Mark W. Kowlzan - Packaging Corp. of America Thomas A. Hassfurther - Packaging Corp. of America Robert P. Mundy - Packaging Corp. of America.

Chip Dillon - Vertical Research Partners LLC Mark Connelly - Stephens, Inc. Mark William Wilde - BMO Capital Markets (United States) George Leon Staphos - Bank of America Merrill Lynch Debbie A. Jones - Deutsche Bank Securities, Inc. Mark Weintraub - The Buckingham Research Group, Inc. Adam Jesse Josephson - KeyBanc Capital Markets, Inc. Scott L.

Gaffner - Barclays Capital, Inc. Steven Pierre Chercover - D.A. Davidson & Co. Brian Maguire - Goldman Sachs & Co. LLC Gail Glazerman - Roe Equity Research LLC Anthony Pettinari - Citigroup Global Markets, Inc..

Thank you for joining Packaging Corporation of America's Second Quarter 2018 Earning Results Conference Call. Your host today will be Mark Kowlzan, Chief Executive Officer of PCA. Upon conclusion of his narrative, there will be a Q&A session. I will now turn the conference call over to Mr. Kowlzan, and please proceed when you are ready..

Good morning and thank you for participating in Packaging Corporation of America's second quarter 2018 earnings release conference call. I'm Mark Kowlzan, Chairman and CEO of PCA. And with me on the call today is Tom Hassfurther, Executive Vice President, who runs our Packaging business; and Bob Mundy, our Chief Financial Officer.

I'll begin the call with an overview of our second quarter results and then turn the call over to Tom and Bob, who will provide more details. I'll then wrap things up and then we'll be glad to take questions. Yesterday, we reported second quarter net income of $187 million or $1.97 per share.

Second quarter net income included special items expenses of $0.11 per share primarily for certain costs related to discontinuing paper operations associated with previously announced conversion of the No. 3 machine at the Wallula, Washington mill over to linerboard.

Excluding these special items, second quarter 2018 net income was $197 million or $2.08 per share compared to the second quarter 2017 net income of $144 million or $1.52 per share. Second quarter net sales were $1.8 billion in 2018 and $1.6 billion in 2017.

Total company EBITDA for the second quarter excluding special items was $382 million in 2018 and $328 million in 2017.

Excluding the special items, second quarter 2018 earnings per share of $2.08 was $0.56 per share above the second quarter 2017, driven primarily by higher prices and mix of $0.47 and volumes $0.26 in our Packaging segment, higher prices and mix in our Paper segment of $0.05, lower fiber costs $0.07, which was a combination of improved fiber usage and lower OCC prices, and a favorable tax rate of $0.16, primarily resulting from Tax Reform changes.

These items were partially offset by higher operating costs totaling $0.24 per share and converting costs $0.02, primarily due to the inflation-related increases with labor and benefits costs, repair and material costs, environmental and other professional services, equipment and building rental costs, et cetera, as well as the addition of converting costs related to our Sacramento Container acquisition.

We also had higher freight expense of $0.09, costs related to the Wallula No. 3 machine, conversion of $0.04, higher annual outage expenses of $0.01, as well as higher depreciation $0.02, and other costs $0.03.

Our results were $0.12 per share above the second quarter guidance primarily due to higher prices and mix and higher volumes in our Packaging and Paper segments, and lower mill operating costs.

Looking at the Packaging business, EBITDA excluding special items in the second quarter 2018 of $363 million with sales of $1.5 billion resulted in a margin of 24.2% versus last year's EBITDA of $305 million and sales of $1.3 billion or a 23.3% margin.

We continued to run our containerboard mills all out in order to keep up with the demand and they performed extremely well during the quarter. We successfully executed scheduled maintenance outages at two of our mills, and the first phase of conversion work on the No.

3 machine at the Wallula mill to a high-performance 100% virgin kraft linerboard machine was executed extremely well both from a ramp-up curve perspective, as well as operating costs perspective. These outstanding efforts allowed us to achieve all-time record containerboard shipments and supply all-time record box shipments.

We ended the quarter with containerboard inventories about 8,000 tons above the first quarter 2018 levels and almost 54,000 tons above the second quarter of 2017, primarily due to the addition of inventory needs of the Sacramento Container acquisition and the need to build inventory in certain regions of the country in order to help mitigate the higher freight and logistics issues that we continue to face.

And now, I'm going to turn it over to Tom, who will provide more details on containerboard sales and corrugating business..

Thanks, Mark. Overall, corrugated products and containerboard demand remained very strong during the quarter. As Mark indicated, in corrugated products, we achieved all-time record for quarterly box shipments which were higher in total by 8.3%, with one additional workday or 6.6% per workday compared to the second quarter of 2017.

Continued strong demand in both our domestic and export markets improved our outside sales volume of containerboard by over 21,000 tons versus last year's second quarter. Outside volume was over 11,000 tons below the first quarter of 2018 in order to help supply record shipments from our internal plants.

