Aug 3, 2011
Executives
James A. Rubright – Chairman and Chief Executive Officer Steven C.
Voorhees – Executive Vice President, Chief Financial Officer and Chief Administrative Officer
Analysts
George Staphos – Bank of America Merrill Lynch Mark Wilde – Deutsche Bank Phil Gresh – JPMorgan Chase & Co. Chip Dillon – Vertical Research Partners Mark Connelly – CLSA Steven Chercover – D.
A. Davidson Mark Weintraub – Buckingham Research Bill Hoffman – RBC Capital Markets Joshua Zaret – Longbow Research Joseph Stivaletti – Goldman Sachs
Operator
Good morning. My name is Caroline and I will be your conference operator today.
At this time, I would like to welcome everyone to the Rock-Tenn's Third Quarter Fiscal 2011 Earnings Conference Call. All lines have been placed on mute to prevent any background noise.
After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions) As a reminder slides are being presented today as part of the conference call.
These slides can be accessed at www.rocktenn.com under the investor’s page. Ladies and gentlemen, this call is being recorded today, August 3rd, 2011.
(Operator Instructions) Thank you. Your speakers for today's call are Mr.
James Rubright, Chairman and Chief Executive Officer, and Mr. Steve Voorhees, Chief Financial Officer.
Mr. Rubright you may begin your conference.
James A. Rubright
Thank you, good morning all. We appreciate you joining our call and your interest in our company.
During the course of this call, we may make forward-looking statements of course within the meaning of the Federal Securities Laws which involves statements regarding our plans, expectation, estimates and beliefs related to future events. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from those that we discussed.
We include a description of certainties, risks and uncertainties associated with forward-looking in our 2010 Form 10-K and similar disclosures on our subsequent SEC filings. Also during the call we may refer to non-GAAP financial measures.
We provide reconciliations of these non-GAAP measures to the most directly comparable GAAP measures in our earnings release and in the appendix of this slide presentation which is also available on our website on the investor tab. This morning I’ll begin with the commentary on the performance of our businesses during the quarter and our recently closed acquisition of Smurfit-Stone.
I’ll provide an overview of our plans and expectations for capital expenditures going forward and then Steve Voorhees will provide an overview of our segment disclosure and cover non-operating items in our financial statements. After our prepared comments Steve and I will be available for questions.
Our legacy operations at Rock-Tenn made about $0.96 per share in the quarter compared to $1.04 at last year in the quarter and this was due to lower production from the major maintenance outage at our Demopolis mill which as you know on a two year major maintenance schedule and as a result the disruption and production reductions from this outage reduced earnings by about $0.10 per share. As a result higher pricing and volume in our consumer packaging business more than offset higher fiber chemical and freight costs.
Our consumer packaging margins were good, our folding carton plants continue to gain share with our volumes up 1.6% against an industry that was down 3.7% over the prior year quarter. Our beverage partition business, which we now report with our folding carton business were nicely over the prior year and performed very well financially during the quarter.
Our integrated partition business is the largest customer of our uncoated recycled paperboard mills, which are now also included in our Consumer segment. Merchandising displays also grew over the prior year as we continue to differentiate ourselves with our customer value proposition and we included the five Smurfit display plants in this sector, they have annual sales of about $240 million bringing our total annual display sales to over $600 million per year.
Coated recycled paperboard market demand continues to be very strong, we again said no economic downtime in the quarter and we take – and we expect to take no economic downtime for this foreseeable future. At Rock-Tenn, our SBS backlogs are healthy and we [go] back to a normal level of about one month’s production as a result of the outage in that levels about normal for this time of the year.
However, we believe that our backlogs maybe significantly stronger than many of our competitors. So, at least for us as with coated recycled paperboard, we expect to take no economic downtime in our bleached paperboard operations.
Our legacy corrugated packaging plants and our Solvay recycled containerboard mill performed well during the quarter, particularly given the higher fiber, chemical and freight costs as we incurred. I would say that balancing those freight costs, our volume increases and the integration benefits, which have continued to keep this acquisition on track to our 2008 acquisition cases.
With that brief summary, I’ll turn to the Smurfit-Stone acquisition. The initial integration went very well renewal service of production disruptions and this allowed us to focus on synergy capture and business improvements.
The customer reception to this transaction has been terrific and it’s more than fulfilled our high expectations. We currently have many opportunities to increase sales of the combined operations.
As part of our plan to improve the cost structure of our corrugated box plant network, we announced the closure of four corrugated box plants. Our goal with these closures is to retain substantially all of the business by transferring into other well capitalized plants in our system.
Our containerboard mills also ran very well during the – one month that we own them. As we previously discussed with you, we believe that our challenge this quarter would be meeting our system demand.
During June, we accordingly took no economic downtime and we had about an average amount of maintenance downtime. During these running conditions, and the improvements we’ve made in the mill and box plant operations, corrugated packaging EBITDA margins were 16.2% for June for first full month of our ownership.
When you compare our EBITDA margins to the – EBITDA margins of the other two high-performing integrated containerboard companies, our corrugated packaging EBITDA margins compared well. We were somewhat below IP, and that has given the value they created with Weyerhaeuser acquisition and they were slightly ahead of packaging core, our margins of course, were well ahead of Temple-Inland just we expected.
From financial standpoint, we’re well ahead of the acquisition pro forma guidance we gave in announcing the acquisition. I'd like to go over some numbers that sort of go back to what we would forecast and then demonstrate just how well we’ve done.
At the time when we announced the acquisition, we forecasted that our pro forma net debt as of March 31, 2011 would have been $3.7 billion. Our actual net debt at June 30 was $3.43 billion.
In addition, our pension under funding as of that date is approximately $100 million or lower than our guidance on a pre-tax basis or $65 million after-tax. Thus our balance sheet has about $330 million less debt and after-tax pension obligations and we established as our acquisition baseline case as of March 31.
This equates to more than $5 per share that were better off from a net debt and pension obligation standpoint than our acquisition forecast. In addition, our acquisition forecast also had beginning debt-to-EBITDA at a ratio of 2.8 times.
In the event, our credit agreement EBITDA as of June 30 was $1.4 billion and our leverage ratio is 2.53 times. So we’re much less leveraged than the 2.8 times acquisition forecast and a 4.3 and 4.2 starting leverage for our Gulf States and Southern Container acquisitions.
