Graphic Packaging Holding Co (GPK) 2004 Q3 法說會逐字稿

Welcome everyone to the Graphic Packaging Corporation's Third Quarter Earnings Release Conference Call. (OPERATOR INSTRUCTIONS). I would now like to turn the conference over to Mr. Scott Wenhold, sir you may begin your conference.

Thank you operator, and good morning everyone. Welcome to Graphic Packaging Corporation's third quarter earnings call. Commenting on our results this morning are Steve Humphrey, the Company's President and CEO, and John Baldwin, our Senior Vice President and Chief Financial Officer, David Scheible, our COO is also on hand to answer questions at the end of the presentation this morning.

Statements of 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 subjected 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 as of the date on which they are made. Additional information regarding risks facing the Company are contained in the Company's periodic filings with the SEC including our Form 10-K for 2003, and our 10-Q for the third quarter '04. Steve, I will turn it over to you.

Good morning, yesterday the Company announced a profit of 3 cents a share for the third quarter of 2004. The positive news comes despite unfavorable business conditions, particularly inflation for key raw materials like energy, fiber, specialty chemicals, and coatings. Quarterly results reflect the continued successful execution of the Company's long-term business strategies.

First we continue to grow the topline. As John Baldwin will touch on later, the third quarter year-over-year net sales have increased more than 5 percent, led by an increase of approximately 3.7 percent in North American carton sales. Despite increasing pricing pressures, topline growth is being achieved through the penetration of new markets, through product innovation, and by taking advantage of cross selling opportunities. As I have consistently stated in the past, both innovation and cross selling are 2 of our key long-term strategies. Our patented Fridge Vendor carton continues to be rolled out by beer and soft drink producers. Now with the third quarter introduction by Pepsi's Aquafina, the Fridge Vendor is making major in roads into the bottled waters market, one of the fastest growing segments in the US beverage market.

I'm also happy to announce that we have completed our strategic alliance with Cin-Made Packaging Group, to exclusively distribute their DorPak Rigid Barrier container in North America. The DorPak container is well suited for a wide range of products including detergents, lawn and garden products, pet products, and food and snacks. These distinctive packages allow Graphic Packaging to showcase our lamination expertise while providing the point of purchase distinction our customers demand. Also the food and consumer product side, during the third quarter we announced the launch our newest microwavable technology, the Quilt Wave. This flexible package greatly expands the food applications that can be prepared in the microwave oven. The Quilt Wave addresses the consumer's desire for what we call grab and go convenience as food product itself gets hot but the inside of the package that is cool enough to be handled safely.

In addition to innovation, the Company continues to leverage the cross selling opportunities that we created by the merger. During the third quarter, a long time legacy Graphic Packaging customer, Quaker, launched its instant Quaker Oats club store variety pack in the Riverwood patented Z-Flute application. The merger also created significant global opportunities as a result of the legacy Riverwood system. In other words Riverwood's converting operations and sales channel have made it possible to service existing legacy Graphic Packaging customers now on a global level. For instance, in the UK, we are now providing serial boxes to Kelloggs, formerly a legacy Graphic Packaging domestic customer. Finally, we are continuing to convert folding cartons away from competing substrates like SPS, and in some cases coated recycled board into our own CUK board. Since the date of the merger, CUK volume has increased by an annualized 40,000 tons to a combination of existing and new business conversions.

The second prong of our strategy involves improvement of net earnings through cost reduction. As mentioned in the last call, I am quite pleased with the integration of the 2 companies that has occurred since the merger. Specifically, we are now running at a target of $72 million per year run rate for recognition of merger-related synergies. And I am proud to say that we have accomplished this goal at a much faster rate than the 3-year time frame that was set up or set out when we announced the merger. One facet of our synergy program is the rationalization of manufacturing asset and that continues. In addition to our beverage manufacturing strategy, we are moving towards the completion of our sheet-fed modernization program.

Already announced plant closures in Clinton, Mississippi, and Bow, New Hampshire will be supplemented with building of a state-of-the-art sheet-fed converting facility in Port Smith, Arkansas. This facility to be completed in mid-2005 along with the modernization and expansion of our Lumberton, North Carolina plant is expected to result in approximately $19 million of improved productivity and cost structures. Over and above the achievements of our synergy program, we are eliminating embedded cost from our operations. During the third quarter, we generated over $4 million of cost savings due to our ongoing continuous improvement projects. This brings year-to-date cost savings of approximately $19 million.

