Graphic Packaging Holding Co (GPK) 2004 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Graphic Packaging Corporation second quarter earnings conference call. (OPERATOR INSTRUCTIONS). Mr. Winhold (ph), you may begin your conference.

(technical difficulty) that the Company's expectations made on this call are forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the Company's historical experience and its present expectations.

Undue reliance should not be placed on such forward-looking statements as such statements speak only of the date on which they are made. Additional information regarding risks facing the Company is contained in the Company's periodic filings with the SEC, including our 10-K for 2003 and 10-Q for second quarter '04.

Almost one year after the merger I'm am happy to report that the integration of the Company's operations has succeeded exceeded expectations. And we continue to enhance our leading market position in the folding carton industry.

The Company has accomplished this by following the key business strategies that would defined at the time of the merger including achieving greater merger related synergies than was planned. Second, we have taken embedded cost out of our production system through our Six Sigma and continuous improvement programs. And third, since our merger topline growth has increased due to penetration of new markets, product innovation, and cross-selling. As a result, we have exceeded prior year's results. Also, we remain focused on cash flow generation to pay down debt and increase shareholder value.

Despite unfavorable business conditions, such as inflation for key raw materials like energy and fiber, increased freight costs due to higher fuel prices and changes in the regulatory environment, and downward price pressures for packaging cartons, we reported a year-over-year increase in second quarter earnings. This increase was driven through the successful recognition of merger related synergies, continued efforts to reduce operating costs, and improved manufacturing efficiency as illustrated by increased throughput and lower scrap than was planned.

We're well ahead of our first-year target of 17.6 million of synergy recognition. In the second quarter alone we achieved over $18 million of merger related synergies, bringing the total since the closing last August 8th to approximately $37 million. We're meeting or exceeding our goals in all synergy categories, including disciplined reduction in excess overhead, more effective leveraging of our purchasing power, rationalization of our manufacturing assets, and integration of the Company's paperboard production into its folding carton converting system.

For example, over the second quarter the Company has continued to decrease its purchases of coated board from a competitor, further reducing the annual run rate to 15,000 tons from the original 50,000 tons.

Over and above the achievements of our synergy program, we are continuing to take embedded cost out of our operations. During the second quarter we generated over $8 million in cost savings due to our ongoing continuous improvement projects. This brings year-to-date cost savings to approximately $15 million.

These savings are a result of projects like our effort to reduce steam consumption per ton on board produced on our No. 7 paper machine at the West Monroe Mill, and through the elimination of chemicals historically needed to counteract upstream caustic usage at our Macon, Georgia paper mill. On the sales side, during the second quarter we began to recover a portion of the CCE, or Coca-Cola Enterprises business, which was lost in 2003 due to nonrenewal of a contract. On a year-over-year basis second quarter 2004 shipments to CCE exceeded that of the second quarter in 2003.

We also continue to see topline strength in the Food and Consumer products sector. As mentioned in the last call, new customer mandates gained in late 2003 and the first quarter of this year have fueled increases in year-over-year net sales through June. In addition, I am pleased to say that during the second quarter we have received formal commitments for new business from both Quaker Oats and General Mills. This incremental tonnage will begin to run through our system in the fourth quarter of this year and into early next year.

On the new product front we're continuing to penetrate a wide variety of sectors within the Food and Consumer products industry. In regards to the microwavable technology, for example, Heinz has launched their Easy Fries in our patented receptor (ph) carton. We also qualified a high barrier innovative canister for Kraft Maxwell House coffee incorporating our integrated board solution. Also we have launched Procter & Gamble's Daily Facial Pillows in the CUK barrier canister package. Our integrated board solution helped to enhance the composite pack high-quality graphics that P&G required for this unique, nonplastic packaging solution used in this product.

Finally, an example of cross-selling opportunities provided by the merger is the recent roll out of our Z-Flute application by Kraft in their Taco Bell Grande product.

On the beverage side, the adoption of our Fridge Vendor carton continues at a rapid pace. In addition to Miller Beer's roll out that was first mentioned in our Q1 earnings release, Heineken and Amstel Light have adopted the innovative 2 by 6 packaging configuration.

