Thank you for joining Packaging Corporation of America’s Fourth Quarter and Full Year 2018 Earnings 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’re ready..

Thank you, Heidi. Good morning and thank you all for participating in Packaging Corporation of America’s fourth quarter and full year 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 the Packaging Business; and Bob Mundy, our Chief Financial Officer.

I’ll begin the call with an overview of our fourth quarter and full year results, and then I’m going to turn it over to Tom and Bob, who’ll provide more details. And then I’ll then wrap things up and then we’d be glad to take any questions. Yesterday, we reported fourth quarter 2018 net income of $204.6 million or $2.16 per share.

Fourth quarter net income included special items of $2.7 million primarily for certain cost related to discontinuing paper operations associated with the previously announced conversion of the No.

3 paper machine at the Wallula, Washington mill to linerboard, partially offset by $2 million of nonrecurring tax benefit from favorable adjustments related to the Tax Cut and Jobs Act that was signed in December of 2017.

Excluding the special items, fourth quarter 2018 net income was $205.4 million or $2.17 per share compared to the fourth quarter 2017 net income of $147.1 million or $1.56 per share. Fourth quarter net sales were $1.75 billion in 2018 and $1.68 billion in 2017.

Total company EBITDA for the fourth quarter, excluding the special items, was $387 million in 2018 and $351 million in 2017. We also reported full year 2018 earnings, excluding special items, of $760 million or $8.03 per share compared to 2017 earnings, excluding special items, of $569 million or $6.02 per share.

The net sales in 2018 were $7 billion compared to $6.4 billion in 2017. Excluding special items, total company EBITDA in 2018 was $1.5 billion compared to $1.3 billion in 2017. Detail of special items for both the fourth quarter and full year 2018 and '17 were included in the schedules that accompanied our earnings press release.

Excluding the special items, fourth quarter 2018 earnings per share of $2.17 was $0.61 per share above the fourth quarter of 2017 driven primarily by higher prices and mix of $0.42, volumes $0.17 in our Packaging segment, higher prices and mix $0.15 in our Paper segment, lower scheduled maintenance outage costs $0.06, lower interest expense $0.03, lower depreciation expense $0.02, and a favorable tax rate $0.27 primarily resulting from the Tax Reform changes.

These items were partially offset by lower volumes in our Paper segment of $0.11, higher operating costs totaling $0.26 per share, higher freight and logistics expenses $0.04, higher converting costs of $0.03 per share. The higher operating costs included certain expenses related to the conversion work at Wallula.

These also included higher wood costs resulting from extremely wet weather in our southern mill locations as well as inflation-related increases with chemicals, labor and benefits expenses, repair, material costs and other outside services.

Lastly, in the fourth quarter of 2017, we had the timing-related benefit of $0.07 per share from the final insurance recovery related to the 2017 DeRidder Mill incident.

Results were $0.02 above the fourth quarter guidance of $2.15 per share primarily due to better prices and mix in our Packaging and Paper segments, lower indirect costs in our mills, and a lower tax rate.

These items were partially offset by lower than expected volumes in our Packaging segment as we ran our containerboard system to demand and effectively managed our production curtailments at the Wallula Mill resulting from a rupture in British Columbia of our gas provider’s main supply line to the mill.

Looking at our Packaging business, EBITDA, excluding special items, in the fourth quarter 2018 of $352 million with sales of $1.5 billion resulted in a margin of 23% versus last year’s EBITDA of $342 million and sales of $1.4 billion or 24% margin.

Our containerboard mills established a new fourth quarter production record while reducing our containerboard inventory by 26,000 tons from the end of the third quarter, as we ran the system to demand and managed the natural gas supply issues at the Wallula Mill.

As a reminder, December’s 18-day fiber box association schedule was the lowest number of cutup days in the last six years. Our containerboard production allowed us to maintain our industry leading integration rate by supplying the necessary containerboard to our box plants which achieved an all-time record quarterly box shipment per day.

The final phase of the containerboard conversion work at our Wallula Mill was very successful with the machine operating at its design capacity and producing a very high quality virgin kraft linerboard. This now puts us in a position to begin optimizing the entire containerboard system platform and improve our manufacturing and freight costs.

Also, just as importantly, this allows us to respond quickly and efficiently to future growth and service our customer needs in a timely manner. Finally, in 2018, we established new annual records for containerboard shipments, total box shipments and box shipments per day.

For the full year, excluding special items, Packaging EBITDA was $1.4 billion with sales of $5.9 billion or a 24% margin compared to the full year 2017 EBITDA of $1.26 billion with sales of $5.3 billion or a 24% margin. I’ll now turn it over to Tom who’ll provide a few more details on the containerboard sales and the corrugated business..

Thanks, Mark. As Mark indicated, in corrugated products, we had record quarterly box shipments per day which were up by 0.2% both per day and in total compared to last year’s fourth quarter.

For the full year, annual corrugated shipment records were set both in total and per day, up 5.6% and 5.2%, respectively, with one more shipping day compared to 2017.

