Graphic Packaging Holding Co (GPK) 2005 Q1 法說會逐字稿

Good morning. My name is Angela and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Graphic Packaging Corp. First Quarter Earnings Release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during that time, simply press star, then the number 1 on your telephone keypad. Should anyone need assistance at any time during this conference, please press star, then 0, and an operator will assist you.

As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, May 5, 2005. Thank you.

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

Good morning, and welcome, everyone, to Graphic Packaging Corporation's First Quarter Earnings call. Commenting on results this morning are Steve Humphrey, the Company's President and CEO, and John Baldwin, Senior Vice President and CFO. David Scheible, our COO, is also on hand to answer questions at the end of the presentations.

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 currently -- upon 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 and the Company undertakes no obligation to update such statements. Additional information regarding risks facing the Company is contained in the Company's periodic filings with the SEC. At this point, I will now turn things over to Steve.

Good morning, everyone. Yesterday, the Company announced its first quarter 2005 results reporting a net loss of 12 cents per share. In a moment, John Baldwin will walk you through our financial performance. I will say, however, that we had a challenging quarter, which was marked by continued inflation for many of our key inputs, and like the last several quarters, these higher costs squeezed our margins. Additionally, our first quarter is typically a seasonally slower one, as our core packaging businesses gear up for the summer high season. We are taking steps to counter the negative impact of inflation.

First, in the second quarter, we expect to realize a greater level of contractual price increases with our customers. These price pass-throughs are primarily related to our higher costs for board and resin. As I've talked in the past, there is a lag time between when board costs increase occur and when we actually see the recovery in net price adjustment. This lag had a negative impact on the first quarter performance, as announced board price increases in the fourth quarter of 2004 contractually will not be passed along until the second quarter of this year. In addition, our contracts often contain limits as to how much price we can recover in any single price adjustment. The result over the remainder of 2005 will be the partial recovery of inflation that impacted us in 2004 and for the first quarter of 2005. In summary, I can assure you that we will make every attempt to recognize the price increases that we are contractually entitled to, but over the remainder of 2005, there will be a deficit between incurred inflation and recovered pricing.

As we look to volumes, we did have some positive developments in the quarter. Although overall, U.S. beverage can shipments declined by approximately 1.4% versus the prior quarter of last year, our beverage carton volumes were up approximately 5% over last year's first quarter. Domestic soft drink volumes were particularly strong, as a direct result of the relatively high number of 2004 soft drink machine placements, along with increased share with 1 of our major customers. North American food and consumer products carton shipments also remained strong, as volume increased approximately 3% over last year's first quarter.

Looking ahead, one of our longer term growth strategies is to continue to increase volumes by introducing new and innovative packaging concepts to our customers. From this standpoint, the first quarter was an exciting one for our technologies and innovative platforms. On the beverage side, we introduced 2 new basket carrier designs for Anheuser Busch's new "B to the E." enhanced beer brands.

In Europe, we announced the introduction of a Twin-Stack® package for Grolsch Beer, under license by Coors Brewers in the U.K. The new package features a 3-ply handle for their 18 and 24 can and bottle packs. Ocean Spray also launched its flavored fruit drinks and 8-once PET bottles in an 8-pack format of Graphic Packaging's Fridge Vendor® package. This launch represents just one more achievement for the Fridge Vendor® product as it continues to catch on in the PET bottle market. We're excited about the future potential for our Fridge Vendor® package in this fast-growing segment. Our net revenues, directly related to this segment, grew more than 1.5 times from the first quarter of last year, although off a relatively small base.

Including consumer products, Quaker restaged their Instant Quaker Oats in our Composipac® Z-flute carton. This innovative carton has improved Quaker's point-of-sale impact by sharpening package graphics, and by providing additional reinforcement to protect the carton through the distribution chain. ConAgra launched their Wolf Chili in a pantry vendor multi-pack this quarter, targeting in-home dispensing to help revitalize their existing product. OxyClean replaced plastic containers for their Orange Glo brand with our laminated Composipac barrier carton. This action was taken in response to escalating resins cost, as well as providing better shipping and cube efficiency to Sam's Club. Finally, Kraft introduced their Tombstone Express Pizza in our Susceptor technology, thereby targeting the snack or single-serve food service category.

We are also combating inflation by continuing to take embedded costs out of our system. During the first quarter, our continuous improvement programs achieved approximately $9m in year-over-year first quarter cost reductions. This is more than in line with our $25 to $30m full year 2005 estimate for reduction of companywide costs. An example of one of our quarterly cost reduction achievements, included in this reduction, was the reduction of steam usage by our West Monroe No. 6 paper machine, which is the most productive machine in the Company. The overriding factor affecting steam usage was found to be the degree of steam balance in the system. To achieve the greatest possible steam balance, a number of changes were implemented, but most importantly, a preventive maintenance program was put in place to ensure that the new provisions remained in place. Thus far, actual project savings are greatly exceeding the original estimates. At equal machine speeds, steam usage has been reduced by approximately 8%, and this would equate to an annual savings rate of just over $1m. And even more exciting is the replication opportunities that exist for our other paper machines.