Although I am pleased with the beverage market's overwhelming acceptance of the Fridge Vendor we are the way a victim of our own success. The market's demand for this product has exceeded our expectation and has outpaced our new manufacturing strategy investment for producing it cost effectively. This has resulted in some negative manufacturing variances which will continue throughout the calendar year until all pieces of the Beverage division recapitalization are in place.

Overall, our mills and converting plants performed solidly during the quarter. All 3 U.S. mills ran at full capacity for the entire period. No market related down time was incurred and none is forecast at this time.

Our Food and Consumer product carton converting plants showed improvements in all areas. Productivity continued to improve across the manufacturing network resulting in better asset utilization and cost savings being at or above planned levels. In particular, focus on spoilage reduction has resulted in a year-over-year 10 percent decrease in scrap rates.

Aside from Fridge Vendor, our beverage carton converting performance during the quarter was marked by the implementation of automation equipment in Cincinnati, Ohio and West Monroe, Louisiana and the startup of additional converting equipment at Perry, Georgia. The Perry start up is progressing favorably with our current plant output ahead of expectations.

And strong operational performance, however, was somewhat offset by rising cost of energy, particularly natural gas, and increased pricing in the secondary fiber market. On the supply chain side we have experienced increased costs related to freight. Higher diesel fuel prices coupled with revised hours of service regulations implemented early this year, has resulted in higher freight costs for the second quarter of '04 versus last year's second quarter.

Although a limited aspect of our business, we are pleased to see that the overall conditions impacting the Company's container board business began to improve during the second quarter. Specifically, we witnessed a second quarter year-over-year volume increase of approximately 8 percent. This volume increase was driven by our higher margin corrugated medium and Kraft bank (ph) product lines. In addition, after a long period of price stagnation tight supplies have made a significant impact on pricing as price increases in the media markets begin to take effect during the second quarter.

In summary, I would like again to review the status of our ongoing business strategy. First, we are increasing sales opportunities through cross-selling and product innovation. This was illustrated during the second quarter through the rapid adoption of our Fridge Vendor, cross-selling of our Z-Flute product line, and cross-selling into international markets, along with numerous new packaging innovations made by our Food and Consumer product customers.

Additionally, our synergy efforts and Six Sigma programs continue to accrue benefits, to a greater degree and faster than we had planned. Successful execution of these strategies, along with a disciplined approach to capital investment and working capital, will generate increased cash flow allowing us to accomplish our ultimate goal of debt reduction and increased earnings per share. During the second quarter debt was reduced by approximately $71 million. Finally, our continued expectation has reduced total debt by approximately $100 million during 2004.

And now John Baldwin will review our financial performance for the quarter.

Good morning. As Steve has indicated, we are pleased with the progress that our Company has made since the merger of Riverwood Holding and Graphic Packaging International Corporation last August. Just as a reminder to you the merger was accounted for as a purchase, and so our comparative income accounts for the second quarter as reported reflect only Riverwood's results for the 2003 quarter, while the financial statements for the 2004 second quarter, of course, reflect those of the combined company.

So most of my comments today are going to be reflective of the comparisons of the actual second quarter '04. And I'll compare those to the 2003 second quarter on a pro forma basis to provide a bit more clarity. You'll see that we have again included in our earnings release an attachment which provides those operating results for the combined companies on a pro forma basis for the individual quarters of 2003, all assuming that the merger had occurred at the beginning of 2003. And we hope that helps your understanding of our results.

The Company reported in the second quarter net income of $200,000, or basically breakeven on a per-share basis, compared to a net loss of $3.9 million or 2 cents a share on a pro forma basis for 2003's second quarter. Our second quarter 2004 net sales were $606.3 million, which was up $7.3 million or 1.2 percent as compared to pro forma net sales of $599 million in the 2003 pro forma second quarter. The increase was mainly driven by favorable foreign exchange rates which made a positive contribution of $7.6 million to sales for this most recent quarter.