Domestic containerboard and corrugated products prices and mix together were $0.38 per share above the second quarter of 2017 and up $0.19 per share compared to the first quarter of 2018.

The realization from our announced price increases was greater in this year's second quarter compared to last year, as the key containerboard price index, which many contractors tie to, occurred one month earlier than last year and our implementation was executed faster than last year as well.

Export containerboard prices were up $0.09 per share compared to the second quarter of 2017 and up $0.02 per share compared to the first quarter of 2018. I'll now turn it back to Mark..

Thanks, Tom. Looking at the Paper segment, EBITDA excluding special items in the second quarter was $38 million, with sales of $251 million or 15% margin, compared to the second quarter 2017 EBITDA of $41 million and sales of $254 million or 16% margin.

Our announced price increases were realized quicker than anticipated during the quarter and volume for our cut-size and printing and converting products remained strong. The decline in EBITDA and margin versus last year was due to the low results in our pressure sensitive business at the Wallula mill.

Additionally, inflation on input costs and operating costs as well as higher freight and logistics expenses negatively impacted EBITDA during the quarter. Excluding the results of Wallula's pressure sensitive business that we're phasing out of, our ongoing Paper business EBITDA margin was 17% for the quarter. I'm now going to turn it over to Bob..

Thanks, Mark. The primary uses of cash during the quarter included capital expenditures of $166 million, common stock dividends totaling $59 million, interest payments of $39 million, and $12 million for state income tax payments. We ended the quarter with $200 million of cash on hand.

There are no changes to our 2018 estimate range for our combined federal and state cash tax rate of 15% to 16% and our book effective tax rate of 24% to 26%.

However, versus the guidance we provided back in January, our planned annual maintenance outage costs will be higher by $0.02 per share in the third quarter and lower by $0.01 per share in the fourth quarter. The full year total will now be $0.01 higher, totaling $0.61 per share for 2018.

In addition, we have updated our full year 2018 estimate for capital spending to a range between $530 million to $550 million compared to the $440 million to $460 million we provided you earlier this year.

The increase is attributable to addressing profitable growth and mix enhancement opportunities at several of our box plants, the large plant expansions going on in the Wisconsin, Pennsylvania and Virginia regions that we've mentioned previously, as well as a few high return, quick payback projects in a couple of our containerboard mills related to fiber and energy.

These projects along with our recent 25% dividend increase fit in very well with our expected cash flow and our balanced approach towards cash allocation in order to profitably grow our company, maximize returns to our shareholders, while still maintaining the financial flexibility to act upon accretive M&A opportunities and adhere to our conservative balance sheet approach as we have in the past.

I'll now turn it back to Mark..

Thank you, Bob. Looking ahead as we move from the second into the third quarter, we anticipate continued strong demand in our Packaging segment. However, corrugated product shipments will have one less shipping day during this quarter.

As Tom mentioned, although the majority of our previously announced price increases were recognized in the second quarter, we expect to implement most of the remaining portion during this third quarter. In the Paper segment, we expect to complete the implementation of our previously announced paper price increase.

However, volumes which are currently on allocation should be lower than normal during the seasonally stronger period as we manage our already tight inventory levels around the scheduled outage at our Jackson mill. Finally, we should have improved operating costs related to the No.

3 machine at our Wallula mill, as the ramp-up curve from the first phase of the conversion is now behind us. We expect continued inflation in most of our operating costs including slightly higher recycled fiber prices and incremental wage pressure with a tighter labor market.

As Bob mentioned, our scheduled maintenance outage costs will be $0.02 per share higher than the original third quarter guidance. And we anticipate freight and logistics expenses, as well as slightly higher tax rates. Considering these items, we expect a third quarter earnings of $2.14 per share.

With that, we'd be happy to entertain any questions, but I must remind you that some of the statements we've made on the call constituted forward-looking statements.

These statements are based on current estimates, expectations and projections of the company and involve inherent risks and uncertainties, including the direction of the economy and those identified as risk factors on our Annual Report on Form 10-K on file with the SEC.

Actual results could differ materially from those expressed in these forward-looking statements.

With that, Heidi, could you open up the call for questions, please?.

Certainly. And your first question comes from the line of Chip Dillon with Vertical Research Partners. Please go ahead..

Yes, hi. Good morning, Mark, Bob and Tom.

First question has to do with, you mentioned some very strong – relative to what – I think you sell pricing benefits in the export markets and if you could give us an idea of how many tons you generally sell there, and do you think some of the issues in China with their shortage of OCC, shortage of board is putting out a very strong bid for export prices for pretty much anything that can be sold?.

Yeah.

Tom, why don't you go ahead and talk about that one?.

Chip, we don't go into great detail about what our exact sales are on the export market. But I will say that the market has remained strong as you can see indicated by our sales. The pricing has still remained very solid, and I see that continuing. Relative to China, I mean, you get back to the same thing. They've got to get fiber into their market.