Outside sales volume of containerboard was about 3% above last year’s fourth quarter while down just over 4% compared to the third quarter of 2018 as we ran our containerboard system to demand and managed through the production curtailment issues at our Wallula Mill that Mark spoke about.

Domestic containerboard and corrugated products prices and mix together were $0.39 per share higher than the fourth quarter of 2017 and up $0.03 per share versus the third quarter of 2018. Export containerboard prices were $0.03 per share above fourth quarter 2017 levels and down about $0.02 per share compared to the third quarter of this year.

I’ll now turn it back to Mark..

Thanks, Tom. Looking at the Paper segment, EBITDA, excluding special items, in the fourth quarter was $52 million with sales of $227 million or 23% margin compared to the fourth quarter of 2017 EBITDA of $24 million and sales of $268 million or 9% margin.

Favorable market conditions continued during the seasonally slower fourth quarter and our prices and mix were better than anticipated. We continue to manage our inventories as we have been running on allocation for most of 2018.

Results also improved versus last year due to not having a schedule outage in this year’s fourth quarter as well as exiting the white paper business at the Wallula Mill.

For the full year, 2018 Paper segment EBITDA, excluding special items, was $165 million and sales were $1 billion or 16% margin compared to full year 2017 EBITDA of $145 million with sales of $1.1 billion or 14% margin.

Finally, I’ll mention that yesterday we notified customers of a $60 per ton price increase effective with shipments beginning March the 1st for all office papers, printing papers and converting papers. I’ll now turn it over to Bob..

Thanks, Mark. We have record free cash flow generation in the fourth quarter with cash provided by operations of $346 million and record free cash flow of $198 million.

The primary uses of cash during the quarter included capital expenditures of $147 million, $55 million for the acquisition of a small corrugated products company in Texas, common stock dividends which reflect our recent 25% dividend increase totaled $75 million, $68 million for federal and state income tax payments, pension payments of $1 million and net interest payments of $37 million.

We ended the quarter with $362 million of cash on hand. Our fourth quarter 2018 recurring effective tax rate of 23.4% was slightly lower than expected due to favorable true-ups compared to our provision once we filed our annual 2017 tax returns during the fourth quarter of 2018.

For the full year 2018, cash from operations was a record $1.18 billion and free cash flow was a record $629 million with capital spending of $551 million. Our final effective tax rate for 2018 was 24% and our final cash tax rate was 15%. Both of these are in line with the guidance ranges we provided throughout 2018.

Regarding full year estimates of certain key items for the upcoming year, we expect total capital expenditures to be between $390 million to $410 million, DD&A is expected to be about $385 million, pension and postretirement benefit expense of $33 million and we expect to make cash pension and postretirement benefit plan contributions of $60 million.

Our full year interest expense in 2019 is expected to be approximately $92 million and net cash interest payments should be about $85 million. The estimate for our 2019 combined federal and state cash tax rate is approximately 22%.

As we pointed out last year, our 2018 rate of 15% was lower than normal due to the overpayment of cash taxes due on December the 15th of '17 prior to the enactment of Tax Reform which reduced our cash taxes paid in 2018. Our book effective tax rate for 2019 is expected to be fairly flat with 2018, but should round to just under 25%.

Obviously, these estimates could change based on continuing Tax Reform guidance being issued. Based on current plan, annual maintenance outages at our mills in 2019, the total earnings impact of these outages including lost volume, direct costs and amortized repair costs is expected to be $0.59 per share.

The current estimated impact by quarter in 2019 is $0.19 per share in the first quarter, $0.18 in the second quarter, $0.08 in the third and $0.14 per share in the fourth quarter. I’ll now turn it back over to Mark..

Thanks, Bob. In summary, 2018 was an outstanding year for PCA as we achieved our third consecutive year of record earnings. We ended the year with containerboard inventories in excellent shape while setting new records for both containerboard shipments and box shipments. We successfully completed the debottlenecking work at the DeRidder Mill.

We improved the operating platform and financial results of the Paper business with the conversion of the No.

3 machine at Wallula conversion linerboard and began or completed several high return projects in our corrugated business that will allow us to better optimize our entire Packaging business for the future and deliver profitable growth and mix enhancement opportunities for our shareholders and our customers.

Although it required record capital investment in order to achieve these important initiatives, we did so of generating annual record cash from operations and free cash flow as well as improve our industry leading return on invested capital to 17%. In addition, we raised the annual dividend by 25%.

We repaid a maturing $150 million bond and we received the benefits of refinancing our remaining variable debt prior to the end of 2017.

These accomplishments clearly illustrate our continued commitment to a balanced approach towards capital allocation in order to profitably grow the company and maximize returns for the shareholders while still maintaining the financial flexibility to react quickly to almost any situation or opportunity while adhering to our conservative balance sheet approach as we have in the past.

Looking ahead as we move into the first quarter of 2019, we expect continued strong demand in our Packaging segment for both containerboard volume and corrugated products volume, and we expect strong market conditions in our Paper segment to continue.

