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Temple-Inland Inc. (TIN)

Q4 2009 Earnings Call

February 9, 2010; 9:30 am ET

Executives

Doyle Simons – Chairman & Chief Executive Officer

Pat Maley – President & Chief Operating Officer

Randy Levy – Chief Financial Officer

Chris Mathis – Vice President of Investor Relations & Treasury

Analysts

Chip Dillon – Credit Suisse

George Staphos – Bank of America

Mark Wilde – Deutsche Bank

Mark Weintraub – Buckingham Research

Richard Skidmore – Goldman Sachs

Joshua Zaret – Longbow Research

Mark Connelly – Sterne, Agee

Peter Ruschmeier – Barclays Capital

Presentation

Operator

Good morning, my name is Sandra and I will be your conference operator today. At this time, I would like to welcome everyone to the Temple-Inland fourth quarter 2009 earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I would now like town the call over to Chris Mathis, Vice President of Investor Relations and Treasury; please go ahead.

Chris Mathis

Good morning. my name is Chris Mathis, Vice President of Investor Relations and treasury for Temple-Inland and I’d like to we will come each of you who have join us by conference call or webcast this morning to discuss results for fourth quarter and full year 2009. Joining me this morning are Doyle Simons, Chairman and Chief Executive Officer of Temple-Inland; Pat Maley, President and Chief Operating Officer; and Randy Levy, Chief Financial Officer.

Please read warnings statements in our press release and our slides concerning forward-looking statements as we will make forward-looking statements during this presentation. in addition, this presentation includes non-GAAP financial measures. the required reconciliation to GAAP financial measures can be found on our website at www.templeinland.com. this morning we will give a presentation on the results for fourth quarter and full year 2009. After the completion of the presentation, we will be happy to take your questions.

Thank you for your interest in Temple-Inland and now I would now like to turn the call over to Doyle Simons.

Doyle Simons

Thank you, Chris. Good morning everyone and welcome. we had an outstanding year in 2009 as our employees delivered solid operating results, return on investment and cash flow despite difficult economic conditions. Excluding special items, net income was $0.70 per share in 2009. this compares with net income excluding special items of $0.11 per share in 2008.

Special items after tax for 2009 were $128 million or $1.19 per diluted share, including income of $134 million or $1.24 per share for alternative fuel mixture tax credits, net charge of $11 million or $0.10 per share related to the substitution of letters of credit in connection with the 2000 sale of timberland, income of $9 million or $0.09 per share related to the purchase and retirement of long term debt, and a charge of $3 million or $0.03 per share related to facility closure and headcount reduction. we generated $640 million of cash from operations and reduced our debt by $482 million in 2009.

As shown on slide four, our long term debt at year end 2008 was $1.192 billion and we ended 2009 with long term debt of $710 million, down $482 million for the year. $307 million of the decrease was from operations and $175 million was from the alternative fuel mixture tax credit.

Let me now turn to our segments, beginning with corrugated packaging. in corrugated packaging, we posted record annual operating income of $347 million. our ROI for the year was an industry leading 16.5% and 2009 was the fourth consecutive year we have earned above cost of capital returns in this business.

Corrugated packaging earnings were up by $122 million in 2009, compared with 2008. While approximately one third of the improvement year-over-year was attributable to market related items, $138 million of lower input costs offset by $99 million in lower prices almost two thirds of the improvement was a result of strategic initiative to improve earning power to box plant transformation, benefits from the acquisition of PBL and lower mill cost.

In 2009, the benefit from our box plant transformations focused on lowering costs through higher asset utilization was $42 million. we also successfully integrated the PBL mill into our system in 2009 and began producing white-top linerboard at this mill. the combined benefit of synergies and production of white-top added another $35 million to earnings in 2009 compared with 2008. we are very pleased with the bottom line contribution of box plant transformation and PBL in 2009 and as we will talk about here in just a few minutes there is much more to come.

Building products, building products lost 27 million in 2009 compared with a loss of $40 million in 2008, an improvement of $13 million despite the fact that housing starts declined by 39% in 2009 compared with 2008. the key driver to this improvement was lower cost.