The Smurfit-Stone acquisition was highly accretive for the 34 days; we own the assets with EPS accretion of approximately 33% per share. This accretion is affected substantially by the GAAP calculation of average shares during the quarter, if you looked only at the actual accretion of the acquisition for the month of June; the accretion was closer to $0.23 per share.
In addition, based on the planning and the work we’ve done to date and the results of a number of our initiatives, I feel confident that we’ll exceed the 150 million in synergies that we forecast. Although, I want to make it clear that in the future to the extend we realize that excess we will characterize it together with other performance improvements that we expect to achieve in the business over the coming months and the next few years.
Now to be clear, we view performance improvements as involving more than the simple elimination of over lapse from the combination. We’ve done an extensive review of the opportunities to flow from this combination and we’ve identified about 400 million in performance improvements that we believe we can capture over the next 2.5 years.
These performance improvements can be thought of this falling into three broad categories. First, we can achieve very high returns on strategic capital investments.
Second, we can reduce our cost and achieve production efficiencies through operational and commercial excellence. We can accelerate initiatives in place in the former Smurfit plants and mills and by extending the Rock-Tenn business model to this very large business platform.
Third, we can achieve further integration benefits through optimizing the combined operations and our administrative functions. To achieve these synergies and performance improvements, we expect to incur about a $135 million in cash restructuring expense over that period and to expand about $195 million in strategic capital investments all of which we expect to occur over the next 2.5 years.
I’d like to turn to some information that we prove previously disclosed and updated with respect to the cost structure of our mills. We’ve previously shown a plot of our mill cash cost on the (inaudible) cost curves and we do so again in the accompanying slide for March 2011.
We’ve added cumulative capacity table at the bottom of the chart and you can see that 72% or our containerboard system capacity resides on the left side of the cost curve. We’ve been asked from time to time about the state of the Smurfit assets and our capital expenditure needs going forward.
At the time of the acquisition, we estimated that ongoing capital expenditures would be about $350 million per year, which represents about a $100 million in the near term for legacy Rock-Tenn given the opportunities we have in that business and about $250 million for the Smurfit assets. Our estimate of $250 million was about $40 million higher than the guidance that Smurfit has previously provided for 2011 and ’12, which was about $210 million.
Their guidance was based on their view of how they would operate the assets, but it also include significant capital of course some high impact projects in their mill system. The additional number that we estimated was based on our belief that we would likely invest more in modernization and maintenance upgrades capital than with Smurfit and our belief that the opportunities for very high return projects would be compelling.
After a lot of work that we’ve done primarily with the mill teams, we expect that $250 million that we forecast will actually be more or like $265 million in 2012. This includes the large capital projects that we’ve previously discussed including those we’ve mentioned at our Hodge and Hopewell mills these are projects that will materially reduce the cost an increase the productivity of those mills and much better balance our mix of virgin and recycle furnish.
However, given the size of these projects, they will result in greater than normal outage downtime next year and concomitantly with greater than normal amount of production curtailment and earnings impacts. However they are very high return project.
In addition to that base capital of $265 million we’ll spend about $35 million in synergy capital. We’ve discussed the need for this its primarily for IT systems, box plant optimization, the facilities cost note will necessary to create a space that will locate the activities and personal Smurfit that historically warehoused in St.
Louis in Chicago and a number of other related projects. In addition, we’ll spend about $35 million as fast as we can on energy projects that we have identified that mainly bring natural gas to some of the large virgin mills to substitute natural gas for fuel oil in mill powered boilers.
These energy projects have very high returns in fact, the pay back periods are typically between one and two years based on the current oil natural gas MMbtu of cost spread. Finally, Smurfit leased virtually all of its material handing equipment.
We of course will buy this equipment so far a more efficient way to own and finance your material equipment. Smurfit had a cluster of leased equipment coming of lease in 2012 and has result in addition to simply buying and rather than leasing this equipment we’ll spend about $16 million to $18 million more than the normal usefulness of this equipment, which indicate would be a normal replacement rate.
All in all, this will require us to incur another $45 million in capital expenditures in 2012 just for material handling equipment. If you add all this up, it results in capital expenditures of about $480 million in 2012.
We expect that our capital expenditures will trend down over the course of the following two years to a normalized range in 2014 and beyond. We think the capital expenditures for the entire enterprise should be in the range of $350 million per year.
This will maintain and replace our assets consistent with Rock-Tenn’s practices and will continue to enhance the cost competitiveness of our overall business. This amount is generally consistent with the guidance we gave when we announced the acquisition.
Further to complete the picture, we expect to spend about $90 million in the fourth quarter fiscal 2011, which includes some synergy, material handling replacement and performance improvement capital as well as normal base sustaining capital. In summary, our expectations for the acquisition have been confirmed by our detailed work and by the results we produced so far, which complement our well-positioned and profitable legacy business.
With those comments, I’d like now to turn the call over to Steve Voorhees and he’ll review certain financial aspects of the quarter and provide some further assumptions to assist you in understanding our business and our prospects going forward.
Steven C. Voorhees
Thanks, Jim. As you’ve seen in the press release, we are now reporting our operating results in three segments.
Corrugated Packaging has a $6.5 billion sales business and that includes our 14 containerboard mills and over 100 box plants. Consumer Packaging has a $2.5 billion business and that includes our folding carton plants, coated mills, specialty paperboard businesses and our merchandizing supplies business.
As Jim said, the supply business has, currently has over annual sales of $600 million. The Recycling and Waste Solutions segment is the largest paper recycling in North America with $1.5 billion in sales.
We are continuing to allocate cost to our businesses very similarly to how we’ve allocated costs in the past. There is an exception with respect to pension cost.
We are allocating the cost of additional pension benefits or service cost to each of our businesses as these benefits are earned by current employees. We estimate the service cost to be approximately $30 million per year or just over a half of our estimated fiscal year ‘12 pension expense of $57 million per year.
The difference between $57 million and $30 million is $27 million and represents expenses associated with the unfounded pension liability and pension investment results. These additional expenses are included in total corporate expenses, which we expect to be approximately $120 million per year.
We have restated our historical financial results to reflect our revised segments and allocations. As Jim said, we acquired Smurfit-Stone on May 27, so the June quarter and month results include 34 days of Smurfit-Stone results.
