Graphic Packaging Holding Co (GPK) 2004 Q4 法說會逐字稿

Welcome everyone to the Graphic Package Corporation Fourth Quarter Earnings Release conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a Q&A period. (OPERATOR INSTRUCTIONS). As a reminder, ladies and gentlemen, this conference is being recorded today, March 3, 2005. Thank you.

I would now like to introduce Scott Wenhold. Mr. Wenhold, you may begin your conference.

Welcome to Graphic Packaging Corporation’s Fourth Quarter Earnings call. Commenting on results this morning are Steve Humphrey, the Company’s President and CEO; and John Baldwin, our SVP and CFO; David Scheible, our COO, is also on hand to answer any questions at the end of the presentation.

I want to remind everyone that 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 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 as 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. It should be noted that as a result of Sarbanes-Oxley requirements, 2004 year-end financial statements will not be certified until the Company completes its review of internal reporting controls and finalizes its annual Form 10-K. The Company expects to file its Form 10-K with the SEC by March 16, 2005.

Steve, I’ll turn it over to you.

Good morning, everyone. As I’ve stated in the past, the Company’s key financial strategy is to focus on cash flow generation and significant de-leveraging opportunities to increase value to our shareholders. Yesterday, the Company announced its fourth quarter earnings, and in a moment John Baldwin will walk you through the financial performance. I will say, however, that results were highlighted by an extremely strong cash flow quarter and a corresponding significant reduction in debt.

Specifically, during the fourth quarter, the Company generated over $122 million in net operating cash flow, reducing gross debt by approximately $100 million. For the full-year 2004, we generated approximately $264 million in net operating cash flow, reducing gross debt by approximately $129 million. When considering the change in cash held, full year-end net debt reduction was approximately $119 million. At the same time, approximately $138 million of cash flow was used to fund CapEx, thus positioning the Company for future growth.

The positive results come despite operating in a period of unfavorable business conditions, including rapid inflation for key production inputs, freight, and labor-related health and medical benefits. In total, inflation had an approximately $50 million negative year-over-year impact on 2004 operating results.

When considering total tons of paperboard internally produced, the impact of inflation equates to an approximate $30-per-ton increase in our cost structure, most of which occurred during the fourth quarter. In addition to the impact of inflation, our core packaging business was negatively affected, particularly in the fourth quarter, by a continued weakness in overall U.S. beverage can shipments. Specifically, shipments of beer cans were down 2.1 percent year-over-year on a fourth quarter basis. Similarly, soft drink can shipments were off an approximate 3.3 percent on a year-over-year quarterly basis. When looking at the full-year, reports indicate that 12-pack soft drink supermarket volumes were down approximately 6 percent, comparing 2004 to 2003.

Now, as we look at our own volumes, our North American soft drink sales were up approximately 12 percent in the fourth quarter year-over-year and approximately 6 percent for the full year-over-year. Our North American beer sales were down approximately 8 percent quarter-over-quarter and down approximately 5 percent on a year-over-year basis.

Although our Company has recently been hit hard by both inflation and declining demand for certain of our customer’s products, we were able to deliver on our cash flow and debt reduction guidance through continued commitment to, first, driving top-line growth by delivering new and innovative solutions to our customers, and two, monitoring and managing cost of working capital at every level within our organization.

During 2004, we identified, evaluated, and managed over 100 new product initiatives, which generated approximately $30 million of new revenues. To emphasize the importance we place on growing the top-line, I’d like to update you in the earnings releases and on these calls about new products or innovation solutions that we’ve launched during the quarter. I think it’s also a good way to illustrate the success of our new product development process.

In the fourth quarter, our patented Fridge Vendor technology continued to redefine the packaged take-home Beverage industry. Furthermore, we are now beginning to see this technology expand beyond aluminum cans. An example of this was Coca-Cola Enterprises’ launch of its 12-ounce PET bottles in a new 8-count Fridge Pack carton. And on the can side, SABMiller commercialized an 18-can-pack fridge carton with new and unique dispensing features.

In the Food and Consumer Product sector, Molinaro Foods launched its frozen pizzas, utilizing our Micro Rite Susceptor during the fourth quarter. The Susceptor disk allows the consumer to heat up or brown a frozen pizza within its box simply by putting it in the microwave for about a minute. This technology represents our first commercial product to address the relatively new and growing grab’n’go market through convenience store channels.

Our cross-selling strategy continues as well. By cross-selling, we refer to sales opportunities created by leveraging off our various products and distribution channels, brought to the merged company by each individual legacy company. During the fourth quarter, for instance, Kraft Nabisco, a former legacy Graphic customer, rolled out the Riverwood patented Z-Flute application and its members marked 72-count Zoo Animal Fruit Snacks. And you can see this pack the next time you shop at Sam’s Club.

The second prong of our strategy involves the improvement of net earnings through the discipline monitoring and ongoing commitment to cost reduction and working capital. As I’ve mentioned in the past, our key mechanism for overseeing and recognizing cost reduction is our Continuous Improvement program. During the fourth quarter, Continuous Improvement programs achieved approximately $8 million in year-over-year fourth quarter cost reductions. For the full-year, our commitment to these programs resulted in an approximate $27 million reduction in Company-wide costs.