On the production side, our U.S. mills performed well and ran at full capacity for the entire quarter. Strong operational performance, primarily driven by efficiency in executing annual outages and process improvement initiatives, enabled significant increase in volume production versus Q1 of 2004. Converting performance was strong during the quarter, particularly beverage converting, as our Perry, Georgia, and Cincinnati, Ohio, facilities showed strong year-over-year first quarter improvements. Efficiency has reached expected levels in anticipation of the busy season. During the first quarter, the last phase of the beverage manufacturing strategy was undertaken, including the installation of a new 67-inch Gravure Press at our West Monroe, Louisiana, facility. We expect that this new press will reach its full potential during the second quarter. This new press, combined with the opening of the expanded Fort Smith, Arkansas, facility, will allow us, as previously announced, to close the Clinton, Mississippi, converting plant early in the third quarter. In summary, we expect inflation to continue to be a theme over the next couple of quarters when discussing financial performance.

Additionally, our sales contracts often limit our timing and ability to raise prices, further exacerbating our inflationary challenges. We do, however, expect to offset some portion of these increased costs with 2004 cost increase being passed along, starting in the second quarter of this year. We will continue to push longer term top line growth by prioritizing new product innovation and by providing our customers with new packaging solutions. We're extremely excited about the future growth and the potential of our Fridge Vendor® product in the PET bottle segment. We'll also continue to push our continuous improvement programs hard, and expect to achieve 2005 cost reduction levels in the range of the $27m that we recognized in 2004. And finally, we're beginning now to reap the rewards of our investment in the Company's manufacturing assets, as both the beverage manufacturing initiatives in the food and consumer product sheet-fed modernization are on or ahead of their original implementation schedules.

And with that, I'll turn it over John Baldwin for a review of the financials.

Thanks, Steve and good morning. As you know by now, we released our earnings for the first quarter last night and reported a net loss of $24.7m, 12 cents per share. That compares to a net loss of $12.4m, or 6 cents per share in the 2004 first quarter. First quarter 2005 net sales were $583m, up $7.1m, or 1.2%, as compared to net sales of $575.9m in the 2004 first quarter. The first quarter is normally a seasonally weaker quarter for us in sales, as well as in working capital, as we gear up for the summer high season.

The increase in sales versus the prior-year first quarter was driven by several factors. First, as Steve mentioned, despite volume decreases in the overall soft drink and beer markets, Graphic increased beverage carton volumes within North America, particularly on the soft drink side. The increase is the result of our high number of machine placements during 2004, as well as a share increase with a major customer. The strong soft drink volumes in North America drove the beverage sales increase, despite lower year-over-year pricing for both beer and soft drink cartons.

We also had a modest increase in food and consumer product carton volumes within North American markets. Unfortunately, the increase in our domestic carton volumes, however, was offset by a decline in both international volumes, as well as domestic open-market roll stock sales. Favorable containerboard sales of $5.4m drove the increase in sales for us. The approximate 29% increase over the prior-year quarter is a result of an approximate $100 per ton year-over-year increase in the price of corrugated medium, and an approximate $115 per ton year-over-year increase in the price of linerboard. And approximately 17% of the Company's consolidated first quarter sales occurred in international markets, so, as a result, foreign currency exchange rates made a positive contribution of $4.3m to first quarter sales.

Income from operations for the 2005 first quarter was $12.3m, which is down from 2004's first quarter income from operations of $26.7m. Net interest expense was $37.1m for the first quarter of 2005, as compared to net interest expense of $37.9m for the first quarter of 2004. When comparing to the first quarter of 2004, we carried a lower debt balance, but this was partially offset by higher interest rates, which mainly impacts the interest incurred on our floating LIBOR-based Term C-loan and our Revolving credit facility.

EBITDA for the 2005 first quarter was $64.7m, or 11.1% of sales, as compared to EBITDA of $84.2m, or 14.6% of sales in the 2004 first quarter. Credit Agreement EBITDA for the first quarter was $75.1m, as compared to $95.6m in the 2004 first quarter. Unlike straight EBITDA, add-backs for Credit Agreement EBITDA include pension, post-retirement and post-employment benefits, as well as merger-related expenses and unusual write-downs.