We anticipate higher labor and benefits costs with annual wage increases and other timing-related expenses. Although we expect costs for freight and recycled fiber to be fairly flat, we do anticipate some inflation with most of our chemical and repair and materials costs, while seasonally colder weather will increase energy usage and wood costs.

We also expect our tax rate to be slightly higher. Finally, the recent decrease in the published price for domestic medium will have a minimal effect on earnings and we expect to begin seeing some of the impact from the paper price increase announcement we made yesterday.

Considering these items, we expect the first quarter earnings of $1.97 per share. With that, we’d be happy to answer any questions, but I must remind you that some of the statements we have made on the call constituted forward-looking statements.

The statements were 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 in 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. And with that, Heidi, I’d like to open the call for questions please..

Thank you. [Operator Instructions]. Your first question comes from the line of Chip Dillon with VRP. Please go ahead..

Yes. Good morning, everyone. Thanks for all the comments and information. Mark, I just wanted to know if you guys or maybe Tom if you guys could review where the box demand situation was for you all in the first part of January. I know we’re going to get a bit of ancient history on Friday about December.

But could you give us any update on where January might have come in or at least due part of the month?.

Yes, Chip, this is Tom. January started out very strong. Through the first 18 days were up 5.3%. Bookings continued to look strong going into February. So we’re very pleased with the start of the year..

Okay, that’s helpful. And just a quick follow up. Mark, you might have mentioned a buyback number, I might have missed it.

But could you just tell us what your thoughts are about buybacks? Did you buyback any, especially in December, any shares when the market really broke down and how should we think about that for '19?.

No, we didn’t buy share during the fourth quarter. And as we’ve said before, share buyback is a Board level discussion matter. And as we’ve done in the past, we continue to utilize an opportunistic approach when evaluating share repurchases in conjunction with other balanced approaches for allocating capital.

And so at this point again we did not buy shares..

Okay. And then just quickly on Wallula, that conversion, you mentioned it’s I believe now already up to design capacity.

Can you just give us a quick recap of the evolution of how you got from – especially with I think the head box, the second stage, when that started up and how quickly you got up to the capacity you planned?.

Yes. It’s part of our inventory management and some of the commentary I made with having to run to demand. We’re a victim of our own success. And I want to step back to the earlier part of the year. We had been buying tons on the outside market.

It was a relatively reasonable insurance policy with all of the work we had going on at the DeRidder Mill finishing up the major work at DeRidder. And then the two phase approach at Wallula. We bought tons on the outside market.

And so not knowing where we would be in October and hedging our bets, we bought – in fact, we ended up buying more than we needed in the third quarter. We called out our inventory at the end of the third quarter. The shutdown at Wallula in October was approximately 17 days. We started up a little bit ahead of schedule.

But we are very pleased with the fact that the machines started up extremely well as the first phase did back in June. We immediately within hours were selling quality product and were running at the design speeds. And so again we were more successful than we planned for in terms of hedging our inventories.

So we quickly had to do a course correction on inventory management and run to demand, balance out the rest of the system inventory, take advantage of the quality and the productivity coming off the Wallula machine, but also dealing with the gas issue, natural gas supply issue out at Wallula at the mill. But bottom line, the No.

3 machine has been highly successful. And I will state that it is now the only gap-former, bell bay type machine in the world that is making heavyweight virgin kraft linerboard. And it has a range of going from the lightweights up to heavyweights now. So we’re very pleased with what we have for our capability at Wallula..

Terrific. Thanks for that rundown..

Next question please..

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

Thank you. Just two things. You mentioned the box plant work that you’re doing.

Can you talk about the new box plant that you built and your debottlenecking plants in general, and how much can that drive your integration rate? And given the success you’re having in all the new tonnage coming from others, is there an opportunity to build a new box plant or to even put more resources into debottlenecking?.

Yes, Mark, I’m going to answer that and then Tom’s going to take that and then I’ll finish it up. But Tom why don’t you give him some color on the plant up in Wisconsin that we started up this fall..

Yes, we built a new plant to replace an old smaller plant up in upstate Wisconsin, strictly built on our own customer demand and the growth that they have so that we’re able to grow with them. We were essentially out of capacity there and we had no choice but to do this. The nice thing about that will be is that it will be a very automated plant.

It will have significantly less labor involved in that plant as opposed to the old plant with a lot more output. So we’ll be able to grow – as the demand in that market grows, we’ll be able to grow with it. Mark, you want to --.

Yes, then part of the question you had was any other plants that we’d be looking at, we are taking advantage of an opportunity we have at the Pacific Northwest, primarily the Wallula region in terms of Richland and Pasco area. We had been currently growing with our significant customer base out there.

And so we were literally outgrowing the regional capacity. So we have begun a project in Richland to build a new plant that already has a business lined up. We will have to get this plant up and running quickly. We are taking a new approach. We’ve never had our own technology people combined with the box plant side of the business build the plant.