Despite very difficult markets we are one of the few companies in this business that has continued to generate positive EBITDA. For 2009, we generated positive EBITDA of $17 million, a $9 million improvement over 2008, again, despite the fact that housing starts declined by 39% in the year.

Turning to the fourth quarter, net income per share in fourth quarter 2009 was $0.34 compared with a loss of $0.06 per share in fourth quarter 2008, and income of $0.61 per share in third quarter 2009. Excluding special items, we had a net loss of $0.07 per share in fourth quarter 2009, compared with net income of $0.11 per share in fourth quarter 2008, and $0.24 per share in third quarter 2009.

Special items after tax for fourth quarter 2009 were income of $45 million, or $0.41 per share, while alternative fuel mixture tax credits. we generator $200 million dollars of cash from operations and reduced our long term debt by $169 million in the quarter. our share based compensation expense in the quarter increased by $37 million compared to fourth quarter 2008, and $6 million compared with third quarter 2009 due to an increase in our stock price.

In corrugated packaging, operating income was $57 million. this compares with $68 million in fourth quarter 2008, and $94 million in third quarter 2009. Operating results declined in fourth quarter 2009 compared with third quarter 2009 due to hire input costs, hire downtime costs, lower prices and lower box volume. As we told you on our last conference call, we had the unique situation of having five less shipping days in fourth quarter 2009 compared to third quarter 2009 due to the way holidays failed on our fiscal calendar.

Accordingly, our absolute box shipments were down over 30,000 tons compared to the third quarter. ROI in the fourth quarter was 10.8%, highest in our peer group. in terms of absolute input costs, comparing fourth quarter 2009 to fourth quarter 2008, input costs were mostly down with energy down $16 million, freight down $6 million, chemicals down $5 million, and OCC up $7 million.

Compared with third quarter 2009 input costs were higher with energy up $6 million, and virgin fiber up $4 million, primarily due to wet weather. While OCC prices were flat in the fourth quarter compared with the third quarter of 2009, going into the first quarter OCC prices are up significantly as they started increasing in December and that trend has continued. January prices were up $38 compared with the fourth quarter average, and February prices will be up another $20 to $25 from January levels.

Box prices were down $4 in the quarter as previous adjustments to linerboard moved through to boxes. Published linerboard prices moved up $50 in the East and $70 in the West in January 2010. most of our box prices either directly or indirectly influenced by adjustments in published linerboard prices. a majority of the earnings benefit from the price increase will not be realized until the second quarter 2010.

On an average week basis, our box shipments were up 8% in fourth quarter 2009 versus fourth quarter 2008. On an average week basis industry box shipments were down 1%. On an absolute basis, our box volumes in the fourth quarter were down 4%, compared with third quarter 2009 and down slightly compared with fourth quarter 2008. we continue to see steady improvement in box demand. On an absolute basis, our January box volumes were the strongest they have been since our acquisition of Gaylord in 2002.

We took 23,000 tons of maintenance related downtime in the quarter, and lost 16,000 tons of production due to curtailment and slow back at our Rome, Georgia and Bogalusa, Louisiana mills as extremely wet weather impacted fiber availability and elevated wood cost. we continue to match our production to our demand and our year end inventories were inline with our three year low 2008 year end inventory levels. in first quarter 2010, we will be taking our Bogalusa down for its annual outage and expect 27,000 tons of downtime as a result.

Turning to building products, building products loss $18 million in fourth quarter 2009 compared with a loss of $14 million in fourth quarter 2008 and a loss of $4 million in third quarter 2009. Results for fourth quarter 2009 include $4 million of non-cash inventory evaluation adjustment and asset write-off.

Building product markets were very weak in the quarter as seasonally adjusted housing starts declined 16% in fourth quarter 2009, compared with fourth quarter 2008, and actual housing starts declined 24% in fourth quarter 2009, compared with third quarter 2009. As a result, demand in pricing was down for all our products in the quarter. in addition, energy costs were higher and fiber costs were up in the quarter due to the extremely wet weather.