Our international sales are $107.8 million in the quarter, which is approximately 18 percent of our total Company sales. Year-over-year pricing for both Beverage as well as Food and Consumer product cartons declined, but as Steve indicated, lower prices for cartons were somewhat offset by a rebound in the prices for container board. As a result our container board sales actually increased $2.9 million or 14.9 percent over the pro forma 2003 quarter.

Gross margins for 2004 second quarter was $98.1 million, or 16.2 percent of sales as compared to a gross margin on a pro forma basis for the second quarter 2003 of $93.3 million or 15.6 percent of sales. Income from operations for the 2004 second quarter was $36.7 million, or 6.1 percent of sales. While 2003 second quarter pro forma income from operations was $35.4 million or 5.9 percent of sales.

EBITDA for the 2004 second quarter was 93.4 million or 15.4 percent of sales as compared to pro forma EBITDA of 88.4 million or 14.8 percent of sales in the 2003 second quarter. Credit agreement EBITDA was $104.9 million as compared to $96.4 million in the 2003 quarter. Unlike straight EBITDA, add backs for credit agreement EBITDA include pension, post retirement and post employment benefits, merger related expenses and unusual write-downs.

Capital expenditures for the 2004 second quarter were $30.3 million, 2.6 million of that was spent on our beverage carton manufacturing initiate, bringing the total expenditures there to approximately $56 million out of the total projected expenditure of $75 million over the 2003 to 2005 period. Total capital expenditures for 2004 are still expected to be roughly $150 million as we have previously indicated.

A number of pluses and minuses resulted in the relatively small net increase year-over-year on our income from operations. I would like to take you through those. Positive impacts on the quarter, as Steve has already mentioned, included the recognition of merger related synergies resulting in favorable second quarter costs of approximately $18 million. On a year to date basis the Company has achieved more than $28 million in merger-related synergies. And this, along with the approximately $8 million achieved in 2003, puts us well ahead of schedule according to our original timetable for the synergies.

We continue as well with the additional cost savings to be realized from our Six Sigma and other continuous improvement programs. These incremental savings totaled over $8 million in our second quarter bringing the year-to-date total to approximately $15 million, as Steve indicated earlier.

However, offsetting these positives were the negative manufacturing variances resulting from the strong demand for our Fridge Vendor package, increased energy costs at our U.S. mills of approximately $2.5 million in the second quarter as compared to the pro forma 2003 second quarter. Natural gas makes up the majority of our energy consumption as the combined companies have historically consumed nearly 10 million MMbtu's of natural gas each year. And the second quarter variance versus last year is attributable to an approximate 20 percent increase in our costs for natural gas.

Increased fiber costs at our U.S. mills of $2.4 million in the second quarter as compared to the pro forma 2003 second quarter was another contributor to our income from operations. In addition to virgin fiber -- the Company purchases approximately 400,000 tons per year of secondary fiber mainly for use at the Kalamazoo recycle plant.

We also had higher freight costs, as Steve mentioned, on a second quarter year-over-year basis. And then items that are affected in the income from operations, but not cash, would include depreciation and amortization expense, which was $56.7 million for the 2004 second quarter as compared to $53 million on a pro forma basis for the 2003 quarter.

Depreciation and amortization, as I believe we mentioned in last quarter's conference call, includes amortization of intangibles of $7.6 million resulting from the merger, which will decrease significantly in the third and then finally in the fourth quarter of the year.

We also had a charge of approximately $1.9 million in the quarter related to asset retirement at our paperboard mills which is reflected in other expense on the income statement.

Finally, selling, general and administrative costs of $49.2 million, which was 8.1 percent of sales in the 2004 second quarter compares to 47.8 million or 8.0 percent of sales in the 2003 pro forma second quarter.

I will add just a few comments on the balance sheet to close. At the end of the second quarter we had 5.3 million in cash and approximately $293 million available under our revolving credit facility. Our total revolver commitment is $325 million. And as of June 30, we had 21.4 million of cash borrowings and 10.9 million in outstanding letters of credit. At the end of the second quarter total debt was $2.147 billion representing a decrease of $71.2 million from total debt at the end of the 2004 first quarter.

