets across the entire organization. Our Six Sigma functions support productivity initiatives in our manufacturing facilities but, as well, we take the same approach in our support organizations in our operating expense structure.
So that's an ongoing tension that's in the financial model that we are driving cost reductions against every year.
George L. Staphos - BofA Merrill Lynch, Research Division
So Ward, just a quick follow-on, the 2% to 3%, is that net of the Six Sigma? Or you think the Six Sigma and other efforts can maybe lower that rate of growth?
Ward H. Dickson
Yes, so the -- what I was identifying was just the inflation itself. The Six Sigma contributes to our productivity, both in our operating expense leverage and then also in our labor productivity that occurs in our facilities -- manufacturing facilities.
Operator
Our next question will be coming from the line of Mr. Anthony Pettinari of Citigroup.
Anthony Pettinari - Citigroup Inc, Research Division
Just following up on Chip's question on sales synergies with the new portfolio. Steve, you referenced some excitement in the sales organization, and is it possible to say whether did the upside in sales synergies come more from having all 3 boxboard grades under the same roof or do you think there's more opportunities from having the leading containerboard franchise and the leading boxboard franchise under the same roof?
Steven C. Voorhees
I think it's the breadth of product offering that we have, which would include what you just talked about, and I think the converting as well as the paper. And just being able to talk to customers about the broad product offering, I think just ends up creating opportunities.
I think one of the things MWV is bringing to the company is a -- just a great commercial excellence capability, and I think that's something we also have at RockTenn. I think the combined companies are going to -- we're going to be able to go to market and I think talk to customers and provide services.
But I can't fully describe what's going to happen, but we've got great people and we've got customer opportunities. And I think extraordinary things will end up happening.
Anthony Pettinari - Citigroup Inc, Research Division
Okay, that's helpful. And then, following up on that, prior to the merger, you made some realignments in how the paper business and the packaging business were organized, and there was kind of a goal of gaining some sales synergies on that reorganization.
Have you kind of seen some of the fruits of that realignment already, x what's going on with MeadWestvaco?
Steven C. Voorhees
We have, and I think just -- we did organize into packaging solutions and paper solutions. We have had, I think very, good success going to the -- many of our customers with the broad product line.
And the addition of MWV just makes that even better. I think we did put out an announcement on executive leadership, and we've maintained the packaging and paper solutions framework.
And I think we have very good momentum on how we go to market, and have a lot of people spending a lot of time on that. And I think the enthusiasm I see across the organization is deserved, and I think is -- I think will bear us well as we go forward.
Operator
[Operator Instructions] And the next question will be coming from the line of Mr. Alex Ovshey of Goldman Sachs.
Alex Ovshey - Goldman Sachs Group Inc., Research Division
On your box shipment volumes and outperformance relative to the industry, which is very impressive, can you say how much of that is driven by new contract wins that should stay in the business model beyond just a quarter or a several-month bump to the volume?
Steven C. Voorhees
It's hard to quantify that. I think what we've seen -- we've gone through, I think, a couple of cycles where we lagged the industry.
Now we've got a quarter to where we exceeded the industry. I think you have to go back to the fundamentals of what the management team has been doing in Container, which I think is doing the right things for the long-term.
And it's a complicated project, it's a multi-year project and I think we're beginning to see the fruits of that. And so the box business right now is stronger than it's ever been.
And I think that's because they are doing the right things that you need to do to operate a profitable box business.
Alex Ovshey - Goldman Sachs Group Inc., Research Division
And then just on the cost side, in your slide deck you show a diesel exposure of 63 million gallons, What does that actually mean? So I guess, from the highs to where we are, diesel prices are down about $1.
So does that mean that, on that component, you should see a $63 million annualized benefit to the P&L? Can you just provide a little more color around what your diesel exposure number in the presentation means?
Ward H. Dickson
So that does show our volume of consumption on an annual basis. Embedded in our inflation numbers are the benefit that we've got from the lower diesel fuel surcharges that we have.
And it's partially offset, though, by higher freight rates. So the math is not quite $15 million worth of benefit in the quarter.
It was something that was less than approximately $10 million. But it is flowing through the P&L and it is one of the components of our deflation, but it's been partially offset by higher freight rates.
Operator
Our last question will be coming from the line of Mr. Philip Ng from Jefferies.
Philip Ng - Jefferies LLC, Research Division
Just taking -- backing off of Mark's question earlier, assuming MeadWestvaco deal closes as planned, is it fair to assume that another transformative acquisition is probably unlikely for next year or 2? The reason why I ask is, given your targeted leverage target and just your free cash flow profile, this should give you a lot of runway on the buyback front in the next few years.
And just wondering, last year, did discussion with MeadWestvaco early last year limit some of that ability early on in the year?