But the fact that the mills are primarily finished with all the big projects, we’re taking mill engineering, combining that with box plant engineering and technology and we put a team together to build this plant and do most of the installation ourselves. So it should be a unique project opportunity for us to apply our unique talents that we have.

But that plant is scheduled to start up at the end of the year..

Okay. That’s super helpful. And just one more quick question.

What percent of your white paper capacity is affected by this price hike?.

All of it..

All of it, super. Thank you..

Thank you. Next question, please..

Your next question is from the line of Mark Wilde with Bank of Montreal. Please go ahead..

Good morning, Mark, Tom, Bob..

Good morning..

Good morning..

Good morning..

Bob, I bet you’re glad – you wish you were Memphis this morning..

Actually we were talking about that..

Probably one of the few times you wish you were in Memphis. But anyway, a couple of questions I had for you.

First of all, Mark, is it possible to get a sense with Wallula running right now what your integration rate is?.

Without trying to get an exact number, you could easily factor in that the incremental tons that Wallula put out puts us back down in the lower 90% range. We’ve been tracking last year in that 95% area and so now we’re somewhere in that lower 90% area..

Okay.

And then, Mark, just sort of related to that, can you give us some sense of what type of debottlenecking opportunities might be open to you at the mills over the next two or three years?.

As far as incremental tons, we’ll obviously take advantage of all of the new capacity at Wallula. Wallula does have in terms of its current design capacity a little over 400,000 tons. We’ve already proven the machine out and identified a few small modifications that we can make.

So by the time we’re done with this, we should be able to extract another roughly 90,000 to 100,000 tons out of Wallula over the next year or so as we need those tons – if and when we need those tons. Again, we took all of our lessons learnt from the DeRidder conversion.

That was a four-year phased effort and applied it to the similar machine at Wallula, only we made it better. The machine at Wallula is quite a remarkable machine..

And is there anything left down at DeRidder or is that pretty much maxed at this point?.

Well, on an ongoing basis incrementally because last year was such a heavy lift for us to complete the work. You’ll see the incremental improvement year-over-year in terms of its capacity. The DeRidder mill is truly depending on the grade mix approaching 1.2 million ton a year capacity mill.

And its accounts in DeRidder are now 1.2 million ton a year capacity mills. Depending on the grade mix you run, whether you end up running 1,150,000 tons, but we’ve got some extra capacity at DeRidder as we have fine tuned and we’re stretching it out and taking advantage of all the work we put in over the last four years..

Okay. The last question I had, Mark, is just kind of returning the capital allocation priorities as we enter 2019. You have a really strong balance sheet by far and away but that’s balance sheet in the sector. And I’d just like to come back to sort of plan for kind of – prospective plan for capital for M&A or for share repurchase.

I was a little surprised in the fourth quarter given the drop off in the stock and given your balance sheet that you weren’t more active with share repurchase..

I want to start that out and say that we continue to be in growth mode. And being growth mode we will be opportunistic whether that means one-off box plants, small box plant business acquisitions and/or mill opportunity that come along.

As the fourth quarter rolled on, again, our discussions let us to believe that it was prudent to continue to build cash and have the flexibility to take advantage of any opportunity that comes along. We have identified many opportunities within the box plant side of the business now to enhance the capability and take out cost.

I just want to point out too that over the last 20 years we have significantly filled the box plant system up and I’m going to use a term, we are approaching saturation capacity in a number of Tom’s plans. And so that’s not necessarily a bad thing.

It gives us an opportunity to deploy some prudent capital and not only enhance the efficiency but take significant cost out of the equation. And so along with just looking at the routine mill opportunities, which the good news in the mills this year we’re finishing up the boiler at Filer City. That’s a relatively small capital project.

And then we have a higher return woodyard project at Counce.

So the business in new order at the mills is just running the business, paying attention, maintaining the assets, taking care of the box plant opportunities, building the new plant out in Richland and then just having a cash reserve that gives us the balance sheet capability to take advantage truly of anything that happens to be presented to us.

So we’re feeling good about where we are, but that’s pretty much in a long formed logic that we’ve applied in terms of --.

Okay. Thanks a lot. Good luck in '19..

Okay. Thank you. Next question..

Your next question is from the line of George Staphos with Bank of America. Please go ahead..

Hi, everyone. Good morning. Thanks for all the details. How are you doing, Mark? Congratulations on the year..

Thanks..

I guess the first question I had in terms of box volumes in the fourth quarter, if you could maybe give us a bit more color had you not had the gas line outage at Wallula, would you have been able to produce more boxes? It seems like part of your demand trend there was driven by a limitation on the Paper side.

If you could call that out, that’d be great. And similarly in the somewhat decelerated number in the fourth quarter from what you’ve been seeing previously in box shipments, how much of that was just number of days are cutup and how much of that was maybe the market taking a pause? Just curious as to your thoughts on those points..

Yes, your first part of the question, the Wallula natural gas line curtailment in the force majeure did not have an impact on box volume for the quarter. And I’m going to let Tom add a little color to the quarter itself and volume and then I might add something else.