The debt decrease in the second quarter was a result of improved operating cash flows, lower capital expenditures, and $9.2 million of proceeds from the sale of our Garden Grove California plant. The proceeds from the Garden Grove sale approximate our expected cash expenditures related to the ongoing Food and Consumer product carton manufacturing and restructuring initiative.

To reiterate a point we made in last quarter's conference call, timing will have some impact on our debt reduction progress, as you can see from our cash flow generation over the last two quarters. Specifically, we pay semi-annual fixed interest payments of approximately $38 million related to our public notes in the first and third quarters.

This is, as well as fluctuations in working capital related to the seasonality of our sales, as well as the timing of capital expenditures, will result in the greatest progress toward our debt reduction goals being made in both the second and fourth quarters of each year. So as a result, we expect that most of our full year debt reduction target of approximately $100 million will end up coming in the fourth quarter of the year.

With that, operator, we will open the line for the question and answer session.

(OPERATOR INSTRUCTIONS). Joe Stivaletti of Goldman Sachs.

I was trying to just fill in some of the blanks in terms of the year-over-year change in EBITDA looking at your using credit agreement EBITDA. You showed up about 8.5 million year-over-year. You mentioned some of the negative variances that you quantified, energy, fiber, the asset retirement charge. But you also mentioned that, if I understood you right, that mergers synergies and other cost savings totaled -- 18 plus the 8 million, so about 26 million year-over-year? Is that the right way to look at it?

Yes.

So I was just wondering when we look at a positive there of about 28 -- 26 million and those other factors that you quantified were only in the sort of 7 million range -- I was trying to quantify some of the other negatives. I know you mentioned pricing was down year-over-year on the carton side. And you mentioned the manufacturing inefficiencies relating to Fridge Pack. I am just trying to understand it so that we can look forward.

All-in in beverage, which is manufacturing and transportation, would be about $4 million in the quarter. And I believe we have previously discussed that the year-over-year decrease across all sectors and pricing is in the 15 to $20 million range. And I wouldn't care to get into how that spreads by quarter.

I'm sorry, the pricing --.

Decrease.

The pricing decrease --.

If you look across all sectors of the Company, that we have been averaging selling price reductions in the range of 15 to $20 million per year.

When you talk about the issues with Fridge Pack, and you mentioned in your 10-Q that you think you'll have lower cost there going forward as you have a more efficient setup for that, is that it in the 4 million you just mentioned?

Yes, it is. Basically what has happened, Joe, is that our customers have switched their carton demand from the traditional 3 by 4 12 pack to the 2 by 6. And as we have explained all the way back to last spring when we announced our manufacturing strategy for beverage, that the 2 by 6 doesn't lay out on our existing presses. So when you could run a 3 by 4, 3 across on a press, today you can only run the 2 by 6, 2 across. So you basically lose a third of your throughput. This is mix related.

So you have got to push the production to more and more presses that are higher and higher cost. And it just jams your capacity utilization and it takes your manufacturing cost higher than what it had been previously.

Now the good news is that most of the manufacturing investments that support the soft drink part of the Company are already done and running. And we've got our last major asset coming in, which is a 67 inch Gragur (ph) press that is largely beer related. And that will start up later this fall. So by the end of the year we will have the right assets to support any mix that the customers present us with.

And as we have talked previously, we expect that the run rate of cost reduction in Beverage division from all of the $75 million investment once it is fully completed, is approaching $39 million a year. And we're still on target to get there. We got a bit of a timing jam in '04.

Can you characterize how pricing is, or was in the second quarter versus the first quarter?

I mentioned earlier, I don't want it into quarter over quarter because it really deals with the renewal timing of contracts and the price give back timing by individual customer contracts. And we don't want to get down to that level of granularity.

How about you didn't really mention a lot about overall volume, I believe, other than you said CCE was coming back and was up year-over-year. But for your total carton system how were you year-over-year?