On the production side our US mills performed well, and ran at full capacity for the entire period. No market related downtime was incurred and none is forecast at this time. At our food and consumer product converting operations, productivity continued to be strong, relative to throughput, waste reduction and fixed cost reduction. On the beverage side the Perry, Georgia expansion and modernization project progressed favorably during the third quarter, with the new equipment fully utilized and operational. In addition, acceleration of the Clinton plant closure is planned to minimize disruption on operations. Unfortunately as in the previous quarter, unfavorable variances related to rising prices for energy, fiber, specialty, chemicals, and coatings negatively impacted performance and is expected to continue for the remainder of the year and likely in the next year. We have also been negatively affected by the high cost of oil as freight carriers pass through higher diesel fuel costs.

On a better note, business conditions have improved on the containerboard side. After several years of over capacity, tight supply has driven increased market pricing for both medium and linerboard. This favorable pricing resulted in an increase of approximately 39 percent in year over year third quarter sales of containerboard. In summary, I'd like to again review our ongoing business strategies. First, we are increasing sales opportunities through product innovation, cross selling efforts, and by integrating products over to our CUK substrate. Additionally, we are managing costs through the accomplishment of our synergy goals and by continuing to streamline and integrate our production system and through our ongoing commitment to Six Sigma and our other continuous improvement programs. Successful execution of these business strategies along with the disciplined approach to capital investment and working capital management will generate increased cash flow allowing us to accomplish our ultimate goal of debt reduction and increased earnings per share. And now, John Baldwin, will review our financial performance for the quarter.

Thanks, Steve. Good morning everybody. We released our earnings for the September quarter last evening, and as Steve said we made $5.5 million of net income in the quarter or 3 cents per share. As many of you now know, our merger last year was accounted for as a purchase by Riverwood of the former Graphic Packaging and therefore the comparative income accounts for the third quarter of 2003 as reported reflect Riverwood's results from July 1, 2003 through the date of the merger August 8 along with the merged company results from August 9, 2003 through September 30, 2003. Financial statements for the 2004 third quarter of course reflect those of the combined Company. In order to provide clarity, we've again included an attachment in the third quarter earnings release, which provides the operating results for the combined companies on a pro forma basis for the individual quarters of 2003. These pro forma statements assume that the merger occurred at January 1, 2003.

Most of my comments today will reflect comparisons of the actual third quarter 2004 results to those for the 2003 third quarter on a pro forma basis. Our $5.5 million of net income for the 2004 third quarter compares to a net loss of $47.6 million or 24 cents per share on a pro forma basis for the 2003 third quarter. The pro forma net loss for the third quarter 2003 included a one-time charge of $45.3 million related to premiums paid to call the Riverwood fixed rate notes and to write off remaining debt issuance costs. Our third quarter 2004 net sales were $617.2 million, which were up $31.8 million or 5.4 percent, as Steve has mentioned, as compared to pro forma net sales of $585.4 million in the 2003 third quarter. The increase in net sales was driven by several factors, most notably a 3.7 percent year-over-year increase in carton sales within our North American market. As mentioned last quarter, year-over-year pricing is down but the third quarter sales increase was driven by higher volumes in both the beverage as well as the food and consumer product sectors.

In the container business, after several years of depressed pricing, a year-over-year sales increase of 38.7 percent was fuelled by increased prices for corrugated medium and linerboard. As in the first two quarters of 2004, we again benefited from the relatively weak dollar. Favorable foreign currency exchange rates made a positive year-over-year contribution of $8.9 million to sales for our most recent quarter. Our international sales were $104.7 million in the quarter, which is approximately 17 percent of Graphic's total sales. Gross margin for the 2004 third quarter was $104.2 a million or 16.9 percent of sales as compared to the gross margin on a pro forma basis for the third quarter 2003 of $100.5 million or 17.2 percent of sales. Income from operations for the 2004 third quarter was 47 million or 7.6 percent of sales. 2003 third quarter pro forma income from operations was $39.3 million or 6.7 percent of sales.