Tom?.

Yes, George, if you recall early in the quarter when we were presenting our third quarter numbers, we indicated that volume at that time and early October was up about 2.5%. What we saw during the quarter is, is that the volume slowed at the end of October and was reasonably slow through some of November, but then accelerated quite a bit in December.

Now December only had the 18 workdays, so that was a little unusual for – it’s been six years since we’ve had an 18-day month. So that had a little bit to do with it.

Also what had to do with it is, is we had a very tough comp because out in Sacramento, that Sacramento container, our two largest customers which we had prepared to exit the business anyway were acquired by West Coast Integrated and they moved that business away from us sooner than what we had anticipated. So that had some impact in our number also.

It wasn’t really a dramatic falloff in demand or anything like that or something in the economy that took place. We just had a couple of things hit us. But I’ll remind you also that starting out the year we continue to have this tough comp. And in spite of that tough comp, as I indicated, we’re up about 5.3% starting out in January.

So I think things are very strong and we feel good about the start of the quarter..

Okay. Thanks for that. And related question and I think you already answered it to some degree or implied, but there’s been much discussion around how the customers and brand owners, the e-tailers are modifying perhaps their consumption of corrugated for that channel.

And I recognize your customer mix and how you approach the market might be a bit different than some of the other players.

But are you seeing any changes in e-commerce in that distribution channel that is sort of filtering back in terms of your demand? And if so, how is it checking out?.

Yes, George, this time again I’ll take that. Our e-commerce or e-tailers, as you call them, demand is still very strong. It continue to grow not at the growth rates that we’ve seen, so I think what you’re probably seeing is, is that segment although growing still is – the growth rate is slowing somewhat because it was at a very accelerated pace.

Another thing that we did definitely observe in the fourth quarter, the inventory levels were at a better – at a higher rate to be able to accommodate the push and the demand that comes in the fourth quarter for that. So I think our customers were better prepared for the seasonality this year as opposed to perhaps in the past.

And there’s a lot of moving parts to this thing and a lot of things that are going on relative to and you hear a lot of discussion about less corrugated or some of these other sort of things.

I think you’re going to see some puts and takes but I don’t think you’re going to see some dramatic drop off or anything like that, because at the same time I think you’ll see things like plastic pouches as bad as they are for the environment that probably – some of that is going to move to corrugated and we’re already seeing some of that.

So it’s still a growing segment, a good segment but I think that overall I think our customers are managing the seasonality a little bit better than they have in the past..

I think as you see more end markets adopt e-commerce as a channel to distribution, you may actually see at least in those end markets greater consumption of corrugated relative to what’s been the traditional in terms of apparel and some of the other items like electronics. But that will be seen over time.

Last question and I’ll turn it over and obviously holding price constant, you’re not going to talk about the price and how it’s going into the market in uncoated freesheet. But if we look at the margin in paper in the fourth quarter, it was certainly better than we were expecting and frankly quite extraordinary, over 20% EBITDA margin.

How do you sustain that over time? And was there anything if not non-operating none the less sort of one-off in terms of some good guys that came your way that won’t materialize and then in containerboard, the mix a little bit stronger than we had expected, what was driving that? Thank you guys and good luck in the quarter..

Regarding the paper part of the question, over the last five years we had worked on and accomplished taking a significant amount of cost out of the paper side of the business and working in significant efficiency capability in the two remaining mills; the Jackson mill and the International Falls mill.

And so price being what it is, we certainly are in a position with our marketplace demand to continue taking advantage of the high efficiency, lower cost operations. And so as we stand, we also take out the Wallula cost for last year. And again, the paper side of the business is a good business for us right now.

And then I believe there was another part of the question..

Just corrugated mix a little bit richer than we were expected, what was driving that?.

I think that’s just the seasonality of our mix. It’s a little heavier the graphics end of the business although sometimes will finish up in the third quarter, this one bled moreover into the fourth quarter as well. For the year we had a very strong mix in price..

Thanks for your thoughts..

Next question, please..

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

Thanks and good morning..

Good morning, Scott..

Mark, when you were talking about Wallula, you said you thought you could produce another 90,000 to 100,000 tons over the next year or so and you said 400,000 ton design capacity.

Does that mean you produced about 300,000 tons at Wallula in 2018?.

No. We’re just saying that after the final phase of the work in October the machine came out of the work during the fourth quarter with a 400,000 ton a year capability. And so to help you understand that we designed that machine to produce approximately 1,150 ton a day type of rate on a daily rate and we’ve obviously achieved that and exceeded that.

And so it’s truly the capability that it currently has..

Okay. And when you talk about the – you said you ran to demand after coming up strong post the October shutdown.

You just ran a little bit slower than you normally would or did you then add 1,150 per day rate or did you actually take some days out of the schedule?.

Well, because of the compounded issue of the natural gas force majeure situation, we opted to just run the No. 3 machine, the new rebuilt machine. We kept the No. 2 medium machine down during the quarter and took advantage of that. And so we did some work on the machine also and it’s much similar to what we’ve done at DeRidder.