As such, quarterly comparisons are difficult that said for the month of June, our Corrugated Packaging business reported $96 million in EBITDA and $596 million in the sales for an EBITDA margin of 16.2%. Consumer Packaging sales were $220 million in June with $32 million in EBITDA for a margin of 14.4% and our recycling business reported EBITDA of $3.6 million on $120 million in sales.
As Jim said in June, Rock-Tenn earned $0.60 in adjusted EPS. We estimated that legacy Rock-Tenn would have made $0.47 per share in the month making the acquisition approximately $0.23 accretive in the month after accounting for their earnings for the Smurfit assets and the new debt and equity used to finance the acquisition.
Jim described the reason for the difference in the GAAP accretion for the month as compared to the quarter. Due to the significant change in the composition of the business during the quarter would include the usage of key end products in the conference call materials.
We are now using 19 million tons of wood and 4.4 million tons of recovered fiber in our mill operations. We are now using 26.7 Bcf of natural gas and 42.9 million gallons of fuel oil.
At over $2 billion in annual run rate of expense we have the opportunity to use the scale of our business to acquire these commodities even more efficiently than we have in the past. And also providing the following information to assist those of you who are developing projections for Rock-Tenn.
We expect the annual depreciation and amortization to be in the range of $550 million, our annual interest expense is currently running at $135 million. While we are expecting our book to tax rate to be between 35% and 36%, our cash tax rate will be substantially below this level due to net operating losses on our books of $497 million pretax or $174 million after tax.
We expect to recover these net operating losses over the next two to three years. We are also expecting to receive the cash from the Cellulosic Biofuel Producer Credit.
This amount is $77 million, which is available from the legacy Rock-Tenn operations and $69 million, which is available from the legacy Smurfit operations. We’re expecting to receive the cash benefit of the cellulosic biofuel credits beginning after recovering the net operating losses and beginning in the 2013, 2014 timeframe.
Finally, we have $70 million of alternative minimum tax credits available from legacy Smurfit that we expect to receive in the 2015, 2016 timeframe. All to all, these tax items aggregate to about $390 million in reduced US Federal cash taxes.
This combined with our expected contributions to our pension plans, which are expected to be about $37 million in the fourth quarter of this fiscal year and $359 million in fiscal year 2012, provide the basis for our expected combined US state and foreign cash tax rate to be substantially below our book tax rate over the next three to five years. As you’d expect, this is dependent on business conditions and other factors.
That concludes by prepared remarks. Now Jim and I now invite your questions.
Operator
Thank you, we will begin to question-and-answer session. (Operator Instructions) our first question comes from George Staphos from Merrill Lynch.
Your line is open.
George Staphos – Bank of America Merrill Lynch
Congratulations, good luck with the acquisition. I guess the first question I had, and Jim, I think you touched on this.
It took like the Smurfit mills ran at around a million eight tons in the quarter, and not a lot of disruption, not a lot of downtime. It looks like a pretty good outcome.
Can you comment how much of that was directed to third party versus internal conversion?
James A. Rubright
You know I don’t have the number exactly in front of me. We’ve indicated we’re about 70% integrated as a system.
We did see strong export demand and we’ve been able to use relatively good export pricing and demand to balance our initiatives within the business to try to make sure that we’re pricing products appropriately and sorting through the mix of business that really works for you and that which does not.
George Staphos – Bank of America Merrill Lynch
Jim, Steve if we think about the amount of downtime you're going to take next year around the maintenance projects, is there a way to quantify that at this juncture about how many tons it might be or what the earnings effect might be as we try to model out?
James A. Rubright
Sure. We expect to take about 250,000 tons on an annual basis next year of maintenance outage reduced production, in that I would estimate that 20,000 tons to 25,000 tons is incremental outage based on Hodge and Hopeville project.
Most of those projects are oriented towards improvement on the paper machine that basically mean you’re going to be down for longer periods of time. That would be normal for our maintenance outage.
George Staphos – Bank of America Merrill Lynch
Okay. Two last ones, then I'll turn it over.
As we look at the corporate expense guidance that you provided, is there any expense that you or the legacy Smurfit operations used to allocate to the segment that's now included in that corporate, and if so, could you help us as we try to bounce between corporate and the segment, what that amount might be?
Steven C. Voorhees
The primary difference is our pension expense associated with the unfunded pension liability. We’re allocating service cost only to the businesses that invest benefits earned by current employees, then the remainder, which is $27 million is within the 120 million.
James A. Rubright
I think the rest is that Staphos we’ve looked at is really in the noise level.
Steven C. Voorhees
Right.
George Staphos – Bank of America Merrill Lynch
Then lastly, it appear as from your comments that you did well in terms of cash flow and debt pay down. Is there any way to size what kind of, thus far, having closed on a deal, what kind of debt pay down you've had?
Thank you.
James A. Rubright
Well, it’s really hard to say what the debt pay down was, because when we benchmark the bench market against what the pro forma would have been at the time we announced the acquisition, so you really are backing up to an expected debt amount as of March 31 which we announced in January. So it’s really hard to just tie it.
I think it is just simpler to say, okay, I’ve got it. I know how much debt you’ve got and just move forward from there.
And we disclose the cash generated from operations during the period of time and we disclose what it would be which includes the 34 days of Smurfit operations. And so we know we’d end up having doing a disclosure of the actual Smurfit earnings and EBITDA and cash flow during the two months of April and May and it really would be difficult to comment on that on a GAAP basis.
George Staphos – Bank of America Merrill Lynch
Okay. Thought I would try, but I appreciate it.
I'll turn it over. Thank you.
Operator
Thank you. Our next question or comment comes from Mark Wilde from Deutsche Bank.
Your line is open.
Mark Wilde – Deutsche Bank
Good morning, Jim. Good morning, Steve.
James A. Rubright
Good morning.
Mark Wilde – Deutsche Bank
Jim, the projects at Hopewell and Hodge, will they boost the mill capacity for container board?
James A. Rubright
Yes.
Mark Wilde – Deutsche Bank
And do you have a sense of how much?
James A. Rubright
Well, it's significant, more than a 100,000 tons at Hodge. I don’t remember exactly the number at Hopewell, but really what we’re trying to do is move our recycle production in to virgin and to optimize the production at the most effective facilities we’ve got.
Hodge has that, you know, three out machine a very wide machine that can, we can increase the productivity of great deal and similarly, we can do the same thing at a very large machine at Hopewell.