Steven C. Voorhees
That's a difficult one to answer. I think one of the great things about the new company is that we do have a platform for growth and so we will continue to look at opportunities.
And I would expect we'll have opportunities to go forward, but we're not really commenting any more than that, just I can't. I mean, it's -- our primary focus now is to merge the companies, get the organization working and get the most out of the existing organizations.
So that's the job we're focused on now.
Philip Ng - Jefferies LLC, Research Division
Okay, that's helpful. And then I guess a question for Jim.
Good to see strong momentum in Corrugated late in the quarter, but can you give a sense how demand is tracking in April? I think you might have touched upon it.
And what's your outlook for the full year? Are the momentum that you've seen in the box business sustainable?
James B. Porter
I think we're on a very positive trend. We're seeing the start of April very much like we saw in March.
And seasonally we're going into a period where winter is over, people are outdoors, they're spending more money on the stuff that we package, and so I think the outlook is good. So that's really the run rate we see, both in the folding carton as well as the corrugated business.
Operator
Our next question will be coming from the line of Mr. Chris Manuel from Wells Fargo.
Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division
A couple of questions, and then just a housekeeping one. But really to kind of come back to the box elements and the folding carton element as well, is this kind of a function of -- I think you mentioned you're 12 or 13 of your EVOLs in of a 30 process, so you've got enough critical mass as you sit there today to continue to do a little better than the market.
I mean, I think you were under the market for a couple of years as you were beginning this process. What you cited was better quality, better service, et cetera.
So do you feel that as you finish rolling out this process, you're at a point where you've kind of re-earned the right to do some business with customers to continue to grow at or better with them? I mean how do you think about that process?
Steven C. Voorhees
You've kind of said how we think about it. I'm not sure I can add very much.
I mean, they've done a great job of I think improving the business and have it on very stable footing and have the opportunity to continuing to improve. So I think that's the -- thank you for articulating the story.
Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division
No problem. A follow-up to that, I guess -- or maybe I'll ask a couple housekeeping questions.
Have you settled on a new name for the company in the fiscal year, things of that nature?
Steven C. Voorhees
We have not settled on a new name. I think with respect to fiscal year, we plan to be on September 30 fiscal year.
Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division
Okay, that's helpful. Can you maybe give us a sense, too, on the folding carton side, I think you were up 1 point or so and the industry was down a 1 or 2 points, maybe some of what's happened there?
You've been closer to the market the last few years. Is there just something basically with customer mix or some segments that you're involved with that's helped you kind of outperform there?
And then the sustainability of that?
Steven C. Voorhees
Mike?
Michael E. Kiepura
Sure, I think it is similar to the strategy that we've outlined on the container side in terms of really focusing on satisfying the customer with outstanding quality and service, and doing that in a cost-competitive way. So to the extent that we bring along those measures, that we're going to be rewarded with the business.
And folding has been taking that approach for the last many years; and certainly container after the Smurfit acquisition 4 years ago, similarly. So I think both of our main converting businesses, box and cartons, are reaping the benefit of that focus on satisfying the customer and bringing value cost competitively.
And we're seeing that in the improved volumes.
Christopher D. Manuel - Wells Fargo Securities, LLC, Research Division
Okay. One last, if can sneak it in.
It looked like your utilization rates in the quarter were in that 92% range. Is that just a function of -- you've typically been more in the mid-90s, more like 95%.
Is that just a function of some of the issues at Panama, on outages or things? Or how should we think about that on a go-forward basis?
Steven C. Voorhees
It's more of a function of the outage schedule. So I think that 80,000 tons -- I think we're 96.5% if you adjusted the outages out of the calculation.
Operator
[Operator Instructions] The next question will be coming from the line of Mr. Mark Connelly from CLSA.
Mark W. Connelly - CLSA Limited, Research Division
Two things, Steve. First, can you talk a little bit about your expectations for virgin and recycled fiber costs in the next quarter?
So it doesn't look like input costs are clearly causing you a lot of margin trouble so far, and I'm just curious where you think that's going. And second, from your comments, it sounds like Recycled and waste is maybe more of a strategically important cost center than a meaningful profit center.
I'm going to guess that you guys are going to stop reporting it, so maybe this is the last time we'll get to see it. Is there more restructuring to come in that business?
Or should we just sort of think that what it's done for the last couple of years is what it's going to do?
Steven C. Voorhees
I'm going to take the second question and then Michael can start on the fiber and then allow Jim to talk about the virgin and recycled. I think you articulated the Recycling as a strategic cost center.
We have split it out as a segment, but I think your view of it is an appropriate view and so I would not expect that to be reported as a separate segment. We've done a lot of restructuring in the business over a period of time.