We did prove that we can make medium on the machine if we have to. But that being said, we also took advantage of the fact that the rest of the system was running extremely efficiently.

With the purchase tons where they were, we immediately ceased buying the volume that we had up through the third quarter and started as we had called out on the October call working on our end of year inventory.

And in order to run to the inventory targets that we had called out and manage the current supply/demand situation on cutup, we went ahead and also took some time during December at Filer City with the No. 1 machine, a very small machine and the No.

2 machine at Tomahawk for a few weeks in December, the smaller machine at Tomahawk to balance out the fourth quarter’s inventory..

Okay. Last one for me just around some of the system optimization on the manufacturing side and then some of the freight savings now that you’ve got the full system up and running.

Should we expect some of those benefits to flow through in 2019? And if so, I would assume its more 2Q and 3Q than it would be in the first quarter?.

Obviously, the system is optimized as we speak in terms of the Wallula Mill currently is running well. So it’s a matter of supply/demand balance. Cutup is strong, so obviously the demand for containerboard is very strong as we are sitting here in January.

And so if you want to look at it, the benefits of this capability flow through immediately in the first quarter and through the full year.

I think that’s why when you – when you look at our guidance of $1.97 on a year-over-year basis, I think that that speaks to the fact that again we’ve got the strong demand, the box plant side of the business and the paper side of the business both strong demand and we have the ability to deliver the tons we need at more reasonably costed [ph] efforts here, because Wallula is fully capable of delivering what we need for the West Coast..

Perfect. Thanks, Mark..

Next question, please..

Your next question is from the line of Anthony Pettinari with Citi. Please go ahead..

Good morning..

Good morning..

Mark or Tom – just wondering if you can discuss what you’re seeing in the export markets you serve in January. I guess some regions are doing a little bit better than others.

And in 1Q, do you have an opportunity to maybe pull some tons out of the export market given what sounds like pretty strong domestic demand? And overall if you can remind us what percentage of your vols go to the export market maybe early in the year?.

Yes, Anthony, as we’ve talked about many times in the export, we’re a relatively small player in the big scheme of things. Our demand has remained very steady throughout the year. It was a very solid year. China was actually up for the year.

Again, we’re not a big player in China but that volume was up for us, slowed a little bit in the fourth quarter but overall was very good. Prices were down a little from the third quarter but still up from a year ago. So that has remained relatively good. Now of course that’s still affected by exchange rates and tariffs.

But overall, we’re very pleased with our export market. We’ve been with these same customers for a long time. We’ll continue to supply them. So when you talk about adjusting our export volumes or anything like that, no. We’ve been with these people through the long haul and seasonally their business is very good for us.

So we’ll continue those relationships..

Okay, that’s very helpful. And then I think just following up on George and Scott’s questions on running to demand. Understanding it’s likely not a big number.

Is it possible to quantify kind of the total tons of downtime you took to kind of balance out those inventories in 4Q?.

As we’ve said, we ended the year with our inventory number. We called out that inventory target in the third quarter. And so with the impact out of Wallula was worth about probably 32,000, 35,000 tons of impact..

Got it. I’ll turn it over. Thank you..

Thank you. Next question..

Your next question comes from the line of Debbie Jones with Deutsche Bank. Please go ahead..

Hi. Good morning.

My first question I realize you can’t comment on why GP did this, but can you discuss how you think about their move exiting the paper business will impact your business, just kind of be on the supply reduction, whether it’d be wood supply or customers looking for more paper?.

Just commenting a little bit as far as where we are, we’re coming out of a year in 2018 where we were on allocation most of the year. We’re producing in terms of the Jackson and I Falls mill have the capability to produce about 1 million tons of uncoated freesheet in printing and converting grade.

And so I think where we are with our business we are fully committed to the customer base we have, but it does allow us to rationalize some of that customer base as we go forward and move tons accordingly into the best avenue of business we see. I can’t speak for the industry..

Okay. And then second question, you gave the CapEx number for the year.

Is there any update to kind of maintenance CapEx for the business between paper and packaging? And then you called out a couple of projects, but are you able to give us a sense of what the strategic CapEx is for 2019 and broadly whether it’s going into the mill or box plant system?.

A good way to look at that, Debbie, is that probably 60% to 65% of the total capital that we called out would be going towards maintenance, business maintaining just taking care of the business. The rest of it is the strategic piece. So 35% to 40% of the total cap is strategic..

All right, great. I’ll turn it over..

Thank you. Next question..

Your next question comes from the line of Mark Weintraub with Seaport Global. Please go ahead..

Thank you. Just first wanted to clarify.

So with Wallula when you’re talking about the 90,000 to 100,000 tons increment, is that saying that at some point the capacity could be approaching 500,000 tons?.

You would have to spend some discrete capital on fiber capability. We’ve identified what that means in terms of providing the type of fiber we would want to provide at the cost, but we certainly have the capability on the machine if we choose to, to approach a 500,000 ton a year capability in the future years as demand calls for it..