EBITDA for the 2004 third quarter was a $105.8 million or 17.1 percent of sales as compared to pro forma EBITDA of $92.8 million or 15.9 percent of sales in the 2003 third quarter. Credit Agreement EBITDA was $115.8 million, that's compared to $106.2 million in the 2003 pro forma quarter. As you know, unlike straight EBITDA, add backs for Credit Agreement EBITDA include our pension, postretirement and postemployment benefits as well as merger-related expenses, and unusual writedowns. Capital expenditures for the 2004 third quarter were $28.1 million and approximately $5.5 million of that was spent on our beverage carton manufacturing initiative, which now brings the total expenditure on this project to approximately $61 million out of the total projected expenditures of $70 to $75 million, which we expected to occur over the 2003 to 2005 time period. A number of positives and negatives resulted in the increased income from operations. Let me just take you through a couple of those.

First, as Steve has already touched upon, we had positive impact in the quarter including the recognition of merger-related synergies resulting in favorable third-quarter cost as well as our continuing recognition of additional year-over-year cost savings from the Six Sigma and our other continuous improvement program. These incremental savings totaled over $4 million in the third quarter bringing the year-to-date total to approximately $19 million. However, we are feeling the negative effects of inflationary pressures on many of our raw materials like energy, fiber, chemicals, and coatings. Energy costs for the quarter at our US mills were approximately $3.3 million higher than the pro forma third quarter of 2003. As I mentioned last quarter, natural gas makes up the majority of the increase. The purchased electricity also increased on the third quarter year-over-year basis.

The Company also experienced increased year-over-year fiber cost of approximately $2.6 million. As already disclosed, the Company purchases about 400,000 tons per year of secondary fiber, primarily used -- for use at our CRB plant in Kalamazoo. Prices are also starting to increase for another one of our major inputs, specialty chemicals and coatings. As a result, in this quarter, we experienced about $1.3 million increase compared to the pro forma results for the third quarter of 2003. The increase in oil prices has also resulted in higher year over year third quarter freight costs for the Company as fuel surcharges are passed through by freight carriers.

Noncash items that affect income from operations include depreciation and amortization expense, which was $58.8 million for the 2004 third quarter as compared to $53.5 million on a pro forma basis for the 2003 third quarter. Depreciation and amortization includes amortization of intangibles of $5.8 million resulting from the merger. We also had a charge of approximately $2.4 million related to asset retirements, primarily at our paperboard mills, which is reflected in other expense on the income statement.

I will add just a few comments on the balance sheet to close. At the end of the third quarter, we had $25.9 million in cash and approximately $314 million available under our revolving credit facility. As you may know, our total revolver commitment is $325 million. As of September 30, we had no cash borrowings and approximately $11 million in outstanding letters of credit. At the end of the third quarter, total debt was $2.126 billion, representing a decrease of approximately $21 million from total debt at the end of the 2004-second quarter. The debt decrease in the third quarter was accomplished despite making an approximately $38 million semi-annual interest payment related to our outstanding public notes. I just want to reiterate a point we have made in previous conference calls that timing greatly impacts our debt reduction progress, as you can see from the first 3 quarters of this year.

As you may know, we pay semi-annual fixed rate interest payments of about $38 million in the first and the third quarters. This as well as fluctuations in our working capital, seasonality of our sales, and timing of our capital expenditures, results in the greatest progress for our debt reduction goals being made in the second quarter and in the fourth quarter of the year. And so, as a result, we still expect that most of our full-year debt reduction target are approximately $100 million this year, will come in the fourth quarter. With that operator, we will open the line now for the question and answer session.

(OPERATOR INSTRUCTIONS). Bruce Klein, Credit Suisse First Boston

Just with regard to -- if you can give us some more color in terms of pricing and volume. I think pricing was down and I didn't know in what segment -- did that relate to the consumer and how hard it was down year over year?

John talked about the actual pricing impact. The pricing across the board for the most part of the carton business was down. You will start to see movement in the fourth quarter though, Bruce, because we will start to see the pass-throughs of the board increases that were announced early in the year, if you remember, SUS and CRB both had price increases announced earlier this year. We will start to see some impact in the fourth quarter and then we will see a significant impact as we move into '05 as well across the board. So pricing will start to move up in that sector. That is primarily consumer products business. The beverage business is sort of a different structure entirely, so that pricing continues to be pretty flat in the fourth quarter and going forward.

When you guys cite -- you are saying carton, you are talking about folding? When you are citing carton, you're talking specifically folding cartons or board as well or --?

