Graphic Packaging Holding Co (GPK) 2005 Q3 法說會逐字稿

Good morning. My name is Michelle and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Graphic Packaging Corporation Third 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. [OPERATOR INSTRUCTIONS]

As a reminder ladies and gentleman, this conference is being recorded is being recorded today, November 3, 2005. Thank you.

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

Good morning, everyone, and thank you for joining Graphic Packaging Corporation's Third Quarter Earnings call. Commenting on results this morning are Steve Humphrey, the Company's President and CEO, and Dan Blount, our Senior Vice President and CFO. David Scheible, our COO, is also on hand to answer questions at the end of this morning's presentations.

Before we get on with that, I will give the customary Reg G forward-looking language out of the way. Statements of the Company's expectations, including, but not limited to, the effect of inflation, the Company's ability to implement price increases and cost savings 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, 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.

And with that out of the way, Steve.

Good morning, everyone. Yesterday, the Company announced its third quarter 2005 earnings, reporting net income of $600,000 or breakeven on a per share basis. And in a moment our new CFO, Dan Blount, will walk you through the financial results.

But first, I would like to take a moment to thank John Baldwin, our former CFO, for his efforts in successfully integrating and strengthening the finance organizations of the two legacy companies and in preparing the company to meet its first assessment of our internal controls under section 404 of Sarbanes Oxley at the end of 2004.

The third quarter was again marked by higher year-over-year costs for key inputs and services. In total, these higher costs had an approximate $21 million negative impact on our third quarter bottom line. Fortunately, we did get some relief from these higher costs in the quarter, as we continued to realize a greater level of contractual price increases with our customers. These price pass throughs were primarily related to published price increases for folding carton that were announced in late 2004 and early in 2005.

Additionally, in September, we announced a $35 per ton price increase for all our coated board folding carton grades, and a $40 per ton increase for both medium and linerboard shipments. These price increases took effect in early October. In addition to the price increases in October, we also began including fuel surcharges on invoices related to both coated board and containerboard shipments. Both the price increases and the fuel surcharges were necessary to cover the continually rising energy, fiber, chemical and transportation costs we're confronting.

Also during the quarter, our innovation efforts continued to have success with numerous new product rollouts. As mentioned in last night's earnings release, our Fridge Vendor carton is now being implemented throughout the non-carbonated beverage industry. Specifically, Gatorade launched its 12 pack "All Stars" line of Thirst Quenchers in the Fridge Vendor carton, while Izze introduced the first Fridge Vendor carton used to package fruit beverages. Coca Cola launched its 12 ounce PET Dasani flavored waters in an 8-pack Fridge Vendor, and internationally, Graphic Packaging has been assisting Kirin Beverage in test marketing the Fridge Vendor in their canned coffee product. It's worth noting in Japan, canned coffee outsells Coca Cola and makes up the largest portion of the soft drink market.

On the food and consumer products side, Kraft continued to increase their utilization of Graphic's Z-Flute substrate by adding our Composipac package to Ritz Crackers and a litho printed Z-flute carton to Chips A-Hoy cookies. Kraft now has more than a dozen items packaged in the Graphic patented Z-Flute solution. In the frozen pizza segment, Schwan's introduced their new "Healthy Pizza" in our patented Micro Rite technology, as did Kraft with their South Beach diet Microwave Pizza. And finally, on the restaurant/retail side, McDonalds launched their new Premium Chicken Sandwich in a Graphic food service convenience clamshell and also utilized Graphic Packaging's labeling capabilities to launch a new in-store Monopoly game.

When taking a look at volumes, our beer carton volumes continue to be negatively impacted by overall weakness in U.S. beer demand. In response to this ongoing decline in demand, the major US brewers have initiated promotional pricing activity earlier in the year in an attempt to jump start sales. Unfortunately, we have yet to see these price cuts result in any material increase in beer volumes.

Despite a similar decrease in US soft drink can shipments, our soft drink carton sales remained strong, as volumes were up over 5% versus the prior year third quarter. The increase on our end is attributable to share gains with several of our major customers, and additional volumes in the expanding non-carbonated beverage markets. The Coca Cola Company's October 20th third quarter earnings release also reflected this trend as they reported a 1% decline in North American carbonated soft drink unit case sales volumes, but a 30% increase in North American case volumes for their non-carbonated PowerAde and Dasani brands.