At any given time, we have numerous project teams working to identify and remove costs from the system. Now let me give you one example. Our Packaging Machinery Division formed a Six Sigma project team to analyze and reduce packaging machine assembly time without compromising quality. Upon review, the team identified and implemented 4 critical improvements. First, to assure availability of assembly staff to minimize production interruptions; two, shorten the delivery of machine parts from 3 weeks to 6 days to align with the assembly throughput requirement; thirdly, to initiate assembly only once 98 percent of the machine parts became available; and fourth, document machine settings and design corresponding assembly fixtures and templates in order to reduce the time to test and debug. Thus far, this one initiative has resulted in over $250,000 of year-over-year embedded cost reduction. Total assembly time was reduced by an approximate 100 hours per machine, while improving customer satisfaction with startup and quality of machine performance.

On the Production side, our U.S. mills reported strong performance, running at full capacity during the fourth quarter. No market-related downtime was incurred and none is forecast at this time. Both the Macon, Georgia and West Monroe mills, however, incurred unplanned downtime in December, as a result of subfreezing temperatures impacting the southeast. The weather-related incident caused malfunctions in control instrumentation at high-pressure boilers, resulting in downtime on paper machines and turbine generators. Note that the costs related to this event will impact our first quarter 2005 financials. And John will elaborate later in the call regarding the financial impact of this event.

The overall performance of our Food and Consumer Product manufacturing system continues to be quite strong, with year-over-year improvements in productivity for both the fourth quarter and full-year. Our sheet-fed modernization and plant rationalization program continues to progress well, as several new converting lines were started up across the system. The expansion of our lumber to North Carolina plant is now complete and the construction of the new facility in Fort Smith, Arkansas is progressing ahead of schedule. The sheet-fed initiative is expected to result in an annualized $19 million of improved productivity and cost structures.

On the Beverage side, during the fourth quarter, we completed the final phase of the Perry, Georgia expansion project, which included the relocation of a printing press line from the West Monroe, Louisiana converting facility. Both of the two new Flexo presses installed during the first half of 2004, along with a relocated press, now perform above expected levels. The last phase of the Beverage strategy manufacturing project includes the first quarter 2005 installation of a new 67-inch Revere press in West Monroe. The successful completion of this installation, combined with the opening of the new Fort Smith, Arkansas converting facility, will enable the full shutdown of both the Clinton, Mississippi and the Bow, New Hampshire plants, as previously announced.

Unfortunately, looking forward into 2005, we expect inflation to continue to be a theme when explaining financial performance. Additionally, our sales contracts often limit our timing and ability to raise prices, further exacerbating our inflationary problems. We do, however, expect to offset some portion of these increased costs during 2005. Additionally, we’re excited about 2005, as we will begin to recognize the full benefits associated with our investment in the rationalization of the Company’s manufacturing assets, with both the Beverage initiative and the Food and Consumer Product sheet-fed modernization projects.

In summary, although we can’t do much about higher prices for key inputs or soft end-user demand, we can offset these negative influences through a continued dedication to our business strategies of growing the top-line through product innovation and cross-selling and managing costs and working capital at every level within the organization.

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

Thank you, Steve, and good morning, everyone. As you certainly know by now, we released our earnings for the fourth quarter last night and reported a net loss of $35.1 million, or 18 cents per share, in the quarter. Let me just note that since our merger occurred during the third quarter of 2003, the fourth quarter of 2003, the comparative period, represents the first prior period where pro forma data is not required for consistent comparison purposes.

Now that we’re moving into 2005, this will be the last time I’ll have to note this, but when comparing full-year 2004 results versus full-year 2003, the comparative income accounts for the first, second, and third quarters of 2003, as reported, reflect only Riverwood’s results from January 1, 2003 through the date of the merger, along with the merged company’s results from August 9, 2003 through September 30, 2003.

In order to provide clarity of financial results, we have again included an attachment to the quarterly earnings release, which provides the operating results for the combined companies on a pro forma basis for the individual quarters of 2003. And these pro forma statements assume that the merger occurred as of January 1, 2003.

Now to get to the numbers for the quarter. Our net loss of $35.1 million, or 18 cents per share, for the 2004 fourth quarter, compares to a net loss of $14 million, or 7 cents per share, for the 2003 fourth quarter. For the full-year, the Company reported a net loss of $41.8 million, or 21 cents per share, versus a 2003 pro forma net loss of $74.4 million, or 38 cents per share.

Fourth quarter 2004 net sales were $587.1 million, which is up $18.5 million, or 3.3 percent, as compared to net sales of $568.6 million in the 2003 fourth quarter. On a full-year basis, the Company had net sales of $2.387 billion, representing a $90.4 million, or 3.9 percent, increase over pro forma 2003 net sales. The year-over-year fourth quarter increase in net sales was driven by several factors, including increased volumes for food and consumer cartons within North American markets, favorable container board sales of $5.7 million. The approximate 25 percent increase over the prior-year quarter is a result of a $100-per-ton year-over-year increase in the price of corrugated medium, and $115-per-ton year-over-year increase in the price of linerboard.

And finally, a relatively weak dollar impacted our sales line. Approximately 18 percent of the Company’s consolidated sales occur in international markets. And as a result, foreign currency exchange rates made a positive year-over-year contribution of $8 million to our fourth quarter sales.