Mark Wilde – Deutsche Bank
Okay. And just the other side of that, I guess, is as you get these productivity gains there, any thoughts on capacity adjustments elsewhere?
James A. Rubright
Well, sure. What we will always do is run our system to our system demand.
These projects because of the capital required in the planning and execution will be executed largely in fiscal 2012 outages, which are at least 12 months away, and as a result, we’re not in a position to estimate what the system requirements are going to be as of that time. It is our view that you can create flexibility in your production requirements both to meet seasonal demand and other fluctuations through ultimately large capacity we’ve got and recycled, because it’s much more, you can either recycle capacity much more easily than you can virgin capacity, so I’m not really anticipating any issues with respective balancing, our system production with respect to system demand.
Mark Wilde – Deutsche Bank
Do you foresee at any point having to take any mill capacity out permanently?
James A. Rubright
I know you’d love me to do that, Mark, but I’m simply indicating that my answer is the answer I just gave you that will match our capacity and production to our system requirements at the time as we evaluate them.
Mark Wilde – Deutsche Bank
Okay. All right.
That's fine. Another question.
What do you think just be the legacy Smurfit business and container board can do on an EBITDA basis? Because if you just get the whole system to say that IP level that you showed, it seems like you've got Solvay and the legacy Rock-Tenn business providing a lot of lift, because your margins have been quite a bit higher than others in the industry.
So I'm wondering, where the underlying Smurfit business can get to?
James A. Rubright
Well, I believe the combined business can be the most profitable business in the industry, that’s our goal. Basically, I didn’t believe we can do it, in 1999, when we started with Rock-Tenn, but we did and I think if you invest right you’d get people directed in the right basis you can.
Certainly, there is no reason that the assets we’d acquire from Smurfit particularly given the state of the mill system can’t be move to the left side of the cost curve.
Mark Wilde – Deutsche Bank
Okay. Last question I had, just there's been a lot of talk just from private guys that I talk to in the industry that maybe Smurfit had been more aggressive from a volume standpoint leading up to the closing.
Have you seen any evidence of that as you've owned the business for a couple months now?
James A. Rubright
I’m not going to comment on what other people have said about, where our business is being conducted more.
Mark Wilde – Deutsche Bank
Okay. All right.
Well, listen, good luck in the coming quarter.
James A. Rubright
All right. Thank you.
Operator
Thank you. Our next question or comment comes from Phil Gresh from JPMorgan.
Your line is open.
Phil Gresh – JPMorgan Chase & Co.
Good morning.
James A. Rubright
Good morning, Phil.
Phil Gresh – JPMorgan Chase & Co.
So, with respect to the additional CapEx for 2012, can you give us any thoughts around what kind of return do you think you can achieve in say, a 12 to 24 month time period on that incremental CapEx? Because I assume that's not in your synergies.
James A. Rubright
Well, as I said, the $150 million in synergies if you go back what we said at the time we announced, and that had primarily box plant synergies in it, but it did not have any mill synergy. So you’re right, if not in the $150 million it is in the $400 million of incremental opportunities.
I think the energy projects of the first ones will be able to get done, so you may see in the late winter or spring some kick from the $35 million of energy capital. By and large, this substantial amount of mill capital we don’t get any benefit from until the end of fiscal ’12 or the end of ’13.
These are very, very high returning projects. I think the lowest returning large project that I’ve seen is a wood yard we’re going to do at Florence and based on what we’ve done at Demopolis and what we expect there you know that’s a mid-20s return, but the Hodge and Hopewell projects are significantly higher than that as our all the energy projects.
And then a good bit of the stuff that we’re doing in terms of productivity and quality improvement through just basically modernization of the facilities have fairly very attractive returns.
Steven C. Voorhees
To quote the nearest range, synergy impact you’re going to see is procurement synergies and energy synergies, which I think you’ll start to see in the first calendar quarter of 2012 as I’ve indicated. So I know I’d love to be able to take the numbers that we’ve achieved now and accelerate them, but there’s just a lot of work to be done to generate those synergies, which will cause timing to be as I have just described.
To quote the nearest range, synergy impact you’re going to see is procurement synergies and energy synergies, which I think you’ll start to see in the first calendar quarter of 2012 as I’ve indicated. So I know I’d love to be able to take the numbers that we’ve achieved now and accelerate them, but there’s just a lot of work to be done to generate those synergies, which will cause timing to be as I have just described.
Phil Gresh – JPMorgan Chase & Co.
That's very helpful. And some of your peers have talked about pretty decent trends in the first half of July in container board.
I wonder if you saw similar trends and if anything has gotten worse in recent weeks just given the macro environment?
James A. Rubright
I think July looks to us a lot like June; the markets seem to be relatively stable, not robust, but stable relative to what we saw in June.
Phil Gresh – JPMorgan Chase & Co.
Okay. And then final question, what would you say, given the progress in the debt pay down, what is your leverage target at this point?
James A. Rubright
Well, I would be comfortable taking leverage down below two turns at that point, you really have to evaluate what’s your optimal capital structure is, certainly based on what we’re showing or going to deleverage at a more rapid rate than that and also for the couple of years, it was making relatively large pension contributions reducing our exposure to the unfunded pension liability. I don’t have a firm target of what we would – what we’re trying to achieve or in the level of which we’d say we’re beginning to be underleveraged.
Phil Gresh – JPMorgan Chase & Co.
Okay, all right, thanks, helpful. Good quarter.
James A. Rubright
Thank you.
Operator
Thank you. Our next question or comment is from Chip Dillon from Vertical Research Partners.
Your line is open.
Chip Dillon – Vertical Research Partners
Yes, good morning.
James A. Rubright
Hi Chip.
Chip Dillon – Vertical Research Partners
Hey, Jim, first question for you. When you look at the – your strategic goals and potential acquisitions in the future, how long do you think you will sort of not be able to pursue those given the integration process?
I mean do feel you’re in a position in the next 18 months to do something that that strategically makes sense or is it more sensible to wait say the ‘13 or ‘14 after you've delevered a bit?
James A. Rubright
We continually evaluate opportunities and with respect to our ability to do another transaction, I would say we could do one tomorrow. We’ve got a very, very efficient team in place, and all of people who were part of the ongoing organization are in place and we’re working together.