Capital expenditures for the 2005 first quarter were $33.3m. Approximately $9.5m of first quarter capital expenditures were related to our food and consumer product sheet-fed manufacturing initiative, bringing total expenditures on this project to approximately $19.3m. The total projected expenditure for this initiative is approximately $26m over the 2004 to 2005 time period.

As Steve emphasized earlier, cost inflation had a substantial negative impact on the quarter. More specifically, inflation, the majority of which is reflected in cost of sales, was responsible for approximately $20.6m of the year-over-year first quarter decline in income from operations. The most significant impact on first quarter costs related to fiber, outside board purchases, and corrugated shipping containers. Pricing for this group, as expenses increased substantially during the quarter, resulting in an approximate $7.1m cost increase when compared to the first quarter of 2004.

Labor and benefit costs were approximately $4.7m higher than the prior-year first quarter as well, and the price for chemicals, coatings, and resins also were substantially higher than the first quarter of 2004. Costs for many of these items are highly correlated with the price of oil, and as a result, costs were approximately $3.3m higher in the first quarter of 2005, versus the same quarter last year.

The Company has also been negatively impacted by higher pricing for freight. The increased costs there are twofold; both higher fuel surcharges and overall lane-rate increases, resulting in an approximate $2.2m increase over similar expenses in the first quarter of 2004.

And finally, energy costs for the quarter were approximately $1.9m higher than the prior-year's quarter. The majority of the increases related to higher prices for natural gas, as well as purchased electricity.

During the first quarter, we also spent approximately $1.4m more than last year in audit fees related to Sarbanes-Oxley requirements.

Our first quarter cost of sales were also impacted by the December 24th weather-related incident that Steve and I mentioned on the year-end 2004 call. To remind you, abnormal freezing temperatures in the southeast resulted in the malfunction of control instrumentation for high pressure boilers, at both the West Monroe, Louisiana, and Macon, Georgia, paper mills. This malfunction resulted in unplanned downtime on the paper machines and turbine generators, as well as costs due to boiler damage.

Excluding required capital expenditures, first quarter expense costs were approximately $2.3m, due to the lost production, repair, and startup.

Depreciation and amortization expense was $52.4 for the 2005 first quarter, compared to $57.5m reported in the first quarter of 2004. The decrease is primarily the result of lower amortization of merger-related intangibles, such as non-compete agreements. This lower amortization is reflected in the Other Expense line on the income statement. Again, due to the lower amortization of merger-related intangibles, along with lower depreciation of assets related to our Clinton, Mississippi, plant closure, we expect full year 2005 depreciation and amortization to be approximately $20 to $30m lower than that we experienced in 2004.

SG&A was just about flat on a year-over-year first quarter basis, despite reflecting the $1.5m in incremental costs related to Sarbanes-Oxley, as well as a portion of the increases in labor and in benefit costs we mentioned earlier.

I'll wrap up with a few comments regarding the balance sheet and cash flow. At the end of the quarter, we had $8.3m in cash and equivalents, and approximately $238.5m available under our revolving credit facility. Our total revolver commitment is for $325m. As of March 31, we had $74.1m in cash borrowings and $12.4m in outstanding letters of credit, which reduced our availability under the revolver.

Total debt at the end of the first quarter was approximately $2.099b, representing a decline of approximately $120m from total debt at the end of the first quarter 2004. As in the first quarter of last year, total debt increased during the period, and this expected increase is a result of seasonal factors, as the Company ramps up working capital in preparation for the summer season.

In addition to seasonality and operating income and working capital, the Company makes its semi-annual fixed interest payments, totaling -- made its semi-annual fixed interest payments totaling $38m in the first quarter. These interest payments are related to the 2 fixed rate public notes that we have outstanding. So, that being said, we expect that the majority of our full year debt reduction will come, as it did last year, during the second and fourth quarters of the year.

With that, Angela, we’ll open the line for the question-and-answer session.

Thank you. At this time, I would like to remind everyone if you would like to ask a question, please press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Bruce Klein with Credit Suisse First Boston.

Hi. Good morning.

Good morning, Bruce.

I was wondering just on the contractual pass-through issue, was there anything -- I know board, I guess, went up, you were saying in the fourth quarter. Was there anything that you realized in the first quarter? And then I guess I'm wondering if the pass-throughs are longer this round than in the past? I thought, historically, it was more in the few months, as opposed to quarter-type range, and then I'm wondering if there's any sort of protection this round in the first quarter that might not have been evident in the past.

There really wasn't anything unusual about the price increases because they're generally about a quarter offset, and that's what we talked about. What I'll tell you is that the pass-throughs we talk about, for the most part, are around board and resins, or those kinds of things we buy on the outside, and we will recover 100% of those as we go through the year, although we'll probably lose about a quarter on timing. The external board, so the SUS that we sold on the outside, we saw some recovery this quarter; we'll see probably an additional $10 per ton or so in the next quarter as those pass-throughs flow through to open board customers.