Lumber prices were down $7 in fourth quarter 2009, compared with third quarter of 2009 and down $19 compared with fourth quarter 2008. our current lumber prices are tracking randomly and are currently in the $300 range. Lumber volumes were down 11% compared with third quarter 2009, and 7% compared with fourth quarter 2008.

Gypsum prices were down $3 in fourth quarter 2009 compared with third quarter 2009, and down $26 compared with fourth quarter 2008. Current gypsum prices are down slightly compared with fourth quarter 2009 average. Gypsum volumes were down 11% compared with third quarter 2009, but up compared with year ago levels.

Particleboard prices were down $13 compared with third quarter 2009 and down $46 compared with fourth quarter 2008. Current particleboard prices are essentially flat compared with fourth quarter 2009 levels. Particleboard volumes are down 17% with third quarter 2009, and down 15% compared with fourth quarter 2008.

Now let me turn it over to Randy to discuss financial highlights for full year 2009 and the fourth quarter.

Randy Levy

Thanks, Doyle and good morning to everyone. Doyle covered the income statement and now I’ll highlight cash flow, debt and liquidity, and then make a few brief comments on a couple of expense related items. Let’s start with cash flow. For the fourth quarter, total cash provided by operations was $200 million. the operations portion, which can be thought of as funds from operations, was $125 million, but that includes cash tax adjusted alternative fuel mixture tax credits of $54 million. Adjusting for these credits, the number is $71 million.

The working capital portion in the quarter was an additional $75 million source of cash. I would note that included in working capital was a federal income tax refund of $58 million. For the year, total cash provided by operations was $640 million. the operations portion or FFO, adjusted for the items noted in our release was $404 million, and compares to $302 million a year ago.

Moving to the balance sheet, our long term debt was $710 million at year end, which was as Doyle mentioned earlier, down $169 million in the fourth quarter and down $482 million from year end 2008. At year end 2009, our total term debt was $555 million that’s down $286 million from year end 2008. As you can see, we have no debt maturities until 2012.

Looking at our liquidity year end, our committed credit facilities total $1.75 billion and our unused borrowing capacity was $890 million with no limitations. our financial covenants are customary for these types of facilities and we have significant headroom versus these covenants.

As you can see, at year end our debt to total capital ratio was 43% versus a 70% maximum and our interest coverage which is the best four out of five trailing quarters, was 10.2 times versus a three times minimum and then to wrap up, just a couple of comments on some expense related item.

First, interest expense was $13 million in the quarter, which was down $10 million, or 43% as compared to a year ago. this reduction reflects not only our debt levels being down $482 million, but also the retirement of $286 million of our fixed term debt at an average coupon in excess of 7%

Finally general and administrative expense were $17 million in the quarter and, for the year, these expenses were $70 million, which was down 8% versus a year ago. I think it’s worth noting that the 8% reduction in these expenses during 2009 follows a 24% reduction in 2008.

Now I’ll turn it back over.

Doyle Simons

Thank you, Randy. I would now like to switch gears and discuss a project that our board approved last Friday to further reduce our box plant system cost. Let me start with some context. in our corrugated packaging operation, we have four key strategic initiatives, maintaining a high integration level, driving for low cost, improving our mix in margins, and profitably growing our business, this project is focused on the middle two.

Driving for low cost and improving our mix in margins. As we have previously discussed, over the past few years we’ve been focused on changing the culture in our box plant system to run box making machines near design capacity there by lowering cost through improved asset utilization. this effort has resulted in fewer machines, fewer people, and significantly lower cost.

We’ve also been focused on improving our mix in margin and getting paid for the value we create for our customers. this effort which we refer to as box plant transformation one, has resulted in four fewer plants, 88 fewer machines, and 1,157 fewer people, and by year end 2010 we will have lowered cost by $80 million per year, including an anticipated $10 million in 2010.

The capital investment to achieve these cost savings has been approximately $174 million, resulting in a return on investment of 46%. the success of box plant transformation one, however, did not come just from purchasing new equipment and technology. It came from successfully configuring, implementing and executing with it and changing the culture of our box plant system.