We've got the whole OCC thing that's going on and nobody can predict really what the future holds other than we know one thing, they're going to have to have fiber. So, that's probably going to pool from different areas and different regions of the world. And so, I think that the global market still should remain very good..

Yeah. Chip, just keep in mind, over the years, the amount of tons we've moved offshore probably been in the range of 8% to 10% of our total production year-to-year, and that hasn't changed that dramatically.

We continue to take advantage of the legacy customer relationships we've got around the globe, we probably sell them to about 36 countries still throughout the world. So, that's pretty consistent..

Got it. That's very helpful.

And looking at your current footprint and I know things can change, you mentioned the almost $100 million increase in CapEx, is any of that maybe timing-wise attributable to the tax incentives we have where, I guess, you get the full write-off? And maybe directionally, getting back to the first part of the question, when you look at your current footprint, do you think directionally we would see the numbers stay in the same area? In other words, are there opportunities like these to the same magnitude next year or do you think it might back off a little bit, again, assuming no major change in your footprint?.

So, first part of the question, the fact that taxes are lower certainly helps us. But the bigger factor is that we've got tremendous opportunity especially on the converting side of the business and that we're aggressively going after on the corrugated side.

We've recognized these opportunities, we've got the demand, and so we're taking advantage of that demand and opportunity and the improved tax position..

Next year..

And then, so for next year, if you think about a lot of the capital this year went into DeRidder activity and Wallula mill activity. Theoretically, we don't have as much – because it's a conversion cost, those are big one-offs. So, those shouldn't be there unless obviously something came along in the future.

But the spending level will remain higher on the corrugated product side to take advantage of the demand. We should see the mill side coming down accordingly because of the big projects won this year.

Tom, do you want to add to that?.

Yeah. I would just add that one thing hasn't changed at all in the way we do business and that is we don't just invest the capital in the hopes to get the business, we do it based on what our customers tell us and what the demands they have and what our opportunities are that are already in place. So, this isn't a build it and they will come.

So, I think when you look at the future, Chip, you say what kind of opportunities do we have in the future, I would expect we'll continue to have these kind of opportunities because they are customer growth..

Understood. Thank you..

Next question please..

Yes. Your next question comes from the line of Mark Connelly with Stephens. Please go ahead..

Good morning, Mark..

Thank you. I'm hoping you could give us a little more insight into the Wallula ramp versus your expectations, what still to come and what happens before the engineers turn onto the next thing. And you've said that that tonnage already has a home.

As that adjustment takes place from purchased tons to internal ton, are we going to be able to see that, or is that going to get caught up in this cost inflation?.

The first part, talking about the ramp-up, we are extremely pleased with our machine started up. We are essentially a few days ahead of schedule. Machine was selling very good quality product within a few hours of startup.

The performance of the machine, if you think about the terms that I talk about quite frequently, and that's about time and efficiency on a paper machine, the Wallula No. 3 machine quickly became the – I believe it was the second best running machine in the company in the month of June with extremely high efficiency performance.

Quality has been great, but again we are limited in productivity because we don't have the new press section and headbox. And so, we'll wait for that in October, we're running – on a daily run rate basis, we're running about where we expected to on tons. We don't disclose that.

But we're probably somewhere around 60% of the total estimated machine design. But the great thing is we took all of the learnings from DeRidder and I mentioned this on a lot of the prior calls.

We took three-and-a-half years' worth of learnings at DeRidder and compressed that into this outage this past May and went ahead with everything all at one time essentially and we'll finish that in October. So, so far, we're extremely pleased.

And then to the other part of your question, for the first half of the year, we purchased outside tons, about 192,000 tons, 195,000 tons, somewhere in that area give or take a few thousand tons. Those tons for the remaining portion of the year – we will bring the purchased tonnage rate down. We're taking advantage of the productivity out of Wallula.

And as we said, we have a home for those tons. Those tons will take the place of some of the purchased tons. And so, we'll definitely take advantage of the Wallula production..

Just one last question.

Once Wallula is fully up and running, what do you think your overall net short position in the company is going to be?.

We're going to probably stay in this range of 200,000 tons of outside purchases right now and that depend – I mean, if you assume that demand remains strong and trending in what we've seen, it is in our best interest to continue buying some of these outside tons because of the transportation benefits we see from the regions we buy within..

Makes sense. Thank you, Mark..

All right. Next call..

Your next question comes from the line of Mark Wilde with BMO Capital Markets. Please go ahead..

Good morning, Mark. Good morning, Tom..

Hey, Mark..

Mark, if we just take a step further back on this China issue, do you have any thoughts on the prospective changes in the way China sources fiber for paperboard packaging and what the implications may be for the North American industry and for PCA over the next 5 or 10 years?.

Yeah. Mark, everything is so dynamic in that regard. The news we see every week, I think, is quite interesting coming out of China.