We also continue to combat inflation through the execution of continuous improvement projects, and by recognizing productivity improvements related to the investment in our manufacturing initiatives. During the third quarter, these programs achieved approximately $9 million of incremental cost reductions and increased productivity.

On the production side, our U.S. Mills performed well and ran at full capacity over the entire quarter. No market related downtime was incurred and none is forecast at this time. Strong operational performance and process improvement initiatives enabled increased production volumes versus the third quarter of 2004.

On the beverage converting side, our Clinton, Mississippi plant was closed during the third quarter, as previously announced. Production has been successfully transferred to both the Graphic Packaging converting facility in Fort Smith, Arkansas and West Monroe, Louisiana. During the third quarter, the new gravure press installed at West Monroe continued to show improved output levels. Full potential of the press is expected to be achieved by year-end, well before the 2006 beverage season. As mentioned earlier, the difficult market conditions continued throughout the quarter, but are being addressed through continued cost reduction, mix improvement, and the new product development efforts.

Sales to Food and Consumer Products markets had another solid quarter, up approximately 6.1% over the same quarter last year. All of our major Consumer Packaged Food customers are showing improved volumes both the prior year quarter, as well as a year-to-date basis. Additionally, the manufacturing system continues to deliver solid productivity improvements and cost reduction results. The startup of the Fort Smith facility continues to go extremely well and the Bow, New Hampshire plant will be shut down in the fourth quarter as planned and previously disclosed.

In summary, the story continues to be inflation. Although our sales contracts often limit our timing and ability to raise prices, we are now seeing price increases related to published board increases. In addition, we have announced significant new price increases and fuel surcharges for both our coated board and container board grades, which became effective in early October.

We also continue to drive longer term growth by prioritizing product innovation and providing customers with new packaging solutions. This is illustrated by the continued success of our patented Fridge Vendor carton, specifically with its push into the fast growing non-carbonated beverage market, and by the emergence of our Z-Flute substrate with Kraft and others, and the continued rollout of our Micro Rite product in the frozen pizza segment.

On the cost side, both our dedication to continuous improvement principles and the investment in new manufacturing initiatives will continue to drive cost savings and productivity improvements over the remainder of the year and into 2006.

And finally, I would like to note that in October, the Company worked with its Bank Group to seek covenant amendments to our Senior Secured Credit Agreement. In the end, we received affirmative votes from 100% of the lenders who I would like to thank for their confidence and cooperation. Going forward, based on our current view of the future, the amended covenants should provide management with room to focus on operating the Company.

With that, I'll turn it over to Dan Blount for the review of the financials

Thank you, Steve, and good morning, everyone. As Steve mentioned, we released our earnings for the third quarter last night, reporting net income of $600,000 or basically, breakeven on a per share basis. This was flat when compared to net income of $700,000 in the third quarter of 2004.

Third quarter 2005 net sales were $605.4 million, down $11.8 million or 1.9% as compared to net sales of $617.2 million in the 2004 third quarter.

The decrease in net sales versus the prior year quarter was driven by four main factors -- one, a 3.8% decline in beverage carton sales to North American markets. This sales reduction was driven by both weaker volumes and lower pricing on the domestic beer side, while U.S. soft drink carton sales were up slightly from the prior year quarter on better volumes. Two, lower international sales during the quarter. Sales abroad were $99.0 million or 16.4% of total sales for third quarter 2005, compared to $104.7 million, or 17.0% of total sales in the prior year quarter. The reduction was primarily a result of lower volumes within food and consumer product markets.

Three, lower sales of both domestic coated roll stock and Containerboard. Containerboard's quarterly sales decline was $7 million. A portion of these reductions was due to internal production and sourcing differences from a year ago. First, we are cutting up more of our internally produced board to make cartons and second, we are producing coated board on machines formerly dedicated to producing linerboard.

And then four, partially offsetting these factors was a 6.1% increase in food and consumer product carton sales to North American markets. The increase was the result of both increased pricing and stronger volumes within several major customers.

Income from operations for the 2005 third quarter was $44.1 million, down from 2004 third quarter income from operations of $47.0 million. In just a moment, I will discuss the drivers of this year-over-year third quarter decline.

Net interest expense was $39.1 million for the third quarter 2005, as compared to net interest expense of $38.4 million for third quarter 2004. The increase was a result of higher interest rates, which impacted our floating rate Term C and revolving credit facility.

Income tax expense was $4.8 million in the quarter as a result of amortization of goodwill for tax purposes. This was lower than the prior year third quarter income tax expense of $8.4 million, which included both the amortization of goodwill and additional tax expense from foreign jurisdictions.