Income from operations for the 2004 fourth quarter was $5.2 million, which was down from 2003’s final period income from operations of $18.8 million. Looking at the full-year, income from operations was $115.6 million, slightly below the $121.5 million in pro forma operating income which we reported for 2003.

Net interest expense was $36.7 million in the fourth quarter, as compared to $36.3 million for fourth quarter 2003. For the full-year in 2004, net interest expense was $149 million, as compared to last year’s net interest expense on a pro forma basis of $148.1 million.

EBITDA for the 2004 fourth quarter was $61.1 million, or 10.4 percent of sales, as compared to EBITDA of $74.3 million, or 13.1 percent of sales, in the 2003 fourth quarter. For the full-year 2004, EBITDA was $344.5 million, or 2.4 percent higher than 2003 pro forma EBITDA.

Credit agreement EBITDA for the fourth quarter was $78.8 million, as compared to $90.9 million in the 2003 fourth quarter. Full-year 2004 credit agreement EBITDA was $395.1 million, or 3.4 percent higher than pro forma 2003 credit agreement EBITDA. Unlike straight EBITDA, add-backs from credit agreement EBITDA include non-cash items, such as pension, post-retirement, post-employment benefits, merger-related expenses, and asset write-downs.

Capital Expenditures for the 2004 fourth quarter were $34.4 million. Approximately $5.7 million of this amount was related to our Food and Consumer Product sheet-fed manufacturing initiative, bringing total expenditures on that project to approximately $9.5 million. We project total expenditures on that initiative to be approximately $26 million over the ’04 and 2005 periods of time. For the 2005 year, we expect Capital Expenditures to be in the neighborhood of $135 to $140 million, approximately what we had in 2004.

As Steve emphasized earlier, cost inflation had a substantial negative impact on the quarter, specifically inflation reflected in cost of sales was responsible for approximately $16.6 million of the year-over-year fourth quarter decline in income from operations. Energy costs for the quarter were approximately $3.2 million higher than the fourth quarter of 2003. For the full-year 2004, energy costs were approximately $12 million higher than they were in 2003 pro forma’s results. Just to clarify, the inflation variances which we talk about are the results of pure price increases, not including any variances due to difference in volumes.

The price for certain chemicals, coatings, and resins also increased substantially during the fourth quarter. These costs were approximately $4.7 million higher over last year’s fourth quarter basis. For the full-year 2004, costs for these inputs were approximately $5.9 million higher than the pro forma results for 2003.

Fourth quarter costs related to fiber, outside board purchases, and corrugated shipping containers increased approximately $5.3 million when compared to the fourth quarter of 2003. For the full-year 2004 costs for these materials were approximately $14 million higher than pro forma 2003.

The Company has also been negatively impacted by higher pricing for freight. The increased costs are twofold – higher fuel surcharges and overall lane rate increases, the latter primarily the result of a capacity crunch in the trucking industry. The result was an approximate $3.4 million increase when comparing yearly quarter-over-quarter costs, and $7.2 million when comparing full-year 2004 versus pro forma 2003.

In addition to cost of goods sold, inflationary pressures are also reflected in higher quarterly Selling, General & Administrative expenses. SG&A costs were $56.3 million during the fourth quarter, approximately $8.6 million higher than the fourth quarter of 2003. The increased fourth quarter expense was primarily a result of higher costs for medical and health benefits. And in addition to the higher costs for benefits, fourth quarter SG&A includes approximately $3.3 million in costs related to the Sarbanes-Oxley compliance. For the full-year, total Sarbanes-Oxley compliance-related expenses, in addition to the required audit, were approximately $5.6 million. Also, during the quarter, the Company recorded a one-time expense of approximately $1.5 million for severance payments related to the closure of our Clinton, Mississippi converting plant.

In addition to inflation for key production inputs, freight, and labor-related benefits, income from operations was impacted during the quarter by the planned rebuild of West Monroe’s Number 4 boiler. The purpose of the rebuild was to restore the integrity of the equipment which was suffering from leaks and ongoing maintenance-related downtime. The majority of the costs associated with this project were Capital Expenditures. But due to the approximate 30 days of boiler downtime taken during the rebuild process, the Company incurred approximately $5 million in expense costs.

More specifically, the $5 million in expense was attributable to incremental transportation to haul black liquor offsite, as the liquor is normally burned in the recovery boiler; lower amounts of a soda byproduct, which is reclaimed from burning the liquor. Because the soda was not available for reclaim, the mill was required to purchase additional amounts of pulp mill chemicals to produce this soda. And in addition, the liquor is burned to produce energy for use throughout the mill. In its absence, additional natural gas was purchased to meet energy requirements.

Also, let me expand on the impact of the weather-related incident, as Steve mentioned earlier in the call. On December 24th, unexpected subfreezing temperatures in the southeast resulted in the malfunction of control instrumentation for high-pressure boilers at both our West Monroe and Macon mills. This malfunction resulted in unplanned downtime on paper machines and turbine generators as well as costs due to boiler damage, the downtime resulted in the lost production of approximately 5,500 tons of roll stock. Between the two mills, the total cost from this incident is expected to be about $3 million of Capital Expense, along with a negative $2.3 million of profit and loss impact, due to the lost production as well as repair and startup. The impact of the lost production will be realized on the Profit and Loss statement in the first quarter of 2005, as we have less volume to sell during the quarter.