So I don’t understand where the 12 to 18 months would come from. We're in a great financial position right now.
If you have an idea that's good enough, somebody's going to finance it. We’d able to come up with the financial structure that would work.
So I don't view there as being any impediments to taking advantage of any strategic opportunity that might be available to us.
Chip Dillon – Vertical Research Partners
Got you. And then looking at the deleveraging equation, it seems like next year with the big pension contribution you're making, and given that it's – and by the way, what is the expense Steve next year going to be?
I know the contribution is 359, but what's going to be expense?
Steven C. Voorhees
57.
Chip Dillon – Vertical Research Partners
157. Got you.
So it would seem to me that.
Steven C. Voorhees
57.
Chip Dillon – Vertical Research Partners
Oh, just 57? Got you.
So it would seem to me that it would be difficult to see your net debt decline next year, say, more than what your net income is. Is that a fair statement given the capital spending being a little higher of the big contribution?
Steven C. Voorhees
We're just – we are not at a point of providing cash flow guidance. I think the details I went through should provide you the ability to come up with a projection for us based on your views of the market and other factors.
Chip Dillon – Vertical Research Partners
Got you. And last quick one.
When you look at the pension, and I don't see the slide, so I apologize if it’s on a slide. But beyond 2012, how do you see the progress or the progression of pension contributions thereafter?
Steven C. Voorhees
Probably somewhere at that same level for fiscal ‘12 for the next two to three years after that, I think, but it's really a function of what happens to interest rates and investment returns and if you can tell me what that's going to be, then let me know and we'll be able to make, some progress together. I mean it's just very determinate moving forward.
Chip Dillon – Vertical Research Partners
(Inaudible) crystal ball.
Steven C. Voorhees
Yeah.
Chip Dillon – Vertical Research Partners
Okay, great. Well thank you.
Operator
Thank you. Our next question or comment comes from Mark Connelly from CLSA.
Your line is open.
Mark Connelly – CLSA
Thanks. Just two questions.
Jim, you know, we've certainly seen some examples of other container board producers successfully shifting an entire system to higher quartiles. I'm just curious if you can give us very broadly the way you’re thinking about how you’re going to approach that, maybe some sort of a rough split between your operational changes, new investment product mix, the big buckets just to get a sense of the strategy?
James A. Rubright
Yeah. I think in the near term, we got 100 million in improvements that come right off capital.
I think that we've got that much that we could achieve over a 24-month period with operational improvements. We have a couple of examples of mills that where we had general manager changes relatively early in (inaudible) as opposed to later where they’ve had a chance to get their team in place and then really starting down the road of operational excellence and based on those mills and the performance enhancements they've been able to achieve, I really think there's 100 million in performance improvement.
I don't think that 200 million is the end of the game in terms of moving these mills to the web nor does it necessarily put a boundary on what we may be able to possibly achieve in the next 2.5 years with even better targeted investments. Mark, if you go back, we've all heard the story, but basically in 2006, 2007, Smurfit figured it had the money to fix one of its mill system or its Box Plant system and it fixed the Box Plant system and literally took 300 million of costs out with about 450 million of capital.
They did not do it on the mill side so essentially you have a mill system that did not really modernize itself over relatively long period of time nor was it very successful with what I would refer to as continuous improvement or best practices. So the opportunities they are really pretty significant.
But I think of the 200 million that's a component of the 400 million of the performance improvement that I've indicated is about half capital and half performance improvement and the upside would, I think, could come from either, but our ability to derive improvements off of capital are limited to a certain extent by just the physical ability of the people we have in place to execute capital projects. We're trying to build that infrastructure back, and we will do so, but we're starting with some limitations from that standpoint.
Mark Connelly – CLSA
Sure. That makes a lot of sense and just one question for Steve.
It certainly does look like you've got your financial house in very good order. Are you likely to sit like this for a while or you antsy to get into the capital market to start rearranging debt maturities?
Steven C. Voorhees
We look at that (inaudible) I think for the next opportunity that we have is the 2016 notes we have coverable in March.
Mark Connelly – CLSA
Right.
Steven C. Voorhees
And I think right now based on the economics that would be called, I think, absent that, we're looking at the capital markets and I think you know that we've had a lot of floating rate debt over time, and that's been a good spot for us to be. We're about 80% floating rate.
I think you saw the treasury come down and we'll continue to look at that and make the best judgment that we can.
Mark Connelly – CLSA
Okay. Super, thank you.
James A. Rubright
Thank you, Mark.
Operator
Thank you. Our next question or comment comes from Steve Chercover from D.
A. Davidson.
Your line is open.
James A. Rubright
Hi, Steve
Steven C. Voorhees
Hi, Steve
Steven Chercover – D. A. Davidson
Good morning. First question just to simplistic, which I am.
Could we infer that the accretion from Smurfit, the $0.23 in one month, that like $0.70 going forward without any other incremental synergies?
James A. Rubright
That's what we did. We just owned new assets we ran them and operated and normal operating conditions.
That was the contribution earnings.
Steven Chercover – D. A. Davidson
Very good and my second question is, in your presentation back in January when you discussed the Smurfit deal, Solvay was virtually the lowest cost mill on the cost curve, and it's crept towards the middle is that simply due to OCC?
James A. Rubright
Recycled fiber costs.
Steven C. Voorhees
Yes, exactly.
Steven Chercover – D. A. Davidson
Is there anything you can do to mitigate that because I mean it is still in a very good fiber basket so?
James A. Rubright
It is in terms of accessibility to fiber but actual that market index has moved up the New England and buffalo indexes have moved up relative to Chicago to a position where that's actually a premium for sellers of recycled fiber. The mill still is a great asset if you live in the middle of the cost curve in what is currently a pretty high recycled fiber environment you'll find.
I think that the opportunities probably reduce the freight circle from the mill and increase the internalization and may be the optimization of great mix and so forth from the acquisition will be there because we've got a large Box Plant footprint in the Northeast and Mid-Atlantic from the Smurfit acquisition. But it is going to limited by its position on the recycle fiber curve.
Steven Chercover – D. A. Davidson
Do you fear that the new mill because scared is going to build in buffalo is going, exacerbate that problem?
James A. Rubright
It's a big fiber basket and I don't know what strategy they're going take to fiber the mill so I don't really know the impact would I rather you not put another 400,000 tons in our marketplace, yes, but I don’t – I think it's manageable.