Got it, okay. And I think that last call and talking about Wallula, you had indicated that in 2018 given all the conversion projects, et cetera, that it wasn’t going to be a net contributor to the bottom line.

Can you just confirm? Was that the case for last year and with some of the stuff that happened in fourth quarter, was it a positive contributor or a drain in the fourth quarter itself?.

Yes, Mark, this is Bob. Certainly going from the third quarter to fourth quarter, third quarter we were running full, obviously had not completed all the work we were planning to do, but we were running full. So when you got into the fourth with the outage work that we had, it’s certainly a drag going from third to fourth.

And then of course year-over-year we didn’t have the packaging business on that machine. So the negative impact we incurred in this year’s fourth quarter was certainly a drag year-over-year as well..

Okay.

And so basically whatever contribution Wallula can have is all net positive for 2019 versus 2018 if I understand it correctly?.

Yes, that’s a good way to look at it..

Okay, terrific.

And then just lastly kind of finishing this line of thought, is the profitability that a mill like Wallula can generate meaningfully different than what we would see across your system on average?.

I think the big difference at Wallula compared to DeRidder account is the fiber cost. We’ve talked about this in the past and I think it’s well recognized that virgin mill operations in the Pacific Northwest do have what I would have to say is probably the highest virgin would cost as far as whether you’re buying chips or logs in the United States.

But that being said, as we’ve looked at these projects in the last three years, we’re able to take advantage of the transportation differential so that what we lose on higher input cost on raw wood, we make up for on – a significant piece of that is made up on transportation benefit..

Okay, super. And then maybe just one last one.

In terms of the acquisition, I think it’s $55 million acquisition, any additional color you can provide on that for us?.

Tom, you want to talk --.

Mark, it’s a small strategic acquisition for us in the state of Texas, provided some necessary capacity that we needed there as well as some product mix that fit our customer base very well.

It’s not big in terms of like tons or anything like that, but it’s very strategic in nature to our marketplace down there which we have an enormous footprint down in Texas..

Okay, great. Thank you..

Thank you. Next question, please..

Your next question is from the line of Gabe Hajde with Wells Fargo. Please go ahead..

Good morning. Thanks for taking the question, gentlemen..

Good morning..

I was going to revisit kind of the shipments that appeared to kind of slow sequentially.

Are there areas within the end markets where you saw a pullback? And I guess in the same vein, were there end markets that struck you that’s particularly strong or weak in 2018 and can you comment at all at what you’re most optimistic about in 2019?.

What we saw was, as I indicated earlier, we lost a couple of significant accounts out in – through our Sacramento acquisition, sheet accounts which we knew we were going to lose as we exited some of that business. It just happened sooner than what we thought. So that comparable – that’s really the slowdown that you see.

Otherwise, it would have been relatively steady. I think the only thing surprised us in the fourth quarter was demand did slow at the end of October and into November, but then picked up dramatically in December again and going into January it’s been very, very good.

So I don’t think there’s – we’re dealing with thousands and thousands of customers in a lot of different end markets and things like that, some hold very steady and some are growing, very few are declining. So I don’t think there’s a lot to talk about in terms of the end markets having some significant change..

Okay.

Tom, I guess specific to PKG, is it fair to extrapolate some call it headwind in '19 for your volumes from the lost volumes in Sacramento for those three quarters --?.

Yes. As I indicated, it’s still going to be a tough comp. But again, as I said, we’re starting out January up 5.3% against a tough comp and bookings remain very solid. So that’s quite frankly, I’d be honest with you it’s a bit of surprise as to how robust the business is right now..

Okay. Thank you. And then, Bob, switching gears, you guys sort of started to provide a little less granularity and you talked about higher operating costs, I think it was $0.26 this quarter but I think for the full year it was about $1 a share. If I did my math, it’s $125 million.

Is that fair to think about that as sort of nonmaterial related inflationary headwind that you have to overcome on an annual basis or was there anything in particular that was kind of out of the ordinary in there?.

It includes those things, but it also includes – and Mark sort of gets into a little more of the detail when he goes through the prepared remarks of what’s in that operating costs.

Certainly energy and chemicals and wood are part of that, but labor and benefits that we talked about as far as an addition to the inflation we see on repairs and material costs and supply costs, all those things we put into the – are a part of operating costs, but they all as we said at the beginning of the year and it held true, there was inflation associated with pretty much all of those items which was something we had not seen in a while across the board on all of our operating costs inflation that we had to work against for this year..

Okay. Thank you..

Thank you. Next question, please..

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

Hi. Good morning, guys..

Good morning, Brian..

Sorry to come back to the 53 number for January, but just since it was so much better than what you put up in the fourth quarter just wanted to confirm. Does that include some contribution from the Texas box plant or converting asset you acquired? I wouldn’t imagine it’d be a huge amount, but just to confirm that.

And is it on a per day basis, any kind of – other unusual impacts we should about in there?.