Non-cash items that affect income from operations include depreciation and amortization expense, which is $55.9 million for the 2004 fourth quarter, compared to $55.5 million reported in the fourth quarter of 2003. Although total depreciation and amortization was flat on a yearly quarter-over-quarter basis, fourth quarter 2004 depreciation was approximately $5 million higher than the 2003 fourth quarter, primarily due to the acceleration of the write-off of assets related to the closure of our Clinton, Mississippi converting plant.

This increased depreciation was offset, however, by lower year-over-year quarterly amortization of merger-related intangibles, such as the non-compete agreements related to the merger of Riverwood and Graphic. This lower amortization is reflected in our Other Expense line on the income statement.

Depreciation and amortization for full-year 2004 was $228.9 million, or $14 million higher than that in pro forma 2003 results. As with the increase in quarterly depreciation, the full-year 2004 increase was mainly a result of the accelerated write-off of assets related to the closure of the Clinton facility. The full-year 2004 impact-related to Clinton asset write-downs was $10.9 million. In 2005, depreciation and amortization is expected to be approximately $200 to $210 million. This is significantly lower than the 2004, as expenses associated with the amortization of merger-related intangibles and the accelerated depreciation of assets for the Clinton plant closure will not be an issue going forward.

In addition to lower amortization of intangibles, other expense was favorable on a year-over-year quarterly basis, as a result of lower charges related to asset write-offs, particularly at our U.S. mills.

I’ll wrap up with a few comments regarding the balance sheet and cash flow. At the end of the year, we had $7.3 million in cash and approximately $314 million available under our revolving credit facility. Our total revolver commitment is for $325 million. And as of December 31st, we had no cash borrowings and $11.4 million in outstanding letters of credit. Year-end total debt was $2.025 billion, representing a decrease of approximately $129 million from total debt at the end of 2003. When the year-over-year reduction of cash and equivalents is taken into account, total net debt decreased by approximately $119 million during the year. Approximately $82 million of the total annual net debt reduction occurred in the fourth quarter.

This large fourth quarter debt reduction is the result of several factors. First, due to the seasonality of our business, the Company is able to operate with lower levels of working capital in the late fall and winter months, specifically drawing down on inventory levels. As the high summer beverage season approaches, however, it is necessary to ramp up working capital and carry higher levels of inventory. In addition to seasonality and operating income, and as mentioned in prior calls, the Company makes semiannual fixed interest payments of approximately $38 million in the first and third quarters of the year. The interest payments are related to the Company’s two fixed- rate public notes. Therefore, looking into 2005, you should expect the majority of our full-year debt reduction, which will again be approximately $100 million, will come in our second and fourth quarters of the year, as it did this year.

With that, Operator, we would like to open the line for our Q&A session.

(OPERATOR INSTRUCTIONS). Joe Stivaletti, Goldman Sachs

I was just wondering if you could help us out a little bit as we look at 2005. I mean, obviously, you guys had great progress through the first 9 months of the year on an EBITDA basis and then big impact in the fourth quarter from these costs. I guess I was wondering if some of that cost inflation, as it relates to medical benefits and some of that, was a little bit of an aberration in the fourth quarter, or if we should continue to expect this higher level of costs? And also, what you’ve announced in terms of price increases in some of your businesses and what your expectations are for (indiscernible) part of ’05?

Let me get started with that, Joe. It’s John. And then David is going to follow up with a little bit of the information on the costs that are impacting the business.

In terms of health and benefits, I don’t think that if you look at our health and benefits over the course of the full-year that you are going to see any give backs in those. I mean we’re experiencing the same kind of double-digit increases in health and benefits that all industrial companies are. However, I think that there is some element of the benefits being a little bit back-end loaded. As you can imagine, putting the two companies together with two different accounting systems all in the same year that you’re complying with Sarbanes-Oxley, we’ve had a more rigorous process as we ended up the year in terms of our reserves for those as well as other items that has impacted us to some extent as we closed out the year.

As far as the remaining costs go, David, do you want to take that?

Well, the second question is really about I think pricing going forward in ’05, so let me talk a little bit about sort of the board pricing. As you know, we really have sort of three grades of board we manage: our SUS, our CRB, and our containerboard. In the fourth quarter, in the SUS business, we saw about $6 to $7 a ton of pricing pass-through. We will see an additional $20 to $25 a ton in ’05 on that grade, as the pricing that was announced rolls through the open-market customer base.

In the CRB, we saw about $28 a ton in the fourth quarter for the limited number of CRB tons that we sell in the open market. I don’t really -- we’re not projecting much in ’05 additional movement in CRB because that’s really sort of a reflection of the last price increase that occurred in the fourth quarter.

In the fourth quarter, we also saw about a little over $100 to $120 a ton in linerboard or containerboard pricing in the fourth quarter. And if you look at that market, there have been additional announcements for price increases for the first quarter. So we do expect in ’05 to have additional containerboard pricing roll through the P&L.

So I believe you mentioned in your comments that your target for this year is another $100 million of net debt reduction. And I wondered what assumptions you might share with us broadly that go into getting that bottom-line. And also, I think prior to this release you had quantified the synergies that you’ve achieved, and I wondered if you had an update on that.