Well, the board increases are separate and of course we don't sell a lot of CRB increases but you will start to see -- for the 40,000 tons we sell externally -- you will start to see pricing moving in the fourth quarter as well. For SUS, again, probably $25 a ton in the fourth quarter for -- the open market tons and then again additional $30 to $35 a ton would have started to move in '05 for the open board sales.

I guess I would have started to move, I thought pricing was doing kind of drifting up year to date, so I would have thought we will start to see some of this already. No?

No. The way the contracts are structure there is delays or some of them are tied to our customers' fiscal years and so on so forth, so what you tend to -- typically for us it is traditionally been a good quarter to 6 months before we start to see some of the prices go through. Until that for us the timing, if you look at when those increases occurred, back in September and in August, you will start to see the fourth quarter or first quarter of '05 when we really start to see those prices flow through not only in board but also in carton.

Okay. And on the volume side, if you guys, I don't know if you are breaking out still, I don't know if I saw in terms of volumes in the US versus international. Are there any colors you can give us how volumes in beverage versus consumer?

Let me start with your first part of it which is international. Our international volumes for the most part were pretty flat. A little bit of improvement in Japan but most of our increases in volume were really in the US business and that primarily this quarter was in our consumer products business as it has been previously talked about, the soft drink business and the beer businesses had sort of a tough year. As you know that beer itself has been pretty flat being attacked by wine and spirits. And soft drinks had an interesting year because of all the pricing through the channel, both at the customer level to distributor level has significantly impacted the volume in take-home cans which is our primary business and so that business in soft drink at least in the third quarter was down a little bit. So most of our volume increased actually within our non-beverage sectors but that was very strong. The low carb business or the low carb issue that we talked last quarter about having some impact in that business is mostly behind us. I think most people figured out that the low carb diet doesn't taste very good so you are starting to see clearly a shrink back at our traditional customers in cereal, frozen pizza, frozen waffles, those kind of things that our core businesses have enjoyed a good third quarter and continue to see strength as we had in the four quarter as well in those sectors.

And lastly just on this Pepsi's Aquafina being packaged now in your Fridge pack. When did that start off and how meaningful could that be?

This is Steve, Bruce. It was a third quarter launch so it is off a base of 0. But as we have talked previously, water is the second largest sector in beverage and it is the fastest growing, and until we started to see some of the coke system put paperboard around their product Dasani. There wasn't any paperboard used in this segment. So, I am not here with a crystal ball, but I will tell you I am very upbeat about the prospects for creating new net demand for paperboard in the folding water segment. There are a lot of machines -- packaging machines, being shipped as we speak, or have recently been placed that are there to support both the water and carbonated soft drink in PET, that will be using paperboard packaging. So, I think there is a lot of traction being gained in that segment.

And do you know, I mean economics -- I might have asked you this couple of months ago, but in terms of the economics of this paperboard packaging for water, versus the other substrate?

Well, there is no question that paperboard is more expensive than the pervasive system which is either high cone rings or corrugated trays with shrink film. Well, what is happening is the growth rate, as I see it anyway, is the growth rate in water has slowed somewhat. The margin compression has been fairly dramatic and we are seeing some real brand building being done particularly by the major national brands like Coke, and Pepsi, and Dr Pepper. And paperboard is an adjunct and we have seen that in carbonated soft drink world and I think it is following over in the water. That is the way that those companies can differentiate their product and ultimately justify charging a higher price. So, I think it is -- water finally, the time got right to put paperboard in.

Okay, I will pass on. Thanks guys.

Joe Stivaletti, Goldman Sachs.

I was wondering if -- you did a good job of telling us the third quarter impact on some of the higher costs. Could you give us a little bit of guidance in terms of the -- what you are expecting for the fourth quarter, what you have locked in, what you have not locked in, in terms of some of those cost movements relative to the third quarter?

Well, there is a couple of different ways of answering that, Joe. This is John Baldwin. I think you are going to see more of the same, would be my first answer to it. We did -- we have in fact locked in natural gas for next year, not completely but at about 80 percent of usage level going out through 2005 and obviously the rates that we've achieved on those natural gas hedges reflect what is currently in the marketplace over the last several months and so you are going to see continuing pressure on the energy side. We are not able to lock in rates of electricity and so we will see some pressure on that side if energy prices in general stay up. But we also are starting to experience, probably increased rates of inflation in some of the other commodity-type expenses that we have, such as chemicals and coatings that we started talking about this quarter. So, I think it is -- I am not prepared to give you a number for next quarter or for next year, but I think it is going to be increasing from the last couple of quarters.