53 is on a per day basis. It does not include the acquisition plant. And again, this is the start, it’s 18 days. So we got a very good indication of January. But certainly can’t predict exactly what’s going to hold for the entire quarter. But as I said, we’re off to a very good start..

I appreciate it. It sounds like it is. In 2018, you said you were buying some outside board, may seem like some insurance and some just to kind of tide you over until some of the conversions were done.

Is there any way to think about the benefit in 2019 from not having to buy that board? Is it just sort of tied into the increased capacity and better operating rates on the DeRidder and Wallula assets or is there an incremental benefit beyond that we should be thinking about?.

Let me give you a number. Last year and this is just an approximate number, right. We purchased about 300,000 outside tons for the year and then we quickly brought that down in the fourth quarter and went ahead and started supplying most of what we were using. But for 2019 we’ll continue to buy some of the normal tons that we buy in the outside market.

We traditionally bought some specialty tons like white top and some SBS. It probably amounts to 60,000 tons of specialty type containerboard that we’ve moved through our box plants. And then we have a small piece of contractual requirement.

A supplier was able to supply us two years ago to help us work through the 2018 demand and part of that was working through some tons this year. So we have a very small or approximately 30,000 tons that we’ll buy this year that will wind itself out and be done. So we would look at probably 90,000 tons of outside purchases this year..

Okay. That helps a lot. Thank you. Just one last one, if I could. Just sort of following on Debbie’s question about GP’s decision to exit the paper business, just wondering how you guys are thinking about that business longer term these days? Obviously the profitability is really good and the outlook is really good these days.

But do you envision yourselves still being in that business 5 or 10 years down the road? Is that something that you still have a long-term commitment to maintaining those assets and those customer relationships?.

Looking at it, if you do some extrapolation and you just assume that we move through 2019 on a run rate that we just finished up '18 and you look at what our first quarter guidance is, you could easily come up with a model that said for since we bought Boise, you’re generating significantly 1 billion to 1.2 billion of EBITDA during the six-year period.

If you just went through 2018 since we owned them, we generated roughly 1 billion. And so it’s been a good contributor to the effort here. Again, we took the cost out early on in the first two years of ownership of the mills. It’s been a good business and it goes back to some comments we made probably three years ago.

The value of business is such it’s hard you would not want to sell it for the wrong price I’ll use that. And so it’s a very valuable significant contributor. It requires very minimal capital. And we have a very good marketplace position. And so we will continue to take advantage of that. It’s a nice business for us..

Okay. I appreciate that. Thanks, guys..

Thank you. Next question..

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

Thanks. A couple of quick ones late in the session.

First of all, with respect to exports, if you maintain those volumes due to the long-term nature of the relationships, can you optimize where you ship from? Is that part of the freight optimization that you’ve alluded to?.

It’s really not because, again, we’ve had these export customers for a long time and we’ve optimized those through our existing mills. So no to the – unless we grew China or something like that significantly, but we really don’t see that occurring..

Okay. Thanks. And a quick on freesheet.

I know you’re not going to commit big capital to it, but are there any debottlenecking opportunities at the two mills if the returns were compelling?.

I’m sorry..

Debottlenecking freesheet opportunities..

Could you ask that question -- Bob and I were talking..

I’m just wondering, if all of a sudden North America was short on freesheet, are there any opportunities to augment your capacity that you do only if the returns were compelling?.

Unfortunately, the I Falls mill and the Jackson mill are running full. We have stretched the capability out over the last four or five years. We’re very pleased with where the mills are running.

But from a practical point of view they’re running at their full capability, which is what’s allowing us to optimize the input cost and maintain peak efficiency..

Understood. Thank you..

Thank you. I think we have time for one more question if there’s anybody left on the queue..

There is. Your final question comes from the line of Adam Josephson with KeyBanc Capital Markets. Please go ahead..

Thanks. Good morning, everyone..

Good morning..

Tom, just on the – back to box demand for a moment just on the January commentary, are you expecting – a couple questions, are you expecting that level of growth to continue for the quarter as a whole just in terms of what’s embedded in your 1Q guidance? And then you’ve often talked about how box demand you think is tied to the economy.

There have been obviously some signs of a slowdown with the ISM PMI in December and numerous other indicators. So what’s your sense of how the economy is doing and what impact that might have on demand for the balance of the year? Thank you..

Adam, the expectation for January is what I gave you. In terms of a number, now some of that probably is inventory rebuild and some other things. And if you looked and you said, well, where would we go for the remainder of the quarter? Probably slightly above whatever the economic growth is which is typical of where we are.

So that’s still very good demand for quarter. But that’s just a prediction. Right now I think that our customer base that we have indicates that they feel very good about the economy and very good about their opportunities. They’re not necessarily heavily reliant on global demand and their own export markets and things like that.

So I think domestically we’re in quite good shape. And I think that’s got the opportunity to continue throughout the year..

Thank you, Tom..

All right. With that, operator, I believe we’re out of time. I would like to thank everybody for joining us. We look forward to talking with you in April for the first quarter. Thank you. Have a good day..

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