Yes, Joe, it’s Steve Humphrey. I believe in the last call we commented that we wouldn’t be speaking to synergies specifically in the future. We had indicated that we had taken about $72 million out on an annualized run rate, and that there would be some additional, but they tended to be coming in over the succeeding quarters, largely attributable to the sheet-fed manufacturing strategy, which we’ve already given you a number of $19 million of benefit, plus the merging of our two IT systems, which won’t be complete until ’06. But suffice to say, we’re very, very pleased with our progress and performance on synergies. We’re getting more and we got it sooner and we got it in all of the categories that we had previously described.

Doing a bit of a dance on guidance, but speaking to net debt reduction, the wild card for us is inflation. We know what the assumptions were that we built into our budget for ’05. We know to the penny how much additional inflation will affect us over and above what that assumption includes. But what is indeterminate at this point is how much additional inflation, beyond which we already understand, we’re likely to face.

Kind of the companion question is that we will recover every dollar of price against customer contracts where we’re entitled to it. I think we described in the previous call that there is almost always some lag in timing as to when you see the board increase and when you can actually recover it in net price adjustment. And then in some cases there are limits as to how much price you can recover in any given price adjustment. So you’ve got kind of this bow wave where costs go up faster than price. But we will see some recovery of last year’s inflation in ’05 pricing.

I think the other comment that we made in the script was we expect to see in ’05, pretty much the full benefits of the investments that we’ve made in our Beverage division, which totaled about $75 million. And while we saw some of the benefit in ’04 results, we’ll see a substantial flow-through in ’05. And our previous guidance is we expect to lower costs $38 or $39 million.

So, when you put it all together, we expect revenues to be up slightly. We see a slightly improved demand level in soft drink and can-packs for take-home. We’ve seen an acceleration in PET for both carbonated soft drink and bottled water, which will create both a cannibalization of some can-pack volume, but also some net new carton demand and our new product performance, where we had about 1.5 percent of sales contribution from new products and cross-selling, and we expect that to continue to expand in ’05. So those are the major moving pieces.

And then we have our continued investments in CapEx, which drive further reductions as well. And I think we’ve spoken previously that our continuous improvement efforts, which are largely non-capital, project-based last year resulted, or produced, $27 million of cost reduction. And that’s in the kind of range that we would expect to get year-over-year-over-year.

Hopefully that’s helpful in terms of the major components in the (indiscernible).

Sure. No, I understand a lot of the -- we have the same problem trying to estimate all those cost variables. Good luck with that. Thanks a lot.

I wish I had a better crystal ball.

Sandy Burns, Deutsche Bank

Maybe a follow-up on the previous discussion. Certainly you mentioned fourth quarter felt the impact of pretty weak volumes throughout the industry. Can you give a little color on how at least ’05 is looking so far? I understand, obviously, the summer is the key selling season, but at least maybe a little flavor for what you’re seeing in the marketplace, any rebound from the fourth quarter trends?

I’ll ask Dave Scheible to respond.

As we said a little bit, it was sort of a mixed bag, even in the fourth quarter though, as Steve said, the volume we saw in soft drink was better than we had seen before. We were up 12 percent quarter-on-quarter in soft drink and 6 percent for the year. The Consumer Goods business is really pretty consistently -- consistently grew all year. We were up about 3.5 percent or so, on that business on an annual basis.

The softness in our business really was beer last year. There are a lot of dynamics in the beer industry, as you probably are aware; a lot of substitution of hard spirits for beer, and also some different packaging styles that don’t necessarily use carton board, maybe some larger bottle packs that use corrugated. So our beer volume last year, or our carton volume for beer, was down about 5 percent. So that was really the softness. I would say that the trends that are in the first quarter continue to reflect those kinds of things.

Consumer Products business continues to look good, so are cereal, pizza, those kinds of product lines. And soft drink continues to be strong. Steve made a comment that we’re also starting to see, what I would consider a solid trend, continuing solid trend, on the use of carton board to surround PET containers, either in water or in carbonated soft drinks. So you’re starting to see the Fridge Vendor product for 8-packs and 12-packs of the small polyethylene bottles for water and soft drink. But the beer business still continues to be softer. We’ve seen a little bit of increase. Of course, this isn’t the best time of year to judge beer, but nonetheless, still softer demand in that sector. So I would say, overall, we feel better about the volume, but I’d really feel better if people were drinking more beer.

We’ll try our best. And just one other thing, in terms of some of the cost pressures you’re seeing. You said that the unplanned downtime will have some impact in the first quarter. I know you also talked about the rebuild costs, because some of the other CapEx initiatives also hitting the income statement. Will those also have a material impact in the first quarter or first half of ’05?

The rebuild costs won’t because those are already in there, but certainly we do expect the carry-over of the lower volumes that were produced at the end of the year to impact us in the first quarter in kind of that $5 million range that I talked about in my prepared remarks.

Kevin Cohen, Credit Suisse First Boston

Kevin for Bruce Klein. If you could comment just a little bit on the North American carton sales, I joined the call a few minutes late, just in terms of volume growth. I think in the third quarter it was up about 3.7 percent or so year-over-year. I’m wondering what you saw overall in the fourth quarter and for the full-year.

We did note that our overall sales grew just less than 4 percent. And as Dave just commented, our volumes have been good across all segments except North American beer. And even in the face of weak industry demand in soft drink, Graphic Packaging’s volumes were up reasonably strong year-over-year and for the quarter-over-quarter. So, as we think about ’05, volumes are not at the top of our worry list, it’s inflation.