EBITDA for 2005 third quarter was $92.7 million or 15.3% of sales as compared to EBITDA of $105.8 million or 17.1% of sales in the 2004 third quarter. Credit agreement EBITDA for the third quarter was $86.3 million as compared to $115.8 million in the 2004 third quarter. Unlike straight EBITDA, add backs for Credit Agreement EBITDA include non-cash pension, postretirement and post-employment benefits, merger related expenses and unusual write-downs. During the third quarter, Credit Agreement EBITDA was reduced by $14.8 million of cash contributions made to fund the Company's US pension plans. The Company made no cash contributions to its US pension plans in 2004.

Capital expenditures for the 2005 third quarter were $17.1 million. $2.4 million of these capital expenditures were related to our food and consumer products sheet fed manufacturing initiative, bringing total expenditures on this project to approximately $26 million. The total projected expenditure for this initiative is approximately $28 million, and that will be incurred over the 2004 through 2006 period.

As Steve emphasized earlier, cost inflation had a substantial negative impact on income from operations this quarter. The most significant increase related to fiber, board and corrugated materials. Costs for these inputs increased $5.5 million when compared to the third quarter of 2004. Prices paid for certain chemicals, coatings and resins were also substantially higher than the prior year third quarter. This resulted in increased costs of $5.3 million. Energy, primarily natural gas and purchased electricity, was up $4.8 million over the third quarter 2004. Freight costs, primarily resulting from higher fuel prices was up $3 million over third quarter 2004. Finally, labor and fringe benefit costs were $1.4 million higher than the prior year quarter.

Partially offsetting the impact of inflation was a $9.2 million reduction in operating costs, which resulted from ongoing continuous improvement programs and productivity improvements related to the Company's manufacturing initiatives, plus we had lower depreciation and amortization expense of $10.2 million. Specifically, depreciation and amortization was $48.6 million for the 2005 third quarter, compared to $58.8 million reported for the prior year quarter. Driving the depreciation and amortization decrease was, one, lower depreciation as prior year third quarter depreciation included the accelerated write-off of assets related to the closure of our Clinton, Mississippi plant, and, two, 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.

SG&A was $50.1 million during the third quarter, compared to $48.6 million for the prior year third quarter. A significant part of this increase was higher labor and benefits, which was included in the inflation numbers I have mentioned previously.

I'll wrap up with a few comments regarding the balance sheet and cash flow. At the end of the quarter, we had $9 million in Cash and Equivalents, and $293.2 million available under our revolving credit facility. Our total revolver commitment is for $325 million. As of September 30th, we had $17.9 million in cash borrowings and $13.9 million in outstanding Letters of Credit. Now, these reduced our availability from the revolver.

Our total debt at the end of the third quarter was approximately $2.040 billion, representing a decrease of approximately $19.0 million during the quarter and a decrease of $85.8 million when compared to the third quarter 2004.

Cash flow --- cash flow availabilty to pay debt during the third quarter was reduced by the $14.8 million of cash contributions made to fund the Company's US pension plans. The Company made the contribution to improve the funding status of the plan this year, and to avoid triggering more onerous IRS tax reduction cash contributions next year.

And with that, that concludes my comments, and I'll turn it back over to the operator for the Question and Answer Session.

Thank you. [OPERATOR INSTRUCTIONS]

Your first question comes from Joe Stivaletti with Goldman Sachs.

Good morning. I was just following up on your pension question. I know you didn't make any payments in '04 and you made this big payment in the third quarter and that does tend to distort your credit agreement EBITDA. I was just wondering what your expectations were looking forward in terms of needs to put more cash in, or do you think that's going to be it for a while?

Well, Joe, what our policy is that we want to maintain a funding status which is in line with the IRS regulations and keep us out of a position where we have to have the government give us restrictions in terms of our future funding requirements on the pension plan. So at this point, unless stock market returns increase, we're looking at probably having pension contributions going forward. But as you know, it's more of a fluid situation where you have service costs, interest costs on the plan assets and they're offset by the returns you have on your investments, but I do want to state that the 14.1 is a payoff of a pension liability and doesn't affect pension costs in the P&L.

I mean, overall are you in pretty good shape in terms of your sort of overall funded status there or -- ?

Right. We're maintaining an above 80% funded status on our pension plans and there's a formula that's somewhat complicated in the regulations that we're going to comply with.

Joe, it's Steve Humphrey. This