And I guess 2 other questions. I just was curious as to your CapEx thoughts for next year and also your overseas expansion. That was one of the things that you talked about at the time of the merger was being able to take some of the former Graphic products overseas and also I know the old Riverwood products, trying to move them into some other countries other than Japan and I just sort of wondered what is -- if you can give us an update on opportunities overseas and if there are any bright spots there?

Let me just quickly address CapEx and turn it over to Steve for the remainder of your question. We will expect our CapEx to be in approximately the $130 million range or so next year starting to come down as we finish up the manufacturing strategy and beverage. We will obviously have an expenditure to make on our manufacturing strategy and our folding carton side and so still expenditures related to that. That is nearly a $30 million capital expenditure and most of that will occur throughout the remainder of the year. Steve, you want to take the rest of it.

Yes, John. I would take you back to the discussions at the time we did the merger and we described cross selling as a long cycle undertaking. We have had a very thorough examination of what is in -- each respective legacy pipeline in terms of product and new product and have a very comprehensive mapping and actions underway to take those capabilities to markets where we believe there's an opportunity. But we've experienced that it takes 6 to 12 months to get a new concept cemented into a consumer products organization. There's a lot of inertia to overcome and so -- of all the things that we've talked about, I feel that we have the best traction and the most plausible growth curves in Z-Flute. As we know, it's a compelling technical and economic story and we have the right distribution channel now through the legacy graphic organizations in the US. We are continuing to press ahead with broadening our cross selling in Europe, in Latin America, Australia, and into the Pacific rim. Dave Scheible and I will be in Japan in early December. He is going onto China because we think that's timely, largely on the coattails of some of our beer customers to raise our presence over there. And once we're there, then it will give us some platform to take some other things. So, I wouldn't expect any monumental quarterly impacts, but good steady traction.

Steve’s right. Besides the opportunities right now, I would quantify for what we've been be able to do in Europe since the merger, for new product roll out. On an annualized basis, we've added about $10 million to $12 million worth of new products that we're selling in Europe through the relationships that were Legacy Graphic in this country or expanded Legacy Riverwood in Europe. And while that's not a huge base for us, $300 million base in Europe, I guess it's more the value added part. It's microwave, it's laminated structures, it's those kinds of things that we want to be selling more of in our overall product mix. So from that perspective, I think we believe we're gaining traction in the right areas.

Sandy Burns, Deutsche Bank.

I was wondering, at this point in time have you completed the negotiations and discussions with the major soft drink customers and if so, and typically pricing is pretty stable there. But if can you give us any color and what to expect next year in terms of either material changes in pricing or volumes? And then maybe related to that, and you touched upon this earlier, could you talk a little bit more about the Company's efforts to get PET in soft drinks and coated board?

I won't talk specific customer contracts because we never do that, only to tell you that we don't really have any open customer contracts heading into '05 in the beverage business. So for the most part that's there and you know what the structure of those are, they aren’t materially changed. They tend to be non-escalator driven contracts or volume and share. We'll continue to increase in beverage as we go forward, but a lot of our beverage business is going to depend upon how successful our customers are as they -- especially in soft drinks, relative to how they look at repricing their product and getting back to more of a volume driven, unit driven strategic approach in their business. And we believe that's where they are spending the money now, we see that in the promotional activities, and so we are pretty upbeat about volume in soft drink and our contracts will allow us to take advantage of that. Steve talked earlier about the PET. As he said, it's working off a small base. We're placing machines, what we call combination machines, which will run both carbonated soft drinks and water because neither of them have sort of enough volume yet to dedicate a long run high speed machine. But on a combination basis, the bottlers are beginning to use carbonated soft drink in 12-ounce, 12-packs in Fridge Vendor products for both soft drink and water and it's growing off a small base. But we're very optimistic that the convenience, will in fact be rewarded at the consumer level.

I think another kind of way to come out of this -- in addition to us being cheerleaders and extolling the fact that consumers really do like the convenience features associated with Fridge Vendor and maybe our customers might consider expanding it beyond the can pack into PET. We have a packaging machine family called Quikflex, that is particularly well suited for the -- PET application, (ph) whether it's water or carbonated soft drink. We did create a somewhat downsized Junior Quikflex, a 200 series, that had lower throughput and thinking that many of the bottlers would want to stick their little toe in the water in terms of initial capital outlay before they brought a bigger Quikflex 600 or 2100 to be able to support higher volumes. But, the facts are that they have been mainly buying the higher throughput capable machines, which tells me that basically the bottlers are planning on getting their volumes up in PET. So --

I guess there has been some talks that Coke and Pepsi may introduce a 12-ounce PET bottle and if so, I guess, that could be an ideal product to put in the coated board? I was wondering if those customers or others have come to you about those plans and --

That's what -- that's the right size container for take home is 12 ounce.