We could think about it in the last 20, 25 years on containerboards trying to build about 50 million ton system, what that says is they have to get fiber from somewhere, what that fiber source is, if they're going to run that system. So, I really don't have a good answer.

It's pure speculation on my part and I'd rather not get into a speculative discussion with you. But to your point, they have to get fiber, if they are going to run their containerboard system or buy linerboard from essentially the U.S. market to ship linerboard to supply their box needs.

Tom, do you want to add to that at all?.

Mark, I mean, it just depends on what you read and what you hear from other – what I'd say knowledgeable people. But, it looks like they may be trying to create more of a closed loop system like Europe has down the road where they're collecting their own recycled fiber that feeds back into the mills.

But, of course, as we all know, you got to have virgin to be able to have that system, which I think it would indicate that they're either going to – they got to get their virgin fiber somewhere and then it's primarily probably going to come from the U.S., and that may be reflective of some of the investments that some of the Chinese firms are making in the United States as well.

I think they're probably looking at the potential of exporting containerboard or pulp or whatever the case might be back into China. That also could revolve around tariff issues as well. Who knows? But that's the way we see it right now..

Yeah. Okay. The other question I had is just you've seen, Tom, to be growing the box business more rapidly than I can recall in the 20 or so years you've been a public company.

Can you give us some sense of where you think you're going to be at in terms of integration level by the end of 2019 with this incremental investment you're making in the box business and the high growth rates you've had?.

Well, let me answer it this way. I don't know what Tom comment. We continue to run – and we just define it as it's fully integrated. We're moving some containerboard tons outside domestic and export. We're buying some of those tons and net that out. But when you call 95% integrated or 99% or 100% or 102%, we're running fully integrated.

And I would expect that as time goes on, especially with the Wallula tons coming up by the end of the year, next year, we'll continue to be in that position, fully integrated. And that's a place we feel really comfortable. It's a good place for us to be. It gives us the ability to source our containerboard in ways that we find advantageous to us.

Especially within our own containerboard system, we're able to run it full health and take advantage of our own efficiencies. And so, I would expect that next year, we'll be talking along the same lines. Tom, do you want to....

Yeah. I'd just say, Mark, I mean, if you think about the prior comments that we've made around the fact that we don't add capacity just for the sake of adding capacity. I mean, we know we have the demand for that.

And we said that prior to the Wallula project, we said we were at 95% plus integration and that's exactly where we'll be when Wallula is fully ramped up. And I'd just add that one of the reasons we do the outside purchase is we don't make all the grades.

And so, it's more advantageous for us in some cases to buy those grades on the outside as opposed to try to make those grades internally..

Yeah. Okay. The one other thing, just related to these conversions, your cost per unit on the conversions seems to be quite a bit lower than some of the other projects we see out there.

Mark, do you have just sort of a couple of general thoughts on that?.

Well, every mill is unique, every mill has certain design characteristics, and I've said this for a number of years now. Any mill can be converted to make virtually any kind of paper product or board product. It's how much you're willing to pay. And obviously, people are willing to pay more and less in some cases.

We have to be very good at understanding how to apply minimum effective capital and get the most return for that dollar. A part of what we do and we've done this for decades is a somewhat of a phased approach. So, we go in with one or two phases at a minimum and make sure we don't overspend.

And then, when the first phase is done, it's easier to look at what opportunities did you leave on the table, and that's part of our engineering excellence and operating prowess. So, again, I think but it goes back to, every mill is unique and every mill has its strengths and weaknesses. So, that's pretty much it..

That's helpful. I'll turn it over. Thank you..

Next question, please..

Yes. The next question is from the line of George Staphos with Bank of America Merrill Lynch. Please go ahead..

Hi, everyone. Good morning. Thanks for all the details.

I wanted to start on the investments that you're making in converting, Tom and Mark, and recognizing you're not going to get into much detail on a live mic presentation, can you give us a little bit more detail in terms of what changes you see in end markets, how they're evolving over time, whether it's more growth in one versus another or changes within one, say like e-commerce, that may be framing the investments that you're making in Wisconsin or Pennsylvania? And any other color around those areas, that would be helpful to start..

George, this is Tom. I'll just give you a kind of a general answer to this. And then, if you really want to get into more specifics, I mean, you can follow up. But our investments in the converting area are around a couple of things. One is, I told you, it's based primarily on customer demand and what a customer wants.

But also, when we're making these investments, obviously, we're looking at the cost side of the equation as well. We're looking at better efficiencies. We're looking at lowering our labor costs, as an example, and more automation, those sorts of things. Those are really the primary drivers that we're looking at in terms of these investments.

The end markets that are evolving, I mean, I think what you're seeing right now is and we'll see the GDP number tomorrow, I believe, for the past quarter that it's projected to be up around 4%.

And in order to get those kind of GDP numbers, obviously, we've had – a lot of sectors have to be growing and a lot of things have to be happening in those sectors.