Yeah, Bruce. This is Steve, and there were no new price protections implemented this quarter.

Okay. But -- so you do expect, I guess you said, the full 100% pass-through to happen this year?

Yeah, it will happen. We'll probably capture about 75% of it, because of the quarter, but we will get 100% on an annualized basis, Bruce.

So, maybe I was confused. I thought I heard earlier there were some limits on how much adjustment you get, but was that more of a timing comment?

It depends on the nature of the business, right?. The businesses that have the pass-throughs available will get 100% of it, but some of our contracts do not have levers for pass-through at all.

But there are some where there -- any individual increase is capped. So you have to wait to a subsequent period to catch on the trailing piece, even though you're contractually entitled to it.

I guess it begs the question, maybe roughly, what percent of your contracts come 100% faster? Is it ½; is it more than 1/2?

Well, we haven't spoken to that previously. What we did say is that we will get a meaningful recovery of inflation through price and we'll get every nickel that we're entitled to, and that's about as much calibration as we're prepared to give.

Okay. And then, the under -- I think in the fourth quarter, you noted, I think, a figure of, I think, $16m and change of under-recovery versus inflation. Is there anything on the first quarter that you would have comparable to that kind of a number?

Probably the same kind of magnitude.

And then last thing -- I'll pass it on -- is just on the cash flow. I'm wondering if there's any other, other than interest, which I think I have $150 in CapEx or $140. Is there anything -- what do you expect, sort of, for working capital taxes, and is there anything on the pension, expense versus cash variance, that we should be reflecting in your financial statement?

I'll take kind of the last one first. The pension expenses we -- our pension cash contributions, we expect to be about in the $7 to $10m range for the year. Working capital, we expect to be about flat on the year, because even with increased business conditions, increasing our level of receivables and payables, we are bringing down our levels of inventory. And then, as far as CapEx goes, we had talked about guiding to CapEx of lower than last year's levels, and I would say that we'll probably still working on the exact amount of CapEx as the year progresses.

Last year, being $137; is that right, $138?

Yeah, it was around $138m, I think.

And what was -- and pension cash, you told me -- what about pension expense growth -- high?

The pension expense, you know typically runs, just pension alone, about $25m. We're not expecting that to be significantly different. But the cash contribution, it's in that $7.3m, I think, range this year.

So you're paying a lot less than you're expensing, so theoretically, you could argue to add that back to the cashflow statement.

Yeah, that's the bulk of the add-back between regular EBITDA and Credit Agreement EBITDA.

Oh. And then cash tax, is there anything expected in -- ?

No, we paid a couple of million dollars of cash taxes last year. I wouldn't expect it to be materially different than that this year. Interest expense tracks at about $150m; about $9m of that is deferred debt issuance expense, or cash interest, is around $140m a year.

And did you have payables for the quarter? I think you gave us inventory and receivables.

Well, we’ve combined payables in both the press release as well as the Q, with other accrued liabilities, so you see that -- that came down, as it always does, in the first quarter with the payments of first quarter items benefits compensation and so forth. Payables, I can tell you, were down about $15m in the first quarter, which is about what they typically do.

Versus the fourth quarter?

Yes.

Okay. I'll pass it on. Thanks, guys.

Your next question comes from the line of Joe Stivaletti with Goldman Sachs.

Hi. Good morning. You had talked about, I believe, on the last call a month or so ago -- a couple of months ago -- about a guidance on $100m of debt reduction for the year roughly. And I wondered if, given how challenging the cost situation is for you and for so many others in the business, if you thought that was maybe -- how comfortable you were with that, or if you thought that was probably a little too optimistic at this point?

Joe, it's Steve. It's a challenge, but it's still the target. There are so many variables in the current full year forecast. The hardest to box down are inflation and how much more inflation will incur, and what the change will be. I would think that we'll be moving towards that number. It might be a little high, as we look at the world today, but as John mentioned earlier, we've got some continuing work to do on CapEx and I think that's still the right kind of target for us to be shooting at.

I know that you don't really want to talk a lot about the percentage of your contracts that have pass-throughs and don't for competitive reasons and what-not.

Right.

But you mentioned that in the second quarter, you think you'll see a greater level of contractual price increases. If we were to see a steady state in the second quarter in terms of costs in some of these areas, is this something -- just trying to get a rough idea. I mean, is this going to be a really noticeable pop because of these higher prices in this pass-through that you're referring to in the second quarter and your press release, or -- I just don't know how optimistic to be about that.

Yes, yes. Well, I've been consistently using the term "meaningful" to try and put some distance between deminimous and something near full recovery; otherwise, we wouldn't speak to it that way. But we would expect that the increases that we're due, and the customers have acknowledged, will make a discernable impact on both the second and third quarters.