Steven Chercover – D. A. Davidson
Got it. I guess ultimately this just indicates the strategy of growing virgin.
Thank you very much.
Operator
Thank you. Our next question or comment comes from Mark Weintraub from Buckingham Research.
Your line is open. Mark, your line is open.
Mark Weintraub – Buckingham Research
Can you hear me?
James A. Rubright
We can, good morning, Mark.
Mark Weintraub – Buckingham Research
Okay good morning sorry about that. Just to clarify, the $0.60 in earnings that you reported that you know that you had made in June.
Is that using a 55 million or 70 million shares in that calculation?
Steven C. Voorhees
It's 70.
Mark Weintraub – Buckingham Research
That is using 70 million?
Steven C. Voorhees
It's actually 71.6.
Mark Weintraub – Buckingham Research
Okay. Wow.
Okay. That's a lot of money in June.
And then could you give us a sense in terms of the synergies that you think you may have achieved in June itself? I know you indicated the run rate at the end was 75, 80.
Was maybe a third or half of that in June or some ballpark?
Steven C. Voorhees
No, most of the corporate synergies occurred on the date of the transaction, so the 28 million we probably had. I would say with respect to the administrative savings which were the last one I referred to, you might have had, a fair amount of that in the June month, but there's a lot of noise with respect to the rest, I don't think you had any.
Mark Weintraub – Buckingham Research
Okay. And now historically, you used to provide earnings and cash flow guidance.
Is that something that you're likely to revisit and this is kind of an exceptional period given having just acquired the Smurfit assets or going forward given that you got a lot more potential volatility in earnings stream is it something you're going to shy away from?
James A. Rubright
Well with respect to earnings, I've been here 12 years. And I think I stopped that as soon as I figured out what a bad idea it was.
And that wasn’t very long into my tenure, with respect to cash flow guidance; we did give cash flow guidance for a longer term view. It was, you know in the $650 million to $700 million range, which was a state-wide number for 2014, 2015.
We're not changing that expectation. I think the cash flow generation ability this enterprise even at a higher cost environment is equal to that.
But in the near term, we haven't decided either to update or to reconfirm more than I've just indicated what those numbers are. Given the impact on our business of price and input cost volatility we think it's better to give you the components of our cost structure and what we think we can do from an operating performance standpoint and then let you come up with a forecast for cash flow generation in the out years.
Mark Weintraub – Buckingham Research
Fair enough. (Inaudible) So that 600, 700, I assume that's just the Rock-Tenn legacy business and now we have this Smurfit-Stone on top of that, is that correct?
And you are just not at this point providing any thought process on the Smurfit-Stone led us to that?
James A. Rubright
Well the 650, 700 million was in annual basis of free cash flow for the enterprise. I think we had guided it at 2014 or 2015 when we had the synergies in place.
Mark Weintraub – Buckingham Research
Okay.
James A. Rubright
Rock-Tenn's legacy EBITDA was $550 million in that baseline of $1.350 billion that we use for purpose and modeling the acquisitions the step free cash flow number was the combined enterprise after the pension contributions that Steve indicated.
Mark Weintraub – Buckingham Research
Okay, so the 650, 700 EBITDA minus pension contributions minus capital.
James A. Rubright
It's after everything.
Mark Weintraub – Buckingham Research
Okay, okay, okay. Fair enough.
And so just maybe to flush out just 2012, 480 million in capital, I think 2014 you suggested you'd be trending down to the 350?
Unidentified Company Representative
We are going to be somewhere in between 2014 and beyond, I'm saying it’s 350 is sort of the sustaining and cost improvement capital that you'd expect. 2013 we simply believe that'll be somewhere in between but we're far too early days in our planning to be much more precise than that.
Mark Weintraub – Buckingham Research
Okay. Thanks very much.
Operator
Thank you. Our next question or comment comes from Bill Hoffman from RBC Capital Markets.
Your line is open.
Bill Hoffman – RBC Capital Markets
Hi, yeah, good morning.
Unidentified Company Representative
Good morning.
Bill Hoffman – RBC Capital Markets
I wonder if you can talk about, you mentioned keeping the system full here with exports in the last quarter. I just want to get a sense of what percentage of corrugated business was in the export market and then second question is just want to focus little bit on the consumer business obviously huge opportunities here on corrugated.
But I just want to get a sense of trends that you're seeing in the consumer side as well as the merchandising business?
James A. Rubright
Let me answer the first part of your question then ask you to reask the second part. Our export volumes in the relatively short period of time that we had the assets was about 10% of total production, and it was up about 9% over the prior year period.
So we're seeing good export demand and favorable pricing. And that's the answer to that question.
If you don't mind, ask the second half of your question because I was distracted.
Bill Hoffman – RBC Capital Markets
That's fine. Just in the consumer business, you talked a little bit about trends in corrugated being decent in June coming into July.
I just wanted to see if you're seeing any shift in trends in your consumer side of your business?
Steven C. Voorhees
Consumers has basically been perplexing for us because if you look at the industry data, it suggests that folding carton volumes continue to be weak and down across the industry, yet our folding carton volumes are up. We know what ours are, and we have extremely strong demand for coated recyclable Paperboard, and we sell half of that, half of our production to other converters and consume half of it ourselves.
So there's a disconnect between our experience and what we're seeing, including demand for underlying Paperboard and industry volume trends. So I'm a little perplexed.
We feel like we're in a good business but the industry data would suggest that the business isn't as good as our experience.
Bill Hoffman – RBC Capital Markets
You think it's specific end market customers that you've got versus the broader market?
Unidentified Company Representative
I don't know.
Bill Hoffman – RBC Capital Markets
Okay. Thanks.
And I guess just final question in this recycling business, obviously a tiny business for you, but is that something you want to keep for the longer term? Is it something you might want to monetize at some point?
Unidentified Company Representative
as plant
Bill Hoffman – RBC Capital Markets
Great. Thank you.
Operator
Thank you. Our next question or comment comes from Joshua Zaret from Longbow Research.
Your line is open.
Joshua Zaret – Longbow Research
Thank you and good morning. First question; your current OCC exposure is bout 45%.
You talked about some projects where you’ll lower that exposure. What's your ultimate target for the OCC versus virgin mix?
James A. Rubright
I really don't have a target. I think we're talking about a shift of a couple hundred thousand tons and increased productivity of virgin right now.