I think we're fortunate because we're aligned with so many thousands of customers and so many different businesses that we're already entrenched there and we're able to react quickly to whatever those changes are and what those demands are that are driven in those particular markets.

And then subsequently, we're making those capital investments around those particular needs that our customers have..

Okay. Thanks for the thoughts on that, Tom.

And then, going from bigger picture maybe to some more nut-and-bolt types of questions, and I'll turn it over, in terms of the variance and the change in EBITDA in Packaging, when I look at second quarter 2018 versus 2017 and looking at the year-on-year that occurred and the improvement in performance there, it works out to roughly about $58 a ton in the second quarter of this year versus $39 a ton in the second quarter of 2017.

And both of these quarters obviously had a price increase at the beginning of the quarter. Is all of that change and improvement explained by the timing difference in pricing or were there other factors at work? That's question number one.

The other question, when we think about third quarter of 2018 versus third quarter of 2017 and the sequential trends that you were seeing in inflation, overall, are you seeing more inflationary pick-ups this year versus last year? And if you could put some numbers or some source on that, that would be great. Thank you, guys. I'll turn it over..

Yeah. Let me start out with this and then Bob can add to this or Tom can add. So, to your first question, it's primarily timing. And then the second question, we called out in January and reminded everyone in April that factors such as energy, chemicals and freight were significant this year, and that's what we've seen.

And so, the logistics issues, not just the cost of rail or cost of truck, but again, just the availability and what that does to certain lanes and certain regions.

But, Bob or Tom, do you want to add supporting details?.

Yeah. I was going to say, yeah, freight, George, is one of the larger ones that Mark mentioned, in addition to some of the chemicals and whatnot.

But labor infringes (31:02) due to the tight labor markets, that's a big change compared to the same period last year, as well as just inflation on all those things that don't get talked about a lot like repairs and materials and supplies and all these outside services and contractors, people who are service providers to your company, they're having to pay more and they're charging you more.

So, all that is more than we've seen in prior periods, for sure..

Thank you very much. Good luck in the quarter, guys..

Thank you. Next question, please..

Thank you. Your next question comes from the line of (31:43) with Wells Fargo Securities. Please go ahead..

Good morning. Thank you for taking the question. The first one centers around the Wallula conversion and sort of looking at the task ahead of you in October.

Can you highlight for us maybe some of the key risks that you see with putting in the headbox and the press section? Is it more risky, less risky than what you've already done either operationally or from the cost side?.

that the vendor that has supplied you with this equipment has done a proper job in building this equipment to proper specifications, and then it comes down to us installing this in a precision manner and yet we've proven we're very good at that. So, I am saying that the risks are no different than what we've done over the years.

We just have to execute well and do it very efficiently. So, quite frankly, the work we just completed this spring was more complex and more demanding than what we have coming up in October. In October, we have discrete work going on. It's a headbox change-out. It's press section component change-out.

So, it's more concentrated with a smaller region compared to what we've just gone through this spring. So, again, I'm not worried about the risks..

Okay. Thank you.

And then, Tom, you normally try to give us a sense for how things are trending in the corrugated business thus far in the third quarter, could you do that for us?.

Yeah. Through 14 days of July, we're up 5.5%. July is an unusual month usually every year because it tends to be just a little bit slower. So, it's trending that way. It'll continue to ramp up through the month. So, we see demand still very strong.

And we had a little unusual Fourth of July in the middle of a week which really caused some changes with some of our customers, but again, that's why it'll continue to ramp up through the month. So, all in all, it's still very strong..

Thank you..

Next question, please..

From the line of Debbie Jones with Deutsche Bank. Please go ahead..

Hi. Good morning. I just wanted to ask about the commentary you had around inventory management related to your Jackson mill.

Is that a thing just related to the project there in the quarter or should we expect anything to move through into Q4? And could you just give us a sense of how material it is in the quarter for guidance?.

Let me answer the first part of that. Obviously, we've been running under an allocated mode in the Paper business. So, with the fact that you have a shutdown, we only have two mills in the Paper business. So, you're taking half of your Paper business down for its annual shutdown.

And so, where we are in allocations to many of our customers, we've already depleted inventories down to certain levels that we have just managed. And so, it's just a case of some – the business is strong. We have the scheduled outage and we will get through that. And so, fourth quarter, both mills will run.

If demand continues to run in the range it's been, you'll continue to be running in an allocated mode. And so, it's just – we'll update you in October where we are with inventories. But, certainly, the outage does change some of the metrics on what you're able to do or not do in terms of supporting customers.

So, we plan that for the year and that's how it works out..

Okay. Thank you. That's helpful. And my second question, thank you for the disclosure around the updated capital allocation or CapEx specifically. I'm just curious if we should read into this at all that the attractiveness, acquiring bolt-on acquisitions, specifically converting assets is something that's less desirable for you at this point.