Um-hum.

And I wish that I felt as optimistic as the question that the rate of new inflation had stabilized, but --

No, I wasn't trying to imply that was my forecast either.

All right. Good.

The other thing was, I know that you have, because of some competitive activity going back over the past couple of years, entered into a number of long-term contracts, and I wondered if there was any attempt or perceived ability to reopen any of those contracts, which I know is probably somewhat unusual when we know that your buyers are some pretty big, powerful companies that like to throw their weight around. But I just wondered if there was -- if that's part of -- could be part of a strategy here to deal with this above-average cost inflation.

Well, let's take it in a couple of layers. One is, I don't personally think we have tripped the force majeure threshold yet, which, I think, until you're there, the customers are going to be totally unreceptive. We do have other opportunities to address margin with customers and it's principally through new products, and we do re-price anything that's new and that gives us an opportunity to recover some margin. And then lastly, in almost all of our contracts, there are operating requirements, lead times, and run lengths that provide some additional cost recovery -- price recovery, of incurred higher cost, and we're pretty vigilant to make sure that we get that.

I think the broader question is that, as you look at the folding carton industry, you see a lot of companies running their carton business just for practice, where it's hard to believe that they're making any operating margin whatsoever. And as long as -- if competitors are willing to use their assets to run it, and not make any money or get any kind of contribution, the general outlook for pricing can't be that great. We don't subscribe to that, but we don't make the market.

Right, right. And just one last question. Is there any -- I think based on your current internal forecast, are you comfortable with all of your requirements from the banks, in terms of your covenants and what-not, or do you see --

Yes, I am. I was -- I knew that question would come, and this is my 35th consecutive quarterly call, and when I joined Riverwood, that's all I thought about, was covenants, and I had a reason to be that preoccupied. But that's not something that I'm concerned about at this point in time.

Great, great. Thanks a lot.

Thank you.

And your next question comes from the line Christopher Miller with J.P. Morgan

Good morning. I wanted to follow up a little bit -- follow up on some of these other questions about the higher costs. It looks like what's broken out in the press release, incremental costs of about $20m, $21m year-over-year. Is that the right way to think about the magnitude? You're kind of thinking about each quarter going forward throughout the year?

No, I don't think that -- that's not the way I look at it, because the rate of new inflation is slowing, and we hit kind of our peak inflation in the third and fourth quarter of last year, so I wouldn't compound that through. The areas that I think that, as you try to decompose it and say, "What are the ones that we can work on," freight -- many of our contracts, we do recover freight costs from customers, so we'll be able to mitigate that partially. Fiber, we announced that we have stopped using hardwood in our Macon, Georgia, mill; converted to 100% pine, that we would be working on a similar conversion in our West Monroe mill. That's progressing very nicely.

Part of our fiber costs or higher hardwood costs, particularly out of the wood basket in Arkansas and Louisiana, where the hurricanes last year disrupted the inventory flow, because we typically put hardwood into inventory through the winter, so we can draw it down during the rainy season, but this year, there wasn't an ability to raise or build inventories, so we've been paying very high prices for hardwood. So, minimizing or eliminating hardwood from our bulk or our core production is a top priority in an area we can mitigate a lot of inflation.

So, I don't see the rate of inflation compounding at the first quarter rate, and I think we will have some ability, and I think we mentioned in the previous call that our West Monroe mill is particularly exposed to natural gas, one, because we're big users of natural gas and plus the tower that we purchased Entergy is all all-natural gas fired, and that's why John said we had a purchased electricity variance in the first quarter. And we are looking at some projects that will require capital, but could have the effect to dramatically lower our exposure to natural gas in that big facility.

I think, one of the other comments, too, is as Steve said in the second and third quarter last year, we saw the ramp up that was very much driven by chemicals as well. It is pretty quickly, with not much ability in the short term, to do much on formulations or adjustments or moderation, but now that we've got a little bit of runway, we've had an opportunity to do some things to mitigate some of the chemical, but that will also help that particular part of the equation. And if you think about our board mills, we're putting clays and TIO-2s and latex binding; that's a pretty significant overall impact on our business that we'll be working to maintain or mitigate over the next couple of quarters.

Okay. And just on that note, I don't know if you've ever broken it out, but what is approximately your annual spend on chemicals each year?

Well, excluding ink, it's about $100m, and then ink is another $65 to $70m.

Okay. And then to focus a little bit on volumes, obviously, in some of the segments, you're seeing very solid volumes. Your overall net funds year-over-year down just slightly. Trying to get a little more color on kind of what you're seeing there and what's leading to that.