There are actually in the market --.

There are in the market now.

You could buy them. Regionally, they are doing testing and rolling out. That is the target.

Bill Hoffman, UBS

If you could just sort of give a little more big picture strategically, and clearly you are making -- improving year over year, but given the fact that we've got improving market conditions, I'm wondering if there is anything you see out there that makes sense for you to make a more larger strategic step with your business and kind of what your thoughts are on that? And the second thing is just, as we look into next year, do you expect from a capital structure/cash flow standpoint, just a more continued debt reduction strategy or adding in some bolt-on type acquisitions?

Well, I know that I've got Board members who listen on the call. So, I'm not going to equivocate. Our focus in on debt reduction. That's why we did the merger, that's how both sides imputed that we could create value for shareholders. So, our number one focus is and will continue to be debt reduction. And, yes, we do expect that cash flow -- free cash flow for debt reduction will increase in '05 versus '04. We have some flexibility in our covenants to undertake bolt-on, if there were something out there that we found compelling. But, right now, there is nothing that's on our radar screen that would fit into that category.

And then the other question is, you mentioned you are running your mills at capacity, which I guess to make the assumption for next year's growth, you are really going to be pulling through the converting operations production from others. Any thoughts on your mill capacity whether you would look to expand it in any way?

We do a very comprehensive, what we call, fiber balance to make sure that we've got the right tons, the right grades, the right calipers to support the sales side of that carton, final sales side of the Company. And I think we are in good shape in terms of board supply for the next several years. Those of you that have followed Riverwood know that we've been pursing a mix-improvement strategy for a long, long time. So, it looks to me like in '05, we will finally be out of brown linerboard and then we have a laundry list based on contribution per ton of what the success of our mix-improvement priorities should be. So, -- but we are in good shape. On the other hand, we've also modeled with some great detail of where we would investment to create additionally internal capacity with capital, once and as it becomes required. So, I feel like we are in a very, very good position.

We've also, this year, just by the rebalancing the OEE or the improvement in the mills this year has added 30,000 tons on an annualized basis just in the rebalancing and the improvement in the utilization of the mill capacity and that will continue. We’re not done with that rebalancing, we'll continue to move it. So, we'll see an incremental improvement in the tons available, new tons available, if you will, from our -- primarily from our SUS mills, not so much in CRB, but certainly in SUS.

And it's really a pretty straightforward algorithm. As we've discussed publicly in prior calls, part of the theory of our beverage expansion in Perry, Georgia is to match the output of that carton plant to the production capacity of the paper machine up in Macon, our number 2 machine, by having a relatively few number of presses cut up a very high percentage of our board off that machine. We get our trim up above 99 percent. As we implement the sheet-fed strategy and get Lumberton and Port Smith with standardized wide-format sheet-fed presses, that will improve the trim of the paper machines that supply them whether they are American or West Monroe . So there's just tremendous opportunity to improve our yield and which creates more usable board capacity, which is why among the reasons we are doing this.

Greg Macosko, Lord Abbott.

Could you talk about the costs like energy and fiber and the like, is that adjusted for capacity -- for volumes, excuse me?

If I understand the question, it is actual cost incurred. So volumes were up slightly. So there is a rate component but most of it is just higher cost paid.

Okay. And we should expect the cost for the Fridge Vendor rollout etcetera to continue as you do. In other words, the 4 million you talked about, you'll continue to have those kind of costs as you put out-- put in new product lines for additional customers.

No, the inefficiencies that we are incurring this year are created by a mix shift that we were -- weren't prepare for where our customers told us they would be using more of the standard 3X4 packs and then basically changed their buying and accelerated their requirement and launch of the Fridge Vendor style carton. And our beverage manufacturing strategy is not fully complete and won't be until mid '05. At that point, we'll have the right manufacturing assets to handle the now current mix, and those variances will go away.