The benefit from box plant transformation one has shown up in our bottom line and has been a key driver to our improving ROI. While this action has clearly lowered our cost it has also enabled us to target a richer mix of products. However, the returns outlined here only include hard dollar cost savings from lowering our costs.

Based on our high level of success in box plant transformation one, we are confident that we can further significantly drive down the cost structure of our box plant system through additional steps to improve our asset utilization. last week, our board approved box plant transformation two, which will result in 12 fewer plants, 66 fewer machines, and 917 fewer people.

Cost will be reduced by about $100 million with approximately 10% of the cost reduction in 2010 and the balance spread roughly evenly between 2011, 2012, and 2013. the capital investment for box plant transformation two will be approximately $250 million, spread fairly evenly across 2010, 2011, and 2012. the return on investment for box plant transformation two is anticipated to be about 40%.

Again, these numbers only include hard dollar cost savings from lowering our cost structure and do not include benefits from improving our mix. While we have provided some guidance on timing and are absolutely confident that the benefits will reach the bottom line, the results will undoubtedly be lumpy just as they were in box plant transformation one.

We will incur approximately $125 million of one time charges for this project. we will provide you with an update of the benefits annually. before I give some closing comments let me turn it back over to Randy to provide you with some guidance on some 2010 numbers.

Randy Levy

Doyle just took you through our box plant transformation two project that will be launching this year. Investment to support this important project will take capital expenditures in total to approximately $200 million to $210 million this year for the company. this will represent roughly 100% of depreciation in 2010 and depreciation in 2010 is expected to be $198 million inline with 2009.

On pension, as many of you know, in the fourth quarter of 2007 we made significant changes to the asset allocation of our qualified defined benefit plan. At that time, we repositioned 80% of our plant assets to match the duration of our plant liabilities and also match the overall credit quality of our plan assets to the implied credit quality of the yield curve used to discount our liabilities.

This action was designed to mitigate a substantial amount of the volatility in changes to our funding requirements and our pension expense that may have otherwise occurred due to the volatility in the equity markets. As a result, from a cash funding perspective our funded ratio as of January 1, 2010, is expected to be about 90% under the pension protection act methodology. due to credit balances we’ve accumulate from our voluntary discretionary contributions in prior years, we have no current year funding requirement.

While not required it is been our practice for each of the last five years to contribute $30 million to our plan, an amount approximately equal to the benefits earned annually by our active plan participants. we anticipate contributing $30 million to our plan again in 2010. from a non-cash accounting perspective, we expect our 2010 pension expense to be $59 million.

Moving to general and administrative expenses, as I mentioned earlier, G&a expenses not included in the segments was $70 million in 2009. For 2010, these expenses are expected to be in the $71 million to $73 million range, or about $18 million a quarter. this modest increase is due entirely to our hire pension expense. On share based and long term incentive compensation, a significant portion of our share based awards are cash settled awards. As a result changes in our share price have a direct impact on our share based compensation expense.

In 2009, our share based and long term incentive compensation was $58 million as our share price increased by over $16 a share from year end 2008 to year end 2009. in 2010 this expense is expected to be approximately $32 million based on our year end 2009 share price. in 2010, for a $1 change in our share price, the impact to share based compensation expense should be about $2.3 million, similar to 2009.

Interest expense; interest expense on our debt was $63 million for the full year 2009, with our debt reduction of $482 million during the year and the retirement of a significant amount of high coupon fixed term debt, our fourth quarter 2009 interest expense of $13 million is a good proxy for our run rate expense in 2010.

In 2010, interest expense is expected to be in the $50 million to $52 million range, or about $13 million a quarter and finally, for tax rates in 2010, the guidance I would give you at this time would be to use 39% for an effective tax rate on a book basis and on a cash basis, due to our significant level of alternative minimum tax credits, we will remain a 20% cash taxpayer in 2010.

That concludes my comments.

Doyle Simons

Thank you, Randy. in terms of our financial priorities, we understand the importance of a dividend to shareholder value and one of the few companies in our industry that did not cut our dividend during this downturn.