Really, just looking at kind of multiples for converting assets currently or is there something else that we should read through from this?.

No, not at all, Debbie. If the opportunities come along and present themselves in terms of acquisition opportunities, we will fully take advantage of that. In the meantime, as Tom mentioned, we're fully taking advantage of growth with customer demand and taking advantage of that within the regions, or within certain plants.

And so, we're going to take advantage of both sides of that equation..

Okay. Thank you. I'll turn it over..

Next question, please..

Your next question is from the line of Mark Weintraub with Buckingham Research. Please go ahead..

Thank you. First, just on the corrugated pricing side, you had mentioned that it was better than normal, I believe, in terms of the way the increase is being put through.

Was that just an observation on the pace of which the price increase is being put through or does that also characterize the degree of pass-through you feel you're going to be able to get, and if there's any color you can provide as to whether or not you might get more than full forward pass-through into boxes at this juncture?.

Yeah. Mark, what you have to understand, demand has been obviously very strong. And the first part of your question was truly is a timing related factor that the index picked up with pricing, we're able to execute on that, and Tom's group did a great job executing on that.

Tom, do you want to add a little more to that?.

Yeah. I think, probably one of the best examples would be this in regards to timing. So, if you have contracts that go up on a quarterly basis and you have a price increase as we did this year in March, announced in March, you can capture that in the second quarter. Last year, price increase was represented in RISI in April.

Therefore, that catch-up wasn't until the third quarter. So, that's probably the best example – as an example of timing that you have, Mark. And relative to the rest of the price increase, we'll have to just talk about that at a future date, you'll see that in our earnings..

Okay.

But, when you had mentioned that the majority was recognized in the quarter, I assume that's a reference to by quarter end as opposed to the average price during the quarter, is that fair?.

That's fair..

And then, lastly, I guess, I'm just trying to understand the industry data, the last 12 months, and not your – your performance, I'd just say, very strong in the volume side, but the industry data has been a little bit softer the last couple of months even while – as you referenced GDP is very – is likely going to be coming in very strong.

Any thoughts as to what might be happening?.

It just depends on where you are and depends on the business. We see a lot of strength in some areas and we see a little more softness in other areas. We talk to a lot of our customers and talk about reducing inventories and doing other things like that, that can create some swings over a 30 or 60-day period.

If I look across there, almost 20,000 customers, I mean, I can tell you that for the most part, they're reporting strong demand. And you'll see some seasonal swings in terms of agriculture, some other things. I mean, the graphics business is seasonal.

So, if you just look in the last few months, I mean, they sometimes tend to be the softer months anyway in any given year..

Okay. Thank you..

All right. Next question, please..

Your next question is from the line of Adam Josephson with KeyBanc. Please go ahead..

Mark and Bob, good morning..

Good morning, Adam..

Good morning..

Just two questions, one back to the CapEx issue for one second.

Sorry to harp on this, but it sounds like your CapEx will be up about $200 million 2018 versus 2017, obviously, some of that's the Wallula conversion, and I think someone asked you this earlier, but could you give us some sense as to what you think a normalized number is or a maintenance number is such that we have some idea of the degree to which CapEx is likely to drop off in 2019 versus 2018?.

Well, again, talking about the discrete opportunities, if you think about the big buckets of capital, you had the DeRidder spend, you had the Wallula project spend, and then, you had some of the converting side, big projects, the new plant we're building up in Wisconsin, and then some of the big regional reconfiguration projects that are very discrete one-off type opportunities.

And then, as we go forward, you will normalize in terms of ratios of maintenance to profit enhancing capital opportunities. And so, over the long term, the ratio of maintenance CapEx to profit improvement should remain somewhere in the normal range at the same store.

But for the time being, while we got the demand, this will allow us to take advantage of this growth opportunity, we will apply capital and continue to do that.

Bob, do you want to add to that?.

Yeah.

I'll say, Adam, the delta you mentioned between 2017 and 2018 and your question around 2019, I'd say, because of the investments on the box plant side of the business with the mill side coming down from the DeRidder and Wallula spending this year, I'd say, the delta for 2018/2019 will be about half of what you saw for 2017 to 2018 right now would be a good ballpark..

Perfect. Thank you for that.

And then, just a housekeeping, just how much of the box and white paper price increases did you realize in Q2 and how much do you have remaining in 3Q or second half?.

We're not going to get into the specific on that. We've got obviously some contractual type activities and some of that kicked in on July 1. We'll have a little of that that kicks in later in the quarter. And then, the lion's share of it is in the quarter and just wrapping up a few odds and ends in terms of customers. And on the Paper, the same thing.

We've got the bulk of that was picked up in the second quarter. We got some contractual that kicked in as of July 1, and then we got a few others rolling in as we speak, so. But I'm not going to get into the details on that..

Thanks, Mark..

All right. Next question, please..