So, we are increasingly better able to handle the mix based on the investments we've already made. So the new press coming in, the next level of that capacity will help but we'll not continue to see the kinds of variances we've had because the primary capacity we needed is now installed and scaled up.

So that 4 million will be down

Yes it will.

And then finally, with regard to the 3.7 North American carton revenue increase, is that strictly volume or how would price relate to that big number?

Price would not be a positive contributor.

The units would be greater than 3.7 percent. It was really mostly by -- at the revenue level it would have been higher had it not been for negative pricing.

So, in terms of volume, what was it?

well, we're not just -- we aren't discussing tons but it would be slightly higher. Because John did give you what are the pricings, 3.7 million of negative pricing.

3.7 percent of increase--.

Increase, yes, as you asked and you also discussed the negative pricing in the quarter.

The negative pricing netted to about $2 million for the quarter, so that's your point.

Ali Motamed, Boston Partners.

I just wanted to confirm that if you were to pursue a strategic deal, it has to be entirely financed by debt to retain those NOLs, right?

First of all, I don't know -- I don't want anybody inferring from my comments that we're pursuing anything other than debt reduction.

Right, but then if you were, you wouldn't be able to do an equity deal to do that right. How does that NOL structure--

Why not? I'll let John Baldwin comment, but it has nothing to do the NOL.

Okay, there's a note, I guess, in your Ks and Qs, that I read, that basically says any conversion of the equity ownership or sort of dilution of the existing stake would compromise $1.3 billion in NOLs. Can you maybe comment on that and help me understand how that works?

Given Steve's statement that we're going to pursue debt reduction, I won't spend very much time on this. The issue that we have with our NOL is simply that if enough stock is issued, in any manner, we'll have a change— a change of control simply triggers a limitation on the use of the NOL, it doesn't get rid of the NOL and so you'll still be able to use it; you'll just be able to use less of it on a per-year basis than you might otherwise be able to do.

And do you know what that limitation goes down to? Is that enough to impact you or does your net income?

It won't impact us in the early years because we won't probably have enough taxable income. There are a variety of scenarios that I think were laid out, when the Company was merged as to how much the limitation is. I wish I could give you a number like 95 or something, but it depends on the share price at the time at which the change of the control occurs. And so its kind of a sliding scale, but you could probably assume that it's at least $50 million, and even end up into the $100 million range for the limitation you have on an annual basis at current share prices.

(OPERATOR INSTRUCTIONS). Tim Burns, Cranial Capital.

The DorPak , which I think you talked about, I didn't see it in the press release, but could you talk about that? Is that a license and is it a product of successful elsewhere in the world, and we're going to capitalize on it?

It's a little above than what it allows us to do. It is a license with -- Door Pack will be making those kinds of products in our Lawrenceburg facility. What allows us to do Tim is to laminate a film in paperboard to create some of these larger containers, You're going to primarily find these things for home and garden, so you'd find fertilizer and those kinds of things, where some moisture protection would be required, also some pet food applications. We've been working with these folks for a while, and it's really an extension of the work that we've done on a smaller scale for Miracle Gro if you remember those kinds of products. It just allows us to have a much larger, heavier walled product using printing and lamination capabilities.

I gotcha. I remember Miracle Gro. So a lot of that lawn and garden stuff that WalMart or Home depot or whomever throws out into the chain-linked outside compartment?

You got it. That's the concept. Yes, sir.

I mean you're calling on the kind of customers, have they seen the product? Are they reacting?

Some of the products are already in the marketplace. There’s a couple applications. I don't have one here in front of me, but I can certainly get more information on the individual products. Yes, these are same kind of guys that we would be calling on normally you think about it -- Procter & Gamble, and certainly Masterfoods those kinds of customers who are in those sectors clearly have opportunities for us in that. It's new we just -- I think we just signed it within announcement just maybe 30 days ago or so around this agreement. So we're just starting to market and manufacture those products.

Where are these guys from DorPak?

Well that's a best question. I don't really know, I mean, geographically, I don't actually know.

For the D-o-h-r or D-o-o-r?

D-o-r.

Steve, you guys are heading your restructuring and synergy numbers quite well. I'm sure when you guys laid out the plan you probably thought that those would be not easier to come by but would arrive quicker to the P&L?

No. You go back and go ahead finish the question, I’m sorry.

I'm trying to layer years ahead where the improvements come, and I got a feeling based on new product development and technical licensing and stuff like that that's kind of later in the 5-year plan I guess.