[Technical Difficulties]

In terms of our financial priorities, we understand the importance of a dividend to shareholder value and are one of the few companies in our industry that did not cut our dividend during this downturn. last Friday, we raised our annual dividends by 10%, $44 per share, which reflects confidence in our ability to continue to generate cash flow and our commitment to return cash to shareholders.

Another financial priority is to reduce debt. we reduced debt by over $480 million in 2009; we believe we can create value for shareholders by continuing to pay down debt. our targeted debt-to-capital ratio is in the 35% to 40% range. we were also continuing to invest in our business. we have invested very wisely in our business over the past number of years and those investments have clearly contributed to our current returns.

Box plant transformation two is a compelling opportunity to invest capital to further transform our box plant system and drive up ROI for shareholders. Finally we will look for opportunities to profitably grow our company but as always we will be very discipline based on ROI. we are constantly looking for acquisitions that are consistent with our strategy and meet our ROI goals.

In summary, 2009 was an outstanding year for Temple-Inland. we demonstrated our ability to execute through the recession as we improved segment operating income by $135 million, reported record earnings in corrugated packaging, generated $640 million of cash from operations, and reduced our debt by $482 million.

Looking forward, economic conditions appeared to have stabilized and seem to be on a slow path to recovery. in corrugated packaging we have demonstrated that execution of our strategy focused on integration, driving for low cost, improving mix in margin, and profitably growing our business throughout superior relative returns even in tough economic conditions.

As the economy improves, we are focused on continuing to improve our relative returns and are confident that box plant transformation two will further lower costs, improve our mix in margins and drive up our returns. in building products fourth quarter 2009 was a very difficult quarter as demand in pricing fell for all our products. the market tone so far in the first quarter is improving, especially in lumber. However, log availability and cost continue to be an issue due to the extremely cold and wet weather. As housing rebounds we are well positioned to capitalize on the recovery.

Thank you and, operator we will now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) your first question comes from Chip Dillon – Credit Suisse.

Chip Dillon – Credit Suisse

I was going to ask you, Doyle, you mentioned that you were going to see $10 million I believe in 2010 from both box transformation programs, is that correct, so you are going get a total of 20, the last ten from one and the first ten from two.

Doyle Simons

That is correct, Chip.

Chip Dillon – Credit Suisse

Then just another clarification from Randy, in terms of the black liquor credits, you mentioned you got a big refund in the fourth quarter, and I know a lot of other companies are talking about getting refunds when they file their tax returns during the course of 2010. Does that mean that you are using a different methodology like the excise tax method and therefore the liquor credits you think will be taxable?

Randy Levy

First, Chip, the tax refund that we got in the fourth quarter was really due to 2008 and really didn’t have anything to do with the alt fuel. As far as the alt fuel credits, we don’t believe that they are taxable, but believe that they might be subject to alt min tax at a cash tax rate of 15%.

So what we did is, we paid into the IRS 15% or $34 million, and if we’re right, then we will get that $34 million back. If we’re not right, then we will only owe another $11 million and what we’ll do is, we will use our alternative minimum tax credits, we’ve got about $280 million of them to cover the difference.

Chip Dillon – Credit Suisse

So the way to think about it is you really have no more money you pay in and you may receive another $34 million into your tax return in 2010?

Randy Levy

Chip Dillon – Credit Suisse

The charge of $125 million, and the $2.3 million per point in the stock, is that pre-tax or after tax?

Randy Levy

Those are both pre-tax numbers.

Operator

Your next question comes from George Staphos – Bank of America.

George Staphos – Bank of America

Two questions, Doyle or Pat, if you could comment a bit on how box plant transformation two might differ from one, either in terms of the activities, what the challenges might be now, since it looks like you are taking out maybe a larger amount of machines and facilities, how you balance that across the system?

Then a similar question, although aimed at building products. last year in the fourth quarter, you had obviously an operating loss, you’ve done a good job on EBITDA, it struck us back then that the company really redoubled its efforts to return to profitability at that point in time. tell us if you can give anything else with your existing building products business or with your operating stance, so as to close a gap on profitability independent of pricing?

Doyle Simons

I’m going to ask Pat to answer the first question.