Those are things that we see the ability to do. I think as we move through beyond 2012 capital expenditures, into 2013 I'll have a much better idea of what we can achieve.
But that's what we're doing in the short-term.
Joshua Zaret – Longbow Research
Okay. Two more questions.
Next, you talked about throwing some capital at certain mills, you named some mills, I’m just wondering if Jacksonville is targeted in this capital program.
James A. Rubright
We have two mills in Jacksonville, the Seminole mill.
Joshua Zaret – Longbow Research
The Seminole mill, specifically.
James A. Rubright
And Fernandina Beach, you said the Seminole.
Joshua Zaret – Longbow Research
Yeah, the Seminole mill.
James A. Rubright
Yeah, Seminole's are fine mill. We've got 220 inch recycle machines there.
Clearly fiberring mills was a Rock-Tenn specialty recycled mills was in Smurfit. So initially I think we have the opportunity for performance improvement there that doesn’t require a great deal of capital and the mill indeed I don’t think does require a lot of capital, but it's certainly in our long-term plans.
Joshua Zaret – Longbow Research
Okay. So it is in your long-term plans?
Okay. Thank you.
And then finally, surprised someone ask this, but can we talk about OCC trends? Obviously, the price jumped maybe $15 a ton nationwide in July in a feeding frenzy?
When we look at August, what are you seeing as a frenzy sort of diminished in anyway?
James A. Rubright
Well, yes. For starters the export price are down a few dollars.
We really see demand sort of stable to weakening in August. It's hard for us to really forecast beyond what we see.
But it's not heating up. Jim Porter's in China as we speak to me with a number of export customers there and surveying that market.
And we understand that China is actually curtailing a lot of economic activity and we think that a number of the, what they don't call it coated recycle paperboard, but they’ve got large production there, a number of those mills are going to be down. And I think that may moderate somewhat Chinese demand, but the long-term trends we think are for very strong demand and therefore pricing for US recycled fiber particularly OCC.
Joshua Zaret – Longbow Research
Okay. So if I were to say to you for August that I thought that the nationwide average would be up $5 to $10 in that range, do you think that's accurate.
James A. Rubright
It's not what we're seeing in the marketplace right now.
Joshua Zaret – Longbow Research
You're seeing more or less?
James A. Rubright
Less.
Joshua Zaret – Longbow Research
Less? Oh, great.
James A. Rubright
We're not seeing August up.
Joshua Zaret – Longbow Research
Okay. Great.
I'm very surprised to hear. Some of your competitors are just, you know, are seeing the opposite.
So that's great to hear. Thank you.
Operator
Thank you. Our next question or comment comes from Joe Stivaletti from Goldman Sachs.
Your line is open.
Joseph Stivaletti – Goldman Sachs
I just had two small questions. One was, have you announced the plans for your bond maturity, the bond that matures this August, this month?
James A. Rubright
We're simply going to repay it from available cash.
Joseph Stivaletti – Goldman Sachs
Okay. And then you walked through a number of cash flow items.
I just wanted to understand, though, away from the capital spending part of, I was wondering what your spending is expected to be in 2012 for the realization of synergies and performance improvements? You might have stated it, but I just wanted to clarify.
James A. Rubright
We haven't really broken it out. As I said there is $265 million of base-sustaining capital.
And there is a fair amount of performance improvement capital in that and then a lot of just maintenance capital, and then the other specific items, I think you could all identify either to a synergy item as we indicated whether it's synergy or IT systems. They combine to be about $70 million, and then $45 million was really simply replacement of material handling stock that was leased.
Joseph Stivaletti – Goldman Sachs
But in terms of spending on an ongoing basis it's not CapEx related to achieve synergies and whatnot, is that…
James A. Rubright
Yeah, I think we gave the number and it was $101 million, $135 million, and the timing of that, Steve, over the next two years, do we have a better view of when we're going to spend that or is it not…
Steven C. Voorhees
We don't have a view to communicate right now.
Joseph Stivaletti – Goldman Sachs
So a 100 away from the CapEx that you outlined in a lot of detail, you at least spending roughly $135 million over the next two years?
James A. Rubright
In cash restructuring cost, right.
Joseph Stivaletti – Goldman Sachs
Okay. That's great.
Thank you.
Operator
Thank you. Our next question or comment comes from Chip Dillon from Vertical Research Partners.
Your line is open.
Chip Dillon – Vertical Research Partners
Yes. Thanks.
Two quick follow-ups. The first one is, when you look at the Hopewell and Hodge projects, do you have other similar opportunities in your system that you could choose to do in later years?
James A. Rubright
Well, we do, but we haven't ground through really the economics of all the opportunity or, you know, done the higher level engineering that work to be able to prioritize them? But, can we increase the virgin mix of the mill system, yes, can we materially reduce this cost structure and increase its productivity, yes.
Chip Dillon – Vertical Research Partners
And I guess the reason you're doing these two mills now is that either someone else had done the engineering or was it just so obvious that as you came in that those were the, that was the low-hanging fruit?
James A. Rubright
When we came to the table, Smurfit had a plan to improve the profitability of its mill system. We modified that plan somewhat, but the notion of doing work at Hodge and Hopewell was a part of that plan.
I can't recall sufficiently the details of their plan versus what we ultimately were executing that, know the extent to which we modified it, but there have been some modifications.
Chip Dillon – Vertical Research Partners
Okay. One last quick one.
I know back in late '05, Smurfit-Stone announced a very major box fit upgrade. It supposedly ended just before they filed.
As you'd gotten in there, it seems like maybe they did make some progress because all we've heard, you know is the fact that you’ve shut down four plants and my guess is you really don't have any obvious further closures, you know, subject to what the market does. So have you found their system to be, you know, a pleasant surprise or about what you expected?
James A. Rubright
Well, let's go back, because I don't want to necessarily be seemed to have agreed with everything that you said. In connection with the announcement of the transaction, we said that the legacy Rock-Tenn box plant system could absorb ten at least average sized Smurfit Box Plants and an average size Smurfit Box Plant across their entire system is about 650 million square feet per year.
So, we also said when these announced foreclosures that these four didn't logically line up with Rock-Tenn plants as the ultimate absorbers of that production or the majority of that production. I'll leave that there.