I guess going back to the inflation topic, did you guys quantify the amount of under-recovery of the $16 million year-over-year hit in the fourth quarter, and maybe what it was for the full-year, and what you might recover in ’05?

No, we don’t get to that level of detail. But I will tell you that almost all of our contracts with customers have some delay built in from the time inflation is incurred and roll stock prices are increased and verified to when it’s effective in terms of when we see higher carton prices. So you can presume from that, since this wave of inflation hit in the fourth quarter, that we virtually have no price recovery during that period. But we will, and we won’t speak to the exact percentage. Every dollar of price we’re entitled to recover from ’04 inflation, and what we know about ’05, we will get. But there will be a deficit between incurred inflation and recovered pricing.

Jeff Harlib, Lehman Brothers

Steve, you talked about ’05 revenues being up slightly. Just given -- you expect prices to improve through some of your contracts. Does that mean you expect volume to be down a little bit, and if so, why would you be planning on that?

No. It’s really a little more complicated. We have spoken in the past that under our existing multi-year contracts, we have price give-backs that average about 1 percent of sales. So that’s what you have to start with. We’ll have some pricing, but we’ll also have unit volume growth, at least that’s what the plan is built on. And the unit volume growth largely is attributable to continued improvement in the Food and Consumer Products packaging; some optimism that the soft drink sector will recover in ’05, not just our volume, but the entire sector; and that contribution of new products and cross-selling will continue to have a positive effect.

This is David Scheible. If you look at our Top 10 customer base, which is really sort of 50 percent of our sales, we saw in ’04 increased share in 7 of those accounts, maintained share in 2, and a slight decrease in 1 of those accounts. So if you look at the overall momentum in those top accounts, which really drive our overall, you certainly believe that ’05 will continue to show progress on the sales line.

The other thing that’s important to remember for us, is that last we sold about 73 new packaging machines. Now some of those were really around –- retooling for Fridge Vendor, as customers rolled out, certainly in soft drink, and to a more limited extent in beer. Nine of those machines were really focused specifically, and manufactured for, the packaging of paperboard around polyethylene, or PET bottles, so soft drink and water. So you’re starting to see that kind of underlying growth where our customers are making investments in machines that will allow them to package, or allow them to put parts that were previously not in paperboard, in paperboard. So we expect to see that kind of underlying growth in ’05 as well.

Okay. And just on the inflation side, I thought you had hedged a lot of your natural gas cost for ’05. Is that the case? And also, if you can say, in your budget, if you’ve planned for more or less than the $50 million of inflationary cost increases you saw in ’04?

The natural gas is almost completely hedged for ’05 requirements. So we know what that’s likely to be. We have a very small amount of what I would describe as open-to-buy, as we fine tune requirements to mill production schedules 60 days ahead of the moment of production.

Inflation, we would expect and build our plan, that we would have higher incurred inflation in ’05 than we did in ’04. But we’re also acknowledging that even through the first couple of months of the year that the actual rate of incurred inflation for January and February is higher than what we built our budget assumptions on. It gives us some concern as to what additional negative effects inflation could have for the remainder of the year, over and above what we built our assumptions around.

I see. So when you say more inflation, you mean more than the $50 million increase?

Yes.

Okay. Is there any possibility of reopening some of your contracts if this continues?

What a great question. Our customers are very determined buyers and we continue to have the same structural issues in folding carton that we’ve had for years, which is there is more demand than supply. And believe me, we have been communicating regularly and very candidly with our customers about the negative effects of inflation. And we have had some success in recovering costs that we’re entitled to that result in better price realization. But I think it’s unlikely that our customers are going to invite us in and say we know you are going through a tough patch and we’d like to solve your problems for you.

As we have said previously, most of our major contracts, as Dave said, our Top 10 customers are over half of our total revenue. We have long-term contracts or multi-year contracts. The next major re-openers are in 2007. So we’ve got some heavy lifting to do on the cost side of this Company to try to minimize inflationary effects and then we’ll have some interesting discussions about the cumulative deficit of price to inflation and how best to address that as these contracts come up for renegotiation.

Okay. And that was on the Beverage contracts you were talking about.

Oh, it’s really our major Consumer Goods contracts of Food and Beverage.

Yeah, we’re sort of in a stable period between now and the end of ’07. We don’t really have any major contracts that sort of expire until that period of time. But we do have escalators in many of these contracts and we’re passing them through. Steve made the comment, you know, there are delays and there are collars and those kinds of things, but also know they all end up getting rolled through at some point and we will continue to recover that in ’05.

The thing is that you’ve got remember for us is though inflationary inputs don’t necessarily drive our contract levers. Our escalators and levers are driven by board price movement in the market though. So as SBS and CRB and SUS go up in the market, that allows us to recover our costs. And there has been a differentiated increase, as you know, the solid bleached business has been more successful because of their supply/demand dynamics to pass those prices through. Whereas, in the CRB side, or the recycled board side, as you know, there tends to be more capacity and that side of the business has been more difficult to see board prices go through and hold that allow us to go through. In fact, if you look right now, you’re seeing a pretty significant separation between those grades from a historical basis. And over time, we believe that will work its way out, but in the meantime, we will be able to pass through what the board price increases allot.