Pat Maley

Relative to box plant transformation two, I guess I would characterize it more as an extension of the learning’s and our success if you will of box plant transformation one. I mean, we spent a lot of time over the last 12 months planning and replanning and configuring and reconfiguring our ideas around just exactly what the investment would be, in which locations and how we would successfully manage it and drive the cost savings to the bottom line.

So I guess as an organization we’re pretty excited about it. We’re actually pretty confident about the execution of it and if anything, I think we can beat what we’ve highlighted here as savings.

Randy Levy

George, on your second question regarding building products, if you take out the onetime $4 million charge, we lost $14 million in the fourth quarter of 2009, which was inline with the loss in the fourth quarter of 2008. You’re right. we did redouble our efforts in the fourth quarter of 2008 and continue to drive down our costs.

However, what you’ve got to factor in is that housing declined another 16% in fourth quarter of 2009 versus fourth quarter of 2008. As a result, demand and pricing was down for all of our products in that period of time and in addition to that, you had higher energy costs and we’ve had extremely wet weather in the south, which has had a significant impact on our long cost as well.

Pat Maley

We made some targeted investments in our building products business here in the fourth quarter specifically around kilns and drying efficiencies at our pineland sawmill and also some work and some boilers that are going to decrease our overall energy consumption and allow to us make more products, more lumber at lower cost, so we are pretty excited about that.

Doyle Simons

George, we are working every day as we do in both our businesses to continue to drive down our cost and we will have some more opportunities to do that as pat just outlined.

Operator

Your next question comes from Gail Glazerman – UBS.

Gail Glazerman - UBS

I was hoping you could talk a little bit more about the cost environment on the corrugated side, particularly in the mills? are you having similar wood procurement production outage issues in the first quarter and any signs of if the situation improving, do you expect it to improve?

Pat Maley

Gail, Pat, yes, I mean wood cost in the fourth quarter was the real unexpected and unwelcome surprise. we had a spike in October, it started to correct itself and then a second boat of unusually wet weather caused another run up in December. Wood costs, pulpwood costs are coming down in January. I would say they are a little bit stubborn, but they are headed down in January and we would expect them to get more to a normal condition in the second quarter, but they are starting to come down, Gail.

Gail Glazerman - UBS

It’s not affecting production this quarter.

Pat Maley

We haven’t lost; knock on wood, anytime in the quarter yet for lack of fiber.

Gail Glazerman - UBS

Can you give maybe some similar views on how you see OCC playing out throughout the year, obviously you talked about the rise in January and February but do you think this is something of a sustainable path or maybe something more like a shock?

Doyle Simons

As we said, Gail, OCC was up $38 per ton in January and we anticipate it to be up another $20 to $25 in February. It’s always very difficult to product what’s going to happen with OCC prices, but it’s our sense that from this level they could stabilize and even moderate some as we move forward. With that said we’ve always indicated that we thought OCC over a period of time could and would be a higher price source of fiber than virgin wood.

Gail Glazerman - UBS

Just last question, you talked about I guess January being phenomenal level in terms of box volumes. is that something that’s continued into February and to any sense what might be driving that, is it something you view as sustainable.

Doyle Simons

What we saw was December demand for boxes was strong. that trend continued into January and has been the same way for the first few days in February. I will let Pat address kind of what we thinking may be driving that.

Pat Maley

I mean, I think peoples, our customers inventories are very lien and I think there is a little bit of restocking. I think that our customers are looking out and feeling better about their businesses and demand from their end users. so I think there’s a gradual improvement in the overall economy and we are seeing it in our box demand.

Operator

Your next question comes from Mark Wilde – Deutsche Bank.

Mark Wilde – Deutsche Bank

Doyle, without getting too specific could you just walk us through in your two main businesses what you think kind of the big puts and takes are going to be here as we look at the first quarter?

Doyle Simons

Let’s talk first about corrugated packaging. I think a couple of the key issues there are OCC, which we’ve already walked through, Mark, clearly is going to have a significant impact on the cost side of the equation and we will have to see how virgin wood plays out as Pat indicated that seems to be improving somewhat, but we are not out of the woods yet in terms of the wet and cold weather.

In terms of the pricing side of the equation, clearly box prices are moving up, but we won’t see significant benefit of that until the second quarter of 2010 and then we are going to be, continued to be very focused on our internal initiatives through getting started on box plant transformation two, but we won’t start to see the benefits of that until later this year.

So I think those are the key issues for corrugated packaging, in terms of building products, Mark, kind of interesting there. As I mentioned in the comments, we’ve clearly seen a rally in lumber prices. the question is how long and how sustainable is that rally. so far that rally has really been a supply side driven rally as opposed to demand side. so it’s still up in the air as to how sustainable that rally is as we move through the quarter.

Offsetting, they benefit from the lumber pricing is, again because of the wet weather. Long cost and long availability are an issue on the soft timber side. in terms of gypsum, those markets continue to be challenging and prices as I indicated are off slightly versus fourth quarter levels.

Particleboard, actually we’ve seen particleboard in MDF. We’ve actually seen improvement in demand in volumes, and prices in that business are flattish. so that’s kind of a quick walk through, how we view first quarter versus fourth quarter in our two businesses.

Mark Wilde – Deutsche Bank

Then, Doyle, coming around to this box plant two initiative, in the past you’ve suggested, that you’ve been real happy with returns on the mill side of your business, but box plant returns have really been sub par. If you take into account both the incremental capital into the business, plus the benefits that you are going to get from that, how will your return on investment look in the box business three years out?

Doyle Simons

Yes, the comment we’ve made historically, Mark, is from an industry perspective, this industry has done a decent job of generating returns, but a very poor job of generating returns on the box plant side. so that’s what box plant transformation one was all about and that’s what box plant transformation two will do is continue to drive up the returns on the box plant side of the system.

Our goal is to maximize ROI for our shareholders. first, we have our mill system where it needed to be and we now have one of the lowest cost mill systems in the industry. After we complete box plant transformation two, we will have the lowest cost box plant system in the industry and you will combine those two and that’s the way we’re going to continue to drive up ROI for shareholders.

In terms of quantifying what that will be, like I said, we will continue to be quantify the benefits of box plant transformation two on an annual basis and at some point, Mark, we will provide you some guidance on the overall ROI from our box plant system.

Mark Wilde – Deutsche Bank

Then finally, Doyle, your balance sheet seems like you’re pretty much at your debt targets right now, can you just talk about sort of acquisition strategy on both sides of the business? what you would be looking for and your willingness to pursue things in both building products and containerboard?

Doyle Simons

Sure, let me make a quick point on our balance sheet. While we are approaching our debt to cap target level, Mark, we’ve still got a little room to go. so we will continue to pay down debt in the near term. in terms of acquisitions, clearly as we’ve consistently said we would like to grow both of our businesses, corrugated packaging and building products.

We will continue to be very disciplined based on ROI, disciplined based on the impact of any acquisition opportunity on our balance sheet, but in terms of corrugated packaging, as we’ve said, I think in response at a question had you on our last call, this is a business or a business model that is very scalable.

We have proven through box plant transformation one that we can drive down our cost in our box plant system and while we clearly as indicated by box plant transformation two, don’t have to grow. we have significant opportunity in our box plant system to continue to drive down our cost.

It is a model that is scalable and could be applied across a larger system. in terms of growth in building products, we are focused on possible growth opportunities there that are consistent with our products win, consistent with our strategy and consistent with our geographic location, which is primarily focused on the South and Southeast.

Operator

Your next question comes from Mark Weintraub – Buckingham Research.

Mark Weintraub – Buckingham Research

I think you said but if you can repeat what was the timing expectations on the box plant transformation program for the benefits?

Doyle Simons

Box plant transformation two timing benefits we said we would get $100 million in lower cost, $10 million in 2010 and I want to highlight roughly, between 2011, 2012 and 2013. As we said in our comments just as it was in box plant transformation one, those numbers will be lumpy, will not be linear, but that’s our best guidance in terms of timing. in terms of the capital spent, again there it will be roughly in this $250 million in capital, it will be roughly a third, a third, a third in 2010, 2011, and 2012.

Mark Weintraub – Buckingham Research

Then kind of following up on the last question coming at it a little bit differently, I understand that there’s still some more debt pay down, but you are interested in doing. What’s your general thought towards share repurchase if you continue to be generating the very sizeable amounts of free cash that you have been?

Doyle Simons

As indicated by our recent increase in our dividend, we are focused on returning cash to shareholders. However, with that said and as I mention in response to Mark Wilde’s question, our near term focus is going to continue to pay down debt. we also have had this compelling opportunity to invest capital in our business and we are really excited about box plant transformation two and we will also look to profitably grow our company through acquisitions. so, all of those are on the list, Mark, but in terms of near term priority, I can tell you that paying down debt is the focus.

Mark Weintraub – Buckingham Research

Then just lastly, if you were to characterize putting through the January price increase, what is that telling you about the market today versus prior times when you’ve potentially put in the first price increases? is there anything that we should be taking a way from the experience you’ve been having, do you think.

Pat Maley

I would just comment that the box price increase is moving smartly. I guess that’s how I would characterize it. we expect the majority to be realized in the second quarter and, as you’re well aware, there’s January price increase in linerboard a corresponding increase in boxes hasn’t happened that many time in the history of this industry so I think there is some, something to be had there in terms of learning and that’s just I guess how I would leave it.

Mark Weintraub – Buckingham Research

Maybe given that costs have obviously eaten into a fair amount of the price increase, what do you see as the biggest obstacles or hurdles to getting a second price increase?

Doyle Simons

Mark, we are not going to speculate on further price increases. However, I would highlight that industry conditions are very constructive. You have demand improving as we already talked about. You have operating rates increasing and you factor in the closures, operating rates are in the 94% to 95% range, and the in, industry inventory levels are at currently the lowest level they’ve been since 1994.

Operator

Your next question comes from Richard Skidmore – Goldman Sachs.

Richard Skidmore – Goldman Sachs

Just a couple questions coming back to box plant transformation number two, are there any remaining box plants that aren’t impacted by box plant number two and that were not impacted by box plant number one such that there might be a third iteration of this or does this really get you to having addressed all of the issues in your box plant system?

Pat Maley

I would say that at the end of transformation two, the vast majority of our plants will have been reconstructed, if you will, and yes, there will be a few plants that will not have been touched by one or two, but at the end of this we are going to have the premiere corrugated converting plants I think in the world, and I think Doyle mentioned it, but we are not just focused on the cost side.

Clearly the returns are solely based on taking out hard cost dollars, but the big part of box plant transformation two is the equipment and the technology that we are putting in place, that are going to allow to us target a richer section of the customer portfolio, if you will, and the very flexible equipment technology that can leverage graphics and short order quantities, and that’s typically where there’s a little bit more margin.

So we are pretty excited about the cost side of transformation two and completely added is the mix in margin improvement that we expect to get but isn’t in the stated returns.

Richard Skidmore – Goldman Sachs

Just maybe to follow up on that topic a little bit more, how does this impact the overall capacity and ultimately your integration back to the mill level?

Doyle Simons

Well, if you recall just a little context, I guess, when we acquired Gaylord, we had 82 box plants and we’ve been able to kind of grow the mill system up about 100,000 tons, 150,000 tons depending on the year, from that level and we’ve also been able to grow our box business in lock step was about 19 fewer plants. so we have lots of really good ideas on the mill side such that we can bring both up together. so we like being integrated. we think it provides benefits relative to the export markets and we see that continuing.

Richard Skidmore – Goldman Sachs

Okay, maybe just one last question if I might just on again this transformation. will you be deploying people that were involved in box plant number one at their respective facilities and moving them to the facilities that you are going to be undertaking box plant number two with?

Doyle Simons

Yes, I mentioned that we are pretty confident about two because we’ve been through it with one. We’ve learned a great deal of how to do it and keep customers happy and grow our business. We’ve learned how to do it from an equipment installation and ramp up standpoint and keeping costs down. so, we share best practices and best people across our business as the need arises.

Operator

Your next question comes from Joshua Zaret – Longbow Research.