I will let Dave Scheible respond to that since he runs that business.

It was sort of a mixed bag. I'm sure you have looked at the same sort of volume detail in the beverage industry, it is pretty well published. Beer overall was relatively flat. Can volume was down to bottles. And so that certainly had some impact on the multipack. Soft drink volume also was softer and that was primarily down in cans. So we saw some unit drop year-over-year slightly.

In the Food sector, we actually saw increases. There were some -- certainly some impact of the Atkins Diet on things like cereals and cakes, a lot of those kinds of products. But we've also seen our customers launch new products. You know, Atkins-free products or low-carb products. And because of that we are seeing some new product launches or extensions in traditional markets. So actually the Food sector of our business was up. So overall volume was up a little bit, but it was different by sector.

Just one final number question. You mentioned in the quarter about 1.9 million charge related to asset retirements. And I believe the year to date number there is about 4.9 in a non-cash charge. I know for your credit agreement EBITDA you did not add that back, but is there any reason why we shouldn't be thinking of your EBITDA for the first half as being about 4.9 million higher on a sort of normalized basis?

Those charges, Joe, are really related to writing off assets at the mills as we expend capital to upgrade equipment there. So I don't think you would really want to consider those as recurring charges. But clearly that is the difference between the year to date credit agreement EBITDA as well as between that and regular EBITDA, as well as the non-cash pension and (indiscernible) that goes into that difference as well. I'm not sure --.

Okay, so you're saying that the 104.9 in EBITDA has already reflected the adjustment for that? It wasn't clear that that had been added back. I was almost going to say you would add back the 1.9 to the --.

Yes, the 104.9 includes the add back of the 1.9.

Bruce Klein with Credit Suisse First Boston.

It is Kevin Kellen (ph) for Bruce actually. If you guys could comment a little bit on the proposed Coors-Molson merger and implications for board suppliers to those guys, for you guys and maybe the industry generally?

First of all, we don't want to comment too much about individual customer activities. What I will tell you is that we have a solid share at Coors. We don't do a lot of business was Molson, but it creates an opportunity for us on a go forward basis. The Coors business, as you know, is a nonintegrated business for us at this point in time. Coors, like all the beer companies, struggled a little bit in the first half of this year. We've seen that in their volume numbers as well. But the overall impact of the merger itself at this point in time is really not predicted to be significant in either direction.

Bill Hoffmann with UBS.

Steve, can you talk a little bit about the international business? I think you indicated it's about 18 percent right now. I just want to get a sense on whether you have seen some growth, especially in your European business as well as Latin America, because before that has given us some volatility. And I just want to get a sense of where we are there?

Let's start with -- things are small but good in Australia. It is much larger and basically pretty steady on the PAC Rim, which we're heavy in Japan. There is -- after the merger of the two big beer companies in Brazil, the folding carton business for beer just about disappeared. So we have been struggling to figure out how to grow in other areas. And haven't had much of a change over the last 7 or 8 quarters.

Europe, the business is generally okay. We have had a number of new product launches and customer launches. And only one major hickey where one customer went out of paperboard into shrink film, which is a brush fire that we fight all the time around the world.

And we have seen -- I will tell you that we have seen some good launches of some cross-selling opportunities, some new microwave products that had been launched in Europe that through our own -- through our sales and marketing organization now that really legacy Graphic did not have access to. So that part of the business gives us some long-term optimism in growing Europe.

It gets us into the non beverage consumer goods companies in Europe in a way that is important to them, because microwavable convenience ready to eat snack food type stuff is among the faster growing categories. So it is a nice entree for us.

When you look at your business today obviously the folding carton market continues to be oversupplied domestically and is still pretty soft. It seems to be competing products taking as much share as anybody else. How do you look at the next couple of years as far as the business prospects? Does it look like you can get more than GDP type growth, or do you think you're going to be running at below GDP growth?