Well, most of it is in the open market here in the U.S. and international, and in the open market, I think you saw one of our competitor's release that they were down pretty significantly quarter-over-quarter on coated board, and part of that is that we're using our own to make cartons, where we used to buy some on the outside. But we're also seeing a lot of our coated recycled competitors trying to enhance their formulations and make a recycled board that can compete in some segments against our unbleached kraft board, so we see some shrinkage there. And then internationally, the demand in Europe is generally very weak, so our board shipments over there have fallen year-over-year.

In fact, that's where most of that reduction is. It's really in board shipments to open market and our own internal consumption in Europe, year-on-year board.

Okay. And then just one last question, and I'll turn it over. In terms of the pricing in the second quarter and then following on Joe's question, is it enough to get you to a flat year with your EBITDA comparison, or should we still be thinking about more of it back-half weighted at this point, in terms of your EBITDA?

We're not going to give that level of guidance, but I think if you go back to my characterization, it'll be meaningful. That's about as much clarity as we're prepared to give.

Well, I tried. I do appreciate it, though. Thanks so much.

Okay, good.

Your next question comes from the line of Bill Hoffman with UBS.

Hey, good morning. It's sort of a two-part question, Steve. The first is, can you talk a little bit about competitive conditions, now that one of your major competitors is entirely focused on the packaging business, or at least intends to be entirely focused on the packaging business? And then just to sort of lead that into a bigger picture question, when we look at the Company and the leverage and the growth rates in the industry right now, and the sluggishness that we're seeing, wondering whether your look at the industry is changing, or whether you think it should change on further consolidation or rationalization of grades? And I know it's kind of a broad-based question, but --

I'll give it a shot. How's that?

Yeah, just -- and then I can -- I'll follow it up with --

Yes, and I'll try not to make it an essay.

Thank you.

Okay. Competitive conditions are pretty tough right now, and as I remarked earlier, I think we've got a number of competitors who are running their folding carton business at break-even at best, and I don't, one, think that that's healthy and I don't think it's sustainable, but it is real and it's having a negative effect on industry dynamics.

As I look forward, I'm a proponent of consolidation. Pick your growth rate and pick your creep in mill capacity and you see an expansion, or a widening of the overhang, particularly in coated or recycled, which I think is the most problematic area of the industry at the moment. I think it's well chronicled that the bleach mills are enjoying pretty good backlogs, but whether or not that's sustainable is a good question, because a lot of that is going offshore. But I feel that we're reasonably close, as an industry, to being in a balance range on mill capacity, but until we get there -- and growth rates remain low, and, hell, some segments are negative.

As far as the question about competitors focusing on packaging, not all of us are as equally centered in the same space. We're in the food packaging business, dry food and beverage. We like that space; we've got great assets; we're with the right customers, and feel pretty good about that, but we've got some of our competitors who are focused in other areas. And as I see it, the ones who are selling packaging into manufactured goods, games, hardware, toys, are the ones that have the toughest road in front of them, because a lot of those commodities are going to be produced increasingly offshore. And then I wonder what's going to happen to the capacity that's been making those cartons today. I haven't -- personally, I haven't changed my longer term view of the business, although I would concede, and it would be folly not to say that right now, it's a pretty tough go.

Just to follow up on that, you seem to be pretty comfortable running at this kind of leverage level. You made the comment of 35 consecutive quarters. When we first looked at Riverwood --

(Inaudible) when I walked in the door.

Yes.

Stephen M. Humphrey I'll never forget it.

But, anyway, leverage-wise, we're still kind of at the same level, and it feels like this year, even if you lose some debt reduction, you're going to still end up in sort of the same leverage level. Are you comfortable with this capital structure as part of a sustaining basis?

Well, I think, one, it's workable for us. We're well practiced; never broke a covenant; don't intend to. We'll take any necessary and tough decision and not labor to do it. We still are focused on reducing our debt. We pledged to The Street that we're going to use our free cash flows, and that's the program. Now, the rate at which we thought we could de-lever has been slowed, but I don't know how long the current economic inversion is going to last. Inflation is -- up until probably June or July of last year, I was totally in sync with our corporate strategy, and then inflation came up like a storm cloud and how long it hangs around, I don't know, but I think we're okay.

Okay. Thanks for your color.

Your next question comes from the line David Frey from Stanfield Capital.

Hey, guys. David Frey at Stanfield. I just want to explore again the pass-through. I think we're all a little frustrated by not being able to figure this out.

Okay.

As I listen to the comments and read the press release, it sounds like what you can pass through is mostly purchase board and resin, but not increased virgin fiber, increased labor and benefits, increased freight and increased energy, which is a big chunk of the inflation you're experienced. Is that the correct interpretation?