Not to dwell on this too much, but it is our biggest issue. I think Steve and David have made the correct points, but you shouldn’t assume just because we locked in natural gas prices that that’s going to be a favorable variance for us next year, because what we were impacted with in ’04 was rapidly rising prices across all of our inputs at the end of the year. And that’s when, in fact, we lock in prices for the remainder of the year. Natural gas is only a little under half of our total energy requirements, and so you’ve got other energy costs as well as all kinds of input costs, such as chemicals, which have some relation to the petrochemical markets. And so this increase in oil pricing to above $50 a barrel is really impacting the business, as we speak, and just started impacting the business in the latter half of 2004. The wild card is how long it will continue on throughout the year.

Okay. That’s very helpful. The last two things. You talk about $100 million of debt reduction in ’05. I realize you’re not giving specific guidance, but CapEx should be a little bit lower. You reduced debt by $129 million in ’04. I mean should we assume this translates into an equivalent amount of expected EBITDA decline, or are there other issues affecting the free cash flow calculation?

Well, I think John spoke to that our likely CapEx for ’05 will be very much in the same level as ’04 - $135 to $140 million. And then I would remind you that we don’t give guidance, but we did say that we thought we could reduce debt in ’04 by about $100 million. And we were able to get above that. We’re going to just keep turning the same parrot over.

(OPERATOR INSTRUCTIONS). Christopher Miller, JP Morgan

One thing we haven’t touched on a little bit is the international side of the business. Could you fill us in a little bit what you saw in the fourth quarter there and is that an opportunity for where you could see a little bit more growth over 2005?

Well, our international business is really two spheres. One is Asia-Pacific and one is Europe. And Asia-Pacific has been a pretty consistent performer for us that we had an increase in EBITDA and growth last year in Asia-Pacific and I expect the same sort of thing in our Japanese market as well. We placed additional machines and we’ve taken some additional share in that market just based on the way our customers have grown. And there are some new product offerings in what they call a third beer, sort of a light beer if you will, in Japan, and that’s all paperboard-based. So I feel pretty good about Japan.

Europe is a little bit different story. In our European market, it is a market where we sell beverage cartons, but we also have some open board market sales in our Fiskeby board mill; in fact, about 140,000 tons of open market board.

And what happened a little bit to us in Europe is that, as the Chinese have brought on some of the recycled machines, paperboard machines, a lot of the board that ended up being produced by other suppliers in Europe and exporting to China is now not necessary there. So it’s ending up back in the European market. The European market is right now actually, believe it or not, a more difficult pricing environment than in the United States. Costs aren’t going up quite as fast, but there is a tremendous amount more board in the recycled side showing up in that market than traditional. So unit growth maybe, but I’m more concerned about pricing issues in Europe than I actually am in the United States.

And I know before you mentioned some of the new products, I think microwave products that you launched in Europe. Any update on the progress in terms of how that’s coming along?

Well, that is a good question. That is a good bright spot for Europe. We have been able to launch a couple of products and that has spawned some additional ones. So we’ve got, and probably a level of detail that you don’t care much about, but we’re launching a new lasagna product over there, some different pizza products. So microwave products are doing well. We’ve got some work going on with companies like Schwan’s, Nestle, and General Mills, all new customers for the combined basis on some microwave and converted products over there. So the value-added product base in Europe is actually showing positive signs, but it’s working off a pretty small base. It’s on a core business sort of -- the problems in that core aspect tends to overshadow a little bit the success that’s occurred on that side of the ledger.

Okay. And just to come back to North America a little bit, the softness that you saw, particularly in the beer market. Was that pretty broad-based across your beer customers, or I mean without trying to name names with a particular customer?

Yes, it was broad-based. I think if you went to a retail spot that sells beer and you looked at the retail price per ounce, you’d see a dramatic reduction as you go from 6 packs to 12 packs, up to the 18 and 20-glass packs. And the 18 and 20-glass packs are in corrugated packaging, and that’s where the price discounting has been the most ferocious and that’s where the growth in sales and packaging demand has been the greatest. So it’s been good for the corrugated suppliers and it’s been tough on us paperboard suppliers because the growth in those two packs have taken business away from 12-packs.

And additionally, the other thing is there has been a fair amount of aggressive pricing by our customers in their distribution channels and there is a lot of debate about how that has impacted the overall business. But clearly, beer is price-sensitive at some level and if you look at the amount of pricing that’s going there, it’s made it more difficult to sell beer generally versus alternatives and that’s impacted our carton business as well.

We see that also in soft drink, where the retail prices have been going up, but the unit sales have been going down. I think it’s well chronicled in the soft drink world that major brands have kind of owned up to the fact that they’ve got to get the unit case sales growing again. And we’re seeing some early evidence that in take-home for both can-packs and PETs that that rebound seems to be taking some shape. And that gives us some optimism that the industry demand level for our kind of packaging may improve in ’05 over ’04.

And if you kind of look out over the next couple of years, I mean given where the folding carton market is, do you still think it’s a GDP growth type business or do you think it lags a little?

I think if you go back and revisit the commentary that we made, I think it was at the end of the second quarter call, that I thought we could grow our revenues better than GDP, but not because of the underlying market but because we have these opportunities from cross-selling and have a very robust new product development pipeline. So I guess the answer to your narrowly-stated question is no.