Your next question is from the line of Scott Gaffner with Barclays. Please go ahead..

Thanks. Good morning..

Good morning, Scott..

Hey, Mark. Just couple of quick questions on input costs. I mean, you mentioned higher recycled fiber going into 3Q versus 2Q.

Can you talk a little bit more detailed about that? And then also, what are you seeing around virgin fiber? Are you seeing increased inflationary rates on virgin fiber, or is it still sort of couple of percent a year inflationary pressure on virgin fiber?.

Yeah. Regarding recycled fiber, two components of that.

If you think about OCC that we use in containerboard side and then some of the sorted office waste – sorted office paper, sorted white ledger type product that we use in the paper mill side of the business, we have seen within regions, OCC has moved up, DLK and LCC (44:40) moved up in a few of the regions where there's very strong demand, sorted white ledger, and some of the recycled white grades have stayed up and moved up, so that continues to be on the high side.

Bob?.

Yeah. I would say, Scott, just relative to Wallula and then as we bring more of that capacity on and as we'd talk about when we announced that project, fiber in that part of the country is higher than it is for the company on average.

So, as that becomes more – we purchase more of that to supply Wallula, that would move up the average on the virgin fiber side of things relative to what you've seen in the past..

Within the legacy side of the business, we haven't seen much change. Again, it's typically weather-related phenomena within the regions and everything is pretty flat quarter-to-quarter, year-over-year right now..

Okay.

And when you look at this CapEx that you're spending, obviously, recycled fiber input costs coming down in total even if they're going to go back up in the second half of the year some, are you looking at potentially investing in some of your mills to up the capacity or the ability to take on some of this recycled or mixed waste paper as part of your production process?.

Not currently..

Okay. One last one for me.

Just around the increases in inventory, I mean, as you bring these new facilities up on line, like Wallula, is there some view to pulling inventories back down because you'll be in a better situation from a location perspective around freight cost?.

Well, theoretically, that's what you'd want to do and so we will continue to monitor the logistics, freight issues on a daily, weekly, monthly basis and see what we're capable of doing as Wallula comes on to full capability at the end of the year. But, theoretically, that's where we want to be..

Okay..

I'd just say one other thing, Scott, to your question about our mills and using recycled – it's about who we sell our products to, and all fibers are not equal.

That's why when you look at the capacity coming on, if it's recycled capacity versus virgin, it's a big difference because it serves different customers and we and the products that we sell are primarily virgin-based and that's a big difference because all fiber is not the same.

You can't just start running it through your mill system because the price is lower. You don't end up where you want to be from servicing the customers..

Understood. Thanks, Bob. Thanks, Mark..

Next question, please..

Your next question is from the line of Steve Chercover with D.A. Davidson. Please go ahead..

Good morning, everyone..

Good morning..

I kind of want to take the opposite tack of that thing on the inventory levels.

If freight is increasingly expensive and perhaps a bottleneck, does it make sense to hold more inventory at some of your box plants simply to reduce that cost?.

Well, again, from a real-time point of view, we will do whatever makes sense whether it's on a weekly, or monthly, or quarterly basis to understand how do we take advantage of the mill production capability and the box plant needs. And so, the fact that we have Wallula coming on now really helps us fill out our U.S.

regional requirements on how we have to supply these box plants. But it's something that you are monitoring, again, daily, weekly, monthly and we'll have a much better capability on how that works out. But, again, a lot of work. Everything depends on transportation availability and transportation cost. (48:42).

Next question, please..

Your next question comes from the line of Brian Maguire with Goldman Sachs. Please go ahead..

Hi. Good morning, guys. Thanks for taking the question..

Good morning..

I just wanted to ask on the Paper side of the business. It seems a little bit stronger than we were expecting in the quarter. You mentioned kind of being on allocation. I just wanted a few thoughts on pull forward and volumes ahead of some of the announced price increases.

And hoping you could also just comment on the – where those price increases stand at the moment, if you got any of it in the quarter or kind of how much you expect to get in 3Q..

Just on the first part of your question, we didn't see any pull forward. It's just that all year it's been a very robust, tight market for cut-size and converting grades, offset printing and the envelop-type grades. So, we're living through a very robust market. We're running full out. And so, it's that simple.

And regarding pricing, we're not going to comment on the pricing anymore than we already have in terms of what we captured in the second quarter and then a few remaining contractual obligations that are rolling to the third quarter.

Bob, do you want to add anything?.

No. I think that covers it..

And I just want to follow up on – just back to the $100 million of incremental CapEx, would it be reasonable to assume something around a 20% return that you'd be targeting on that investment and in what year or what kind of cadences realizing that should we expect?.

Well, again, we generally are more ambitious than 20%, and so I'm not going to qualify that except to say that the projects that we've identified are right in line with our historical return expectations. And so, we'll answer it that way..

Okay. Thanks very much..

All right. Next question, please..

Your next question comes from the line of Gail Glazerman with Roe Equity Research..