We shut down, I think, an excess of 10 plants and so we've got over -- and now Jim is telling me it's 29 plants, and that's in excess of 10. But I mean, we've done a lot of restructuring, and the impact -- the cumulative impact of that has been with our eye on the strategic cost centers as compared to stand-alone business, our new segments will reflect that going forward.
I think with respect to virgin and recycled, our virgin costs have been very -- have been managed extremely well. I think we just have a terrific procurement department in wood.
And I think that has helped -- we're reaping the benefits of that. And I think with respect to the direction of virgin and recycled, Jim?
James B. Porter
Okay, Steve. So I would build on the -- kind of relative to our Recycling business, because we're in the -- the making of paper and it's all about fiber.
And so our recycled system is very important to us as we use just south of 5 million tons, so we need to be very good at buying fiber. And that's what that business allows us to do.
We have rightsized it with closing over half of the facilities. And the ones remaining are very strategic parts of our business from a supply chain standpoint to supply our mills.
And so I think we've got that business on a very important state, at present. And costs have come down.
Wood recycle. Wood down year-over-year, wood down sequential quarter.
We're generally very pleased with how our system's functioning. Our team has really improved the management of our inventories and put our supply chains in a much better stead so that we're not having to react to weather and various special cause situations.
So we've got a much more stable and efficient wood process. Will it trend it up or down?
We think we're in a really pretty stable position relative to wood. Recycled fiber, we've continued to have a period of declining fiber prices.
There are some indications that we may have bottomed. And with the port situation cleaning up, we would expect Asian demand to increase and we're starting to see that a bit in the international markets.
And so I would say there's likely some upward trend line on recovered fiber. But we don't see that as being something that is an extraordinary spike.
I hope that's responsive.
Steven C. Voorhees
I think we allowed 1 hour or the call, and we're past that. But we'll take another question if somebody has it.
Operator
The next question will be coming from the line of Mr. Mark Wilde from BMO Capital Markets.
Mark Wilde - BMO Capital Markets Equity Research
Yes, just to 2 quick follow-ups, Steve. One, you're still about 300 to 500 basis points below your 2 big public peers in the containerboard and corrugated business.
I'd like to get your thoughts on narrowing that gap over time. And then the other question I had is I think you have some kind of a joint venture relationship with David S.
Smith over in Europe. The Europeans seem to be kind of way ahead of us on shelf-ready packaging, and I would just wonder how applicable you think some of that stuff is to the North American market?
Steven C. Voorhees
I'm going to allow Jim to the relative margin question.
James B. Porter
Thank you, Mark, for that question. We get that often.
But we've got a, I think, a very good system and we have some very good competitors. I think you've seen us do a lot of heavy lifting to put our portfolio of containerboard mills and Corrugated Packaging operations under a much better state of management.
The relationships with our customers has been deepened. Our commercial execution, our cost management have all been improved dramatically, and I think we're seeing that gap close.
And you can bet every single day, we are focused on doing more of that. So I think, over time, you will see us get better.
I can't speak to what our competitors are going to do, but I'm sure they're not going to stand still. And where it all goes from a pure margin standpoint compared to each metric, I really wouldn't predict.
But we are keenly focused on generating free cash flow for our shareholders and satisfying our customers.
Mark Wilde - BMO Capital Markets Equity Research
But structurally, Jim, is there any reason for the gap to kind of maintain at that level?
James B. Porter
You can look at...
Mark Wilde - BMO Capital Markets Equity Research
I know you guys export a lot, right, so that might be a piece of the equation. But I think at least 1 of the 2 peers also exports.
But I'm just trying to figure out whether this is something that's fixable or you can tighten over time.
James B. Porter
We're constantly focused on that, Mark, and we do have a portfolio of customers that are our customers and that mix is our mix, and it is different from that mix for our other competitors. And so we have similar businesses, but they're different.
And so I really could not try to predict what any structural change would be going forward. We're constantly trying to optimize our system and that's our focus.
Steven C. Voorhees
And just with respect to the question on Europe. We do have a licensing arrangement with DS Smith to market some equipment, which has worked out really well for us.
I think the issue of shelf-ready packaging and the application of, call it, retail that we're seeing in Europe applicable to the U.S., that's there, meaning, as an issue. Many of our customers have purchasing organizations in Switzerland.
A benefit of the merger, for me, is that we'll now have physical operations in Europe and we will have a office in Geneva and we will be able to have, I think, constructive dialogue with customers about to the extent that it does come here or vice versa, I think we're going to be well positioned to take advantage of those opportunities. So I think you've articulated one of the potential benefits of acquisition.
The merger is not based on that, but the economics or the potential for improvement is there.
Operator
Thank you. At this time, we don't have any further questions on queue.
And that concludes today's conference. Thank you, all, for participating.
You may now disconnect.
Steven C. Voorhees
Thank you.
Ward H. Dickson
Thank you.