Now, with respect to the Smurfit system itself, I have been to a number of plants, but not nearly enough to have personally in assessment of the overall asset quality, but other members of our team have. I think that they have a number of examples of just what we want to do across the entire system.
Our legacy Rock-Tenn Box Plant system which obviously we had the lowest cost in the industry, because we had by far the highest margins I mean, the legacy Rock-Tenn EBITDA margins were 20%. You know with Solvay in the middle of the cost curve, so we’ve got very little box plant cost and yet our average production is about 1.1 billion to 1.2 billion square feet in the course of the year.
I’ve visited several Smurfit plants that are over two. One plant we're investing some capital and to take it to 3 billion square feet.
So we have plants that have really massive production capabilities and with that extremely efficient and low-cost systems. Now that’s obviously not the case across the entire system.
The other place I was very pleased were the quality and location of the display plants which fit very well with our plants. Now, there are a number of small Smurfit plants including those in Canada, which is resulted their geography are very nicely positioned in secure markets where they have the opportunity to make a lot of money.
And then you have plants that are really not as well sighted and not as productive. So we’re going to continue to work on the system.
Frankly, I think Smurfit had done a lot, but clearly, we think there are examples out there of what we like the system to be and the opportunities to make it a much more profitable system exist. Part of the capital that we’ve got in that 265 million continues to improve the productive capabilities of the plants and upgrade the box plant system as well.
It's not outside of our focus or outside the anticipated improvements we believe we can make.
Chip Dillon – Vertical Research Partners
That's terrific. Thank you.
Operator
Thank you. Our next question or comment comes from Mark Wilde from Deutsche Bank.
Your line is open.
Mark Wilde – Deutsche Bank
Yeah. Jim, just a follow up on that.
Can you talk about sort of in the first two months differences you've seen between sort of Smurfit's converting business and their customer mix versus what you had in Rock-Tenn?
James A. Rubright
I think the businesses from a customer standpoint are quite similar. They have a number of national account customers that we believe would be very attractive long-term partners for us.
They have lots of local business as well, so I would say the similarities are greater than the differences in their overall mix of business with ours. As I responded to the gentleman before, I think their plant system is a very, let's say, desperate plant system, from very large plant severity to small plants with quite a few in between, but the geographic footprint to really provide opportunities in the market place for continued capital improvements and performance improvements.
Mark Wilde – Deutsche Bank
And what about sales incentives for guys who actually shoes on the street selling packaging? How do they vary between the two companies and what are you doing to bring them into harmony?
James A. Rubright
Well, today they don't vary at all. People are compensated on sales performance, which includes the profitability of the business that they sell.
Mark Wilde – Deutsche Bank
Okay, very good. Thanks.
Operator
Thank you. Our next question comes from Mark Weintraub from Buckingham Research.
Your line is open.
Mark Weintraub – Buckingham Research
Thank you. Just trying to get a sense of some of the puts and takes when we go to the third quarter.
As you had indicated that June, the run rate was $0.60. Is it fair to say that Smurfit system probably didn't take a lot of downtime in June.
I know they normally take quite a bit in April and May, not so much in June and also was Demopolis, was that downtime in April and/or May?
James A. Rubright
The Demopolis outage was in April and May, yes. so it didn't affect the month of June.
Smurfit did, in fact, take a significant amount of downtime in April and May, but as I mentioned and you may have missed this, in June, they took what was about an average amount of outage downtime relative to the annualized total amount of outage downtime. We did not take any economic downtime in the month of June, because it is a seasonally strong period and as I’d indicated we didn't anticipate that we would be taking any.
Over the course of the year, the seasonally weakest period of time is November, December, and January into early February. So that's really the time when one would be concerned about running flow and balancing the system requirements.
Outside of those months, the system should be tested if anything with respect to production.
Mark Weintraub – Buckingham Research
Okay. So is it fair to – if we take the June and times it by three and we have the buck 80, then you're going to have additional costs related to any inflationary pressures.
And that really should bate you the biggest differentiator from just taking the June and multiplying it by three. Is that a fair way to look at it?
James A. Rubright
Well, again, I don't want to comment specifically in that degree of specificity with respect to our forecasted earnings or cash flow. but what I would say as I try to go through in the beginning, there was no economic downtime in containerboard, coated recycle board, bleached paperboard, uncoated recycle board always has economic downtime, because the industry simply isn’t full nor are we, although we didn’t have significant amount there.
And then the converting plants were simply meeting the market demand. Although, I think with respect to our folding businesses, as I've indicated, we've been gaining share and with respect to the containerboard business, our volumes were down more than the FBA data which suggested.
And as I said, we’re continuing to really sort through the overall business portfolio of the acquired operations.
Mark Weintraub – Buckingham Research
Thank you.
Operator
Thank you. Our next question or comment comes from George Staphos from Merrill Lynch.
Your line is open.
George Staphos – Bank of America Merrill Lynch
Thanks. Hi, Jim one last question.
James A. Rubright
Sure George.
George Staphos – Bank of America Merrill Lynch
Smurfit at one point in time I talked about significant opportunities to optimize the grades they were making across their mills and machines and really tighten up relative to demand any one region go their Box Plants. Did you sense of this (inaudible) fairly large opportunity to reduce the number of grades and have the mills and the machines produce more akin to their sweet spot, and if so, how much of that is in your performance improvement target?
Thank you.
James A. Rubright
There are some issues in the Smurfit systems that are endemic and they are mainly related to inconsistent quality across the machines and its – that is the limit or more than simply the physical ability of the machines to produce the Ideal grades. So we have been working with the teams at the mills to understand that we're going eliminate all of the quality issues.
We're going make one consistent grade of quality across all of the machines and we're going back it with the capital that's necessary and they're going have to back it with the performance improvements that are necessary to do that, and yes it is baked into the performance improvement estimate of 100 million in savings. And it will eliminate one of the glaring issues with respect to that mill system.
But these are solvable problems they just aren't going to happen overnight.
George Staphos – Bank of America Merrill Lynch
Okay. Thanks again.
Good luck in the quarter.
James A. Rubright
Thank you.
Operator
Thank you and I'm currently showing no further questions. I'd like to turn it back over to our speakers for closing comments.
James A. Rubright
We have no further comments. Thank you very much, all, for joining the call.
We look forward to the opportunities ahead of us.
Operator
That concludes today's conference call. Thank you for your participation.
You may disconnect at this time.