Not exactly, because cost of goods, labor, and energy inflation is all in cost of goods, so when rolls -- when the price of board goes up, it reflects those and other input cost inflation. SG&A inflation certainly is not included in that board that we make, and we sell where there are noted price increases become part of the pass-through calculus in those customer contracts where those pass-throughs are permitted.

Some of the disconnect, I'm sure, is the fact that we don't -- pricing moving up in the industry is not based on, as you say, fiber or energy. It's based on supply/demand economics of board, that allow those costs to be recovered as part of a board movement. So there isn't this trigger that fiber goes up; therefore, there isn't a pass-through to a customer. So as you see some of these delays, it is the time for -- as board price increases get announced, they get reflected in what's actually paid; they get reflected in the external documents that the customers use to document. Then the price increases go up. So there is clearly a correlation in costs driving those board increases up, but it's not a one-for-one relationship.

Yes, and it seems like a less than one-to-one relationship on less than 100% of your business. I'm try to just reconcile in my mind if there's a $20m cost increase, not all of those costs can get passed on in the pass-through contracts, and not all of your business is pass-through, but I get to a much smaller number that I think is going to get passed on, I guess.

Well, let's turn the clock back. We've reported previously that we have a -- more than 50% of our total Company business is done with our top 10 customers. And those are all done under multi-year agreements, and they include contractual price reductions, and our price reductions average about 1% a year. And prior to this spike of inflation, our internal cost reduction performance fully offset the price reduction and helped us expand margins, okay? So, that's kind of the way we've structured the Company.

Right.

Now, with this spike of inflation, you have costs going up very quickly and the ability to recover, it's stretched out affected by -- some contracts do not take price increases for any reason and others do, and ones that do, don't take any increases as it's incurred, okay? And it's not a matter of being coy or evasive. It is complicated, and as we report in successive quarters, we'll tell you what the net inflation increases were over the prior period, and you can look at the total margins and the difference will largely be prices that we've recovered.

But let's just call that math for a second. If half your business, you're down 1% price every year, it implies to me that you can't pass on any inflation.

No.

So now you're passing on inflation on the other 5% -- on the other 50%, but with a lag.

No, we didn't get -- I didn't get a (inaudible). The ones where we have long-term contracts, some of those do not allow price increases and some do. The ones that do are all board and resin pass-throughs. And those, where we can recover board and resin pass-throughs, the timing is generally 3 to 6 months from when the price increase has been confirmed in the market to we're actually billing at the new price per shipment, okay?

Your next question comes from Jeff Harlib from Lehman Brothers.

Can you just talk a little bit about what you're seeing from your customers on demand and to Q2 so far? I mean, it's been reported soft drinks and beer shipments continued weak, but you seem to be outperforming the market. And then also on capacity, you mention you're operating full-out in Q1, but I think Q2 and Q3 are your strongest quarters. Does that mean you're going to be shifting more linerboard to CUK and how do you deal with that capacity?

Well, let's take the first -- the demand side is generally good and we are perhaps faring better because of the customer mix and product mix. As we have provided color on several previous calls, we are particularly well positioned with machine placements and contracts for PET paperboard packaging, both carbonated -- well, it's now flavored drinks, a la the Ocean Spray carbonated and bottled water, so we would expect that -- those are the growth segments in the non-alcoholic sector growing faster than overall carbonated, particularly can packs, so we would expect to do better there. I guess that's as much -- the second part of the question was --

Was capacity.

Capacity. The reference was our mills. We believe that we have produced the last of brown linerboard finally, after all these years. One of the reasons our working capital is up is because our inventory build. In support of the beverage season, we start driving real stock inventory in December, January, and February, and then we go carton WIP in March. Finished carton inventories kind of peak in April and May, and then we draw from that throughout, plus our normal production. In the carton plants, we flex up, basically from 5 day to 7 day during the beverage season, and then by late September, early October, we're taking shifts out and shutting lines down and getting back to system-wide, about a 5 day operation, by the time we get to the fourth quarter.

Okay. Good. And what about the cost savings from the beverage carton initiative, the folding carton and the new plant in closings. I mean, you've felt before almost $40m from the beverage carton, $20m. What about the phasing of those? It doesn't seem like you're talking quite as much about those anymore and I'm just wondering what kind of realization we should get throughout the year on those.

Well, I think our script said that we're on track. We're running at planned productivity levels and our beverage system, we're bringing the last new piece of equipment up as we speak. It's a 67" Gravure Press in West Monroe, and that'll be running at full productivity by the end of second quarter, so by definition, we will be at our full run-rate on the beverage savings by then. The sheet-fed strategy is principally the new facility in Fort Smith, Arkansas, and it should be operational at mid-year. And then that'll be a new savings going forward from that. So we feel as though we're right on top of the performance that we planned and committed to on both of those programs.