We try and be as specific as we can. Thanks so much and good luck to you.

Jeff Bencik, Jeffries & Company

Can you give me, sort of on a percentage basis, what was the increase in costs for energy, chemicals, fiber, and freight year-over-year?

It’s all different numbers, Jeff. I don’t really have those to hand. I mean we have -- the range of increases went from just a few percent up to as high as 30 percent, which is something that we’ve talked about before on some of our chemicals where it’s clear that we’ve gone beyond just inflationary pass-throughs and into margin expansion from the suppliers. But I don’t have to hand the individual components like that for you.

Okay. Well, which one -- I guess chemicals was the worst in terms of the highest inflation. Can you sort of rank order them?

Well, I think energy was right there in terms of dollars. As Steve said, it was very high. I mean you can look at -- kind of look at your own percentage calculations just in what happened to oil prices and that was kind of prognosticated for what happened in any kind of energy inputs. Benefits, sort of medical benefits and what have you, were in kind of that 10 to 15 percent range. So that would be also a very large dollar amount of increase for us as well.

If you think about it as our primary input though, John is absolutely correct, sort of utilities lead. Fiber, we buy a lot of secondary fiber, so that would probably sort of our number two. But the one is sort of a sneaky one is really freight. Our freight costs, on a dollar basis, were one of the higher cost increases in ’03 versus ’04. So those are the ones you’ve got to look at – utilities, fiber, freight, and then chemicals.

I guess what I’m just –- I mean I understand with the typical contracts you have, pricing deflation of 1 percent, but it seems to me that, overall, these costs, and even the board somewhat, have increased, let’s say, 10 percent. So if that’s the case and volume is flat to up to 2 percent, or something like that, why would revenue not increase somewhat, because of the escalators, more than that?

Now are you speaking to ’04?

No, no. For ’05.

We didn’t provide any revenue guidance for ’05, other than we expected it to be up year-over-year.

Okay. And assuming all your inflationary factors stay flat from this point forward, what would sort of your expectation of a time lag be for you to recover the higher inflationary costs?

Well, as Steve said earlier, some of these costs will not be recovered through pricing increases because they’re not tied -- our cost escalators, or price escalators, are not tied to costs; they are tied to board movement. So some of them will be embedded and will need to be taken out through our productivity improvements, our Six Sigma efforts, and our continuous improvement effort. But I don’t think we have a -- we’re not forecasting forward, but I would suspect that we do not have a projection that covers all of our cost increase through price take-backs in the marketplace.

Think of it this way, the pricing that we capture in 2005 will relate to inflation that was incurred in ’04. And we would expect that the pricing to which we are entitled, we would largely have recovered by mid-year ’05. Now whether there will be subsequent roll stock price increases that reflect late ’04 and ’05 inflation, which then gives us additional pricing opportunities in the second half of the year, it’s too soon to know.

Okay. That works. This is sort of bookkeeping. The shares changed a little bit downwards. Why was that, and what should we expect going forward?

That’s just a function of the amount of options which are in or out of the money that goes into the fully diluted shares outstanding. And so, I don’t know what periods of time you are referring to, you know, from to what to what where they changed downwards, but obviously the stock prices change, which causes less options to be in the money, which causes less fully diluted shares. So that’s the reason for that.

Okay. And then in terms of, if we look at your gross profit margin, if I normalize and take out all the changing costs from the higher inflationary factors, I end up with a gross margin of somewhere around 14.5 percent versus 14.6 percent in 4Q ’03. Yet you guys achieved some –- one, higher sales, and then some synergies in Six Sigma benefits. My question is why is that not a little higher, excluding those inflationary changes?

I think just for the reasons that we’ve been going through. We can -- maybe it’s best to just kind of walk you through some of these details off-line, Jeff, if you want to call us.

Okay. And then just one final question then. The MeadWestvaco decision to sell its paper mills and concentrating on the packaging segment, can you just go into that and how that affects you?

It should have no effect on, because we didn’t compete with them in fine paper. And I don’t believe they’ve sold any of the structure that supports their folding carton business.

Okay. Do you think their focus on the packaging sector is going to make them a stronger competitor to you, or is that something you worry about?

I have no comment on that. I don’t think they have been -- they haven’t shown their hand in terms of what they might do differently over and above what they already do.

Okay. I’m sorry. I lied. One more question.

This is our last question too, so make it a good one.

Just a quick update on bottled water and how that’s progressing and are you seeing any potential increase in volume from that from sort of a trial run to maybe full production?

I’ll give you -– the short answer is the packaging for PET, which includes both bottled water and carbonated soft drink, is running well ahead of our internal assumptions. And as Dave mentioned, we had a very strong packaging machinery placement last year and a portion of those machines are exclusively for PET. And most of the ones that have been placed are on lines, filling lines, that can do either water or carbonated soft drinks. So we view it as net/net, a real positive.

Jeff, we’ve built a specific machine to allow the entry into that market a lower cost easier quick change machine and we built them sort of ahead of the curve, we sold them all, we’ve got more in the pipeline, demand to fill. So I would tell you that I think if you would ask a Coke or a Pepsi, they would tell you they’re generally surprised and excited about the consumer response to Fridge Vendor around bottled water.

I think we’ve used our time. I want to thank everybody for calling in and we’ll talk to you next time.

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