Let's put the definitive reference on synergies is our S4 and that's the table we said there would be $51.6 million of synergies over a 3-year period. And we've currently disclosed that we are at an annual run rate of 72 million, so we got it sooner and we got more of it. We also said in that disclosure that there were some areas that would take additional time to be fully vetted and that was the manufacturing consolidation and cross selling. And that is largely explanatory of why we're ahead of the 516 in total and then I guess we would give ourselves somewhat out of a pat on the back for the fact that we're a couple of years ahead in getting the realizations. I think most people who tried to model our future understand that in addition to the synergies we have in ongoing annual cost reduction undertaking that we call continuous improvement and Six Sigma that we expect to produce about $25 to $30 million of cost reduction. We've also spoken to our beverage manufacturing strategy where we are investing $75 million from '03 through '05. That when it's fully mature, we'll generate somewhere in the area of $38 to $39 million of annual cost reduction. We will start to see some of that in '05 and then we will see the full maturity in '06 and beyond. We've also spoken that we're working on our sheet-fed strategy and that will add some additional synergies on top of the $72 million. So, and we've got some new business under contracts that will add some volume in '05 and beyond. So, ours is very much volume and cost driven in terms of how we intend to continue to expand our margins through time.

The other thing is that we talked earlier about, when we talked about sales growth, we mentioned last quarter, you got to remember too as we looked at buying a company, there was at that point a million dollars of our ongoing business that just didn't fit our structure long-term. So, as you look at our sales and you look at our of sort a year-over-year recognizing that we've exited portions of the business that on a legacy basis may have made sense, but on a combined basis we had better opportunities, better options, and so to some extent, it's a moving target to improve the business mix and the margin mix. And you are seeing some of that in the P&L as well.

So $20 million roughly is kind of withered away?

Yes, we didn't wither it away, we gave it away. We literally disengaged the bill from that customer set.

And last question, you know there's a lot of talk on the call about M&A and all the other stuff, which I don't think I am a big fan of, so again I am not an investment banker, but the question I have is there's probably some interesting small things that you guys could do, that could turbo charge your revenue either from a technology standpoint or I guess peripheral product standpoint, that would I think mean a lot to your customer and might actually enhance your business?

Well, if you know what they are, call me privately. I don’t want it on the call.

Alright, well I’ve got Dave’s number, and I’ll call him. He’ll give me your number.

We've talked I think on all of the call since the merger occurred in August, a year ago, that one of our high priority activities in this company is new product development. And both of the legacy companies have very specific and viable and very similar new product development processes. One of the things we've accomplished through the first year of the merger is we've fully rationalized and vetted and prioritized the pace in the specific projects looking at through the prism of the combined company rather than the legacy companies. So, we've accelerated some projects and we've decelerated or killed some that we just don't think have the right impact. We've also been in front of all of our major customers. We hear similar themes from the major consumer goods companies whether they are in beverage or the non-beverage, which is they've got challenges to grow their revenue. And they've had a nice run improving their margins by driving purchasing cost down. And I think if you look at the margin structure in the packaging business plus the specter of inflation, a reasonable conclusion is that those days are probably over. And now they're talking more about how do they get their suppliers working with them to accelerate innovation? We've a very, very full closet of innovative packaging solutions and now we're just trying to find the right partners to accelerate and what is that we said was [Inaudible] we're getting some traction there. Fridge vendor and derivatives of that type of what we now call dispensing and convenience packaging are migrating outside of beverage into the club store applications. So, these are the things that were in front of customer saying, if you got a problem, we've got war chest of solutions, so let's get started.

Now, it is the only answer. I mean, you can buy another company and have a year or two of fun and then you are right back here, right?

Well, when you said fun, everybody around our table just looked at each other.

Well, fun in the sarcastic sense.

No. I think that we were fortunate in this merger, because it made sense all the way around, and there was a tremendous conviction from the Board of Directors all the way down through the organization to get this thing done, get it done well, and get it done pretty quickly, and change our focus from internal integration to how do we capitalize on all the capabilities that is resident in the new company, and that's where we're really in that process now of shifting from inward to external.

Well, listen, good luck in the fourth quarter, and will be in touch.

At this time, there are no further questions. Gentlemen, please proceed with any closing remarks.

Well, you had the closing remarks. I'd like to thank everybody for their participation. And with that we will end the call. Thank you.

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