Okay. And just the reason you expect a more meaningful impact on price in Q2 than Q1 is that, in other words, you started feeling inflation in 3Q and 4Q. It's just more of those contracts or you're able to get the escalators….?

Right. It's when the window opens by contract, and we've gone -- and as you would expect -- through every contract and we've confirmed with customers and got their concurrence on how much roll-stock inflation that they're noting and when we are entitled to charge higher prices, and so there'll be no surprise.

Okay. And do you get some benefit in Q2 due to lower energy costs, warmer weather? How are you seeing inflation, versus -- I know it continued, obviously, in Q1. What do you see now?

It's higher, okay, than last year, although we have hedged our natural gas purchases to about 80 to 85% of our full year requirement, so we pretty well know what that number is going to be. And fortunately, our hedges are well below the current clearing price for gas contracts.

I see. Okay. Thanks very much.

Your next question comes from the line of Mike Segall from Regiment Capital.

Yes, good morning. Just a couple of questions about the freeze event in the fourth quarter of last year. What was the duration in the first quarter of that outage?

Well, the outage occurred in the fourth quarter.

Right, but it extended to the first quarter. I mean, you accrued some costs for it in the first quarter.

Well, it just -- we had to get started back up again. We have 5500 less tons produced in the fourth quarter that were able to be sold, so, basically, it was over with by the end of the first month, the first quarter.

Okay. And the last question is, are any of these costs recoverable by business interruption insurance?

A very minor amount, but we've netted that in the 2.3 that we talked about.

Okay, great. Thanks. That's what I had. Thank you.

Your next question comes from the line of Jeff Bencik with Jeffries & Co.

Okay. Thank you. Most of the questions have been answered, but could you give a specific savings amount for the closing of the Clinton plant and does that start in the third quarter of this year?

Well, it's part of the savings amount that we discussed before for the entire -- food and consumer products sheet-fed manufacturing strategy, and we talked about that being about a $19m annual savings that we expect to have fully ramped up by the end of '06, so we haven't given guidance as to what impact to that $19m would come in '05 and then '06 itself. But in answer to sort of the second part of your question, we do expect to close the Clinton facility by the third quarter of this year.

Okay. And what are your expectations for inflation going forward for the rest of '05?

Well, I’ll tell you Jeff. I wish I was that smart.

Come on. Where's your crystal ball?

It's fogged up. We track every input cost commodity every month, down to units of production, in our forecast so that we can kind of get a handle on how much inflation we've incurred, and what the exposure is for the remainder of the year. We have discussed previously that in all of the categories that are part of the Petro Chem and Monimer chain, when crude went from 23 to high 40s, everybody came in loaded for bear and told us that their recovery or the pricing was kind of indexed to crude in the mid 40s. And now it is bumping right around 50, which would suggest, if you believe our suppliers, that they still have some inflation they're looking to pass on, and we're looking to not let that happen. But what I can tell you is that the rate of new inflation has slowed.

Okay. And what percentage of the inflation that you saw in the third quarter and fourth quarter will you get with the pass-throughs? Is that 50% of that or -- ?

No, we don't -- we haven't -- we're not going to speak to that, but as I said, we will get a meaningful recovery. So you get an "Atta boy."

I tried too, so, all right. That's all I have. Thank you.

Operator, I think we've got time for about one more question before we run out of time.

Thank you. Your final question is a follow-up from Bruce Klein with Credit Suisse First Boston.

Hi. You touched on -- I don't know if you touched on this, but just the normal spring selling season, I know your guys' products seem to be doing okay, but how would you characterize the normal bump-up versus the typical cycle in the second quarter?

Well, for the first time in 4 or 5 years, I'm actually starting to feel optimistic about the soft drink or the non-alcoholic sectors. And I think that the woes of our major customers are well chronicled, that we can see a flurry of new product introductions, promotional items, and some lift in their retail sales. And we're a lot less exposed to just can packs than we used to be with PET for drinks, soft drink, water, and non-carbonated drinks. So I feel better about that. Beer, I don't feel quite so optimistic, because I think the general theory is that they've got some price compression against alcoholic spirits and they've got a pipeline -- all of the major customers have a pipeline of new product and new promotion, but it's still a little early to see how effective they'll be in the market, but at least, from our view, they're working on the right things.

Yes, and could you remind us of the breakdown in terms of the food versus soft drink versus beer? Do you have that, a rough breakdown on that?

No, we don't try to get down to that level of detail. It was a lot easier when it was just Riverwood, but it hasn't gotten any smaller in the new Graphic Packaging.

Okay. Thanks, guys.

Okay, thanks, everyone. Operator?

Yes, there are no more questions.

All right. Well, then, we'll end the call and thank everybody for joining in.

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