Good morning. Thank you. I just wanted to dig into demand a little bit further.

When you speak to your customers, are you hearing any concerns or any thoughts that they might adjust their business given all the trade issues that have been roiling for the last couple of months?.

Hi, Gail. This is Tom. We hear a little bit. I mean, obviously, they're concerned to some extent, but it hasn't impacted demand as of this point in time..

Okay. And then, when you look at uncoated freesheet and your own allocation, you kind of seem to expect that to continue for the foreseeable future.

I'm just wondering, any sense that customers are starting to look abroad again and that imports might start to creep up?.

Well, publications have called out that there's some incremental tonnage coming in for long shorts (51:55), nothing significant, but you would expect some of that. But, again, in total, the imports are a small percentage of the total demand in the United State, so..

All right. If I could just sneak in one last one, trade publications have talked about Chinese producers looking to process waste paper outside of China and then import it to China.

I'm just wondering if you have any perspective on whether that makes any sense cost-wise, like, whether there's – this is an area that you can see that would make sense to create recycled pulp sheets in Southeast Asia and then ship it to China..

Yeah. You got to talk to them. I mean, I'll be just offering speculation. I mean, they are the ones who are running their own models and trying to understand how they satisfy their own needs..

Okay. Thank you..

All right. Next question, please..

And we have a follow-up from Chip Dillon with Vertical Research. Please go ahead..

Yes. Hi. Thanks for taking my follow-up. Mark, this morning, we saw – Cascades has indicated they're going to convert a mill in Virginia. At least, from what I've heard folks like you and others in the industry say, it's simply that, if you can convert anything, you've said on the call, if you put the money into it.

What I'm asking is, it seems like the only announcements we've seen and it seems like seven of the top eight have either said they're not doing something like WestRock or – where they've actually made announcements for the next four years.

The only ones involving $100 million or more dollars, or real money, are the top eight integrated, or within that top eight integrated players. And question is, does the level of vertical integration in the industry make it just unwise to do a project without having a box plant system, or said – to say differently, if you decided to enter the U.S.

industry today, would you need to also build a whole network of box plants at least as you look at the economics?.

And again, looking at two parts of that question. Cascades is an integrated company. And so, they already have demand as you would expect an integrated company would have that that would seem to be the logic of why they would be looking at capacity.

And so, it's not as just somebody just thinking about building a mini mill and then trying to understand how they go to market. In this case, they're an integrated North American participant and that has converting capacity and converting demands.

Tom, do you want to answer the other part of that?.

Yeah. Chip, I would just say that my opinion is, is that you're absolutely correct when you say you have to have some sort of a level of vertical integration in order to take on a project like this. And of course, I mean, when you're talking about the level of integration in the total industry, it's incredibly high.

And so, if we modeled a mill that we said we were going to do with no customers, it would appear that we would have to sell from coast to coast and we would have to get a significant market share just to be able to continue to operate that mill.

So, I think you're right on in terms of what people would have to do in order to really get these conversions in place. And, as Mark said to Scott, I mean, they can export back into Canada, they can do a whole lot of different things.

But, again, that's – very few have been virgin and most all of these have been 100% recycled which, as Bob alluded to, again, that's – you narrow your market when you're producing just that grade..

Understood. Thank you..

Next question, please..

Your next question comes from the line of Anthony Pettinari with Citigroup. Please go ahead..

Good morning. Just following up on Scott's earlier question on CapEx.

With the high-return projects on the mill side, is it accurate to say those are purely cost reduction projects and you're not debottlenecking any capacity either virgin or recycled? And does any of the work on the mill side carry through to, I mean, first half of 2019?.

Yeah. There are two discrete projects that we move forward funding on. One is a high-return energy project and that's at the Filer City mill, and the other is a fiber-related project. It's a virgin wood chips-related capacity opportunity at the Counce mill. But it's a high-return investment at Counce for woodyard enhancement.

Those are two good examples of high-return cost..

Okay. That's helpful. And then, on the converting side, I mean, Tom, you reminded us you don't add capacity in anticipation of demand or waiting for demand to come.

Is it fair to say that you're sold out or running on allocation maybe in some areas of your corrugated business?.

Well, I never like to use the word sold out or anything like that because we do have other plants, they can pick up the slack and with literally just under 100 plants around the country, we work very hard to service our customers totally.

But, yeah, you could say that in these particular cases, I mean, demand is outstripping our ability to supply some particular markets with our current customer base. So, therefore that's why we're doing the things that we're currently doing in the box plants..

Okay. That's helpful. I'll turn it over..

Next question, please..

Mr. Kowlzan, there are no more questions.

Do you have any closing remarks?.

Yes, Heidi. Thanks a lot. Everybody, I appreciate you joining us on the call and look forward to having you join us on the third quarter call in October. Have a good day, everybody. Thank you..

This concludes today's conference call. You may now disconnect..