You tell me what GDP number you're using, but if you are picking 3.5 percent, I think we can mark-to-market with that on a nominal dollar basis even after absorbing some price reduction. Whether or not we do it in every quarter is to be determined. But when we look at the pipeline that we have of new product and new technology, and the quotation and presale activities that is underway, there is certainly enough opportunity for us to get to that level. We are certainly not expecting an organic growth of our customers' business.

And then I guess the last question. In your mill system, when you look at coated versus container board, can you give us an idea of where you're running at mix at this point?

I would say our annual production of brown liner on coated capable machines this year will be no more than about 40,000 tons. We are running a like amount of coated liner board on those same machines for both post print and pre-print liner applications where we make attractive margins. For the score keeping purposes, that is really a coated category. And then our bag Kraft machine and our medium machine are basically dedicated to those two product lines, so they will continue to produce those grades.

As you start to see some further increase -- price increases in the liner board side, is there point in time where you start to think about pushing more liner through there?

Never. I'm a reformed center. Now, that is too cyclic. We like the coated board business, particularly our end of it because the pricing and margin structure is pretty stable. And so the sooner we can pull that needle out of our arm the better we will like it.

Christopher Miller with J.P. Morgan.

I wanted to follow up -- just you had the kind of good news, bad news in terms of the big demand for the Fridge Pack. You know as you look out you kind of touched on this point, but to just to get a sense quarter over quarter how should we think about those inefficiencies working their way out of the system?

They will be gone by the end of the year.

But kind of evenly distributed do you think, just running down over the course of the year?

I would expect that -- that is a very seasonal business, so we will get an equal dose of pain in all likelihood in the third quarter. And then it will drop in the fourth quarter because our shipment scale back at the end of September of the beverage world.

And then previously you have talked a little bit about the multipack for water as well. Do you have any updates on that and what is going on in that business?

There's a lot going on. I'm not allowed to discuss it because our customers are treating it as proprietary information. But the energy level is good. The machine production and placement is ahead of what we have allowed ourselves to project. And as a matter of fact, our overall placement of packaging -- we are going to have the strongest packaging machine placement year in the 7.5 years that I have been with this Company. And a meaningful portion of that is both machines for bottled water, but also machines that can do carbonated soft drinks and PET, because that is another big mix that is occurring is that can volumes, the bottlers want to take down because is is their lowest contribution per ounce, and PET is a lot better. So it is another component of they need new in-plant equipment, but it is also playing somewhat hell with our production mix.

We got the question earlier about growth and Steve commented that we -- GDP growth targets are doable. Part of is also because there is ongoing product mix change that allows things that have not been traditionally multipack to become multipack. And still it is growing off a small base, but if you look long-term we have good reason for optimism to believe more and more of those kinds of products as the margins in those products ultimately become a more mature paperboard it offers a solution to differentiate price points and convenience for customers. And we have generally gained when that -- when those market dynamics have occurred.

Give us a sense of what percentage of your revenue or business right now would fall into packaging for PTE containers?

I would say that it would be less than 5 percent of the soft drink, and effectively zero in beer. If you listen to the bottler conference calls, that is where a lot of their attention is being directed at PET. So I look at it as whatever demand we see is a measure of their success.

And then just looking out a little bit, you clearly set out a nice debt reduction target for the year. When you think about a leveraged number that you're comfortable operating this business on on a longer-term, basis, obviously things are running long along just fine now. Do you have a target in mind down the road?

I think everybody would love to see 3 or something close to it. And how long it takes to get there and whether some opportunity would come along that would drive that up somewhat, who knows? But I think anything under or approaching 4 is a really meaningful milestone.

Along those lines when you think about getting down the road next steps in terms of expansion, would Europe likely be the focus there?

I would have no comment, because in truth our focus is squarely on debt reduction. It is unanimous with our Board. That is where we think we can do a really a good job of creating value for our shareholders in the short term.

(OPERATOR INSTRUCTIONS). You have no further questions.

With that said, operator, we will end the call. Thank everybody for joining us, and we'll talk to you next time.

This concludes today's Graphic Packaging Corporation second quarter earnings conference call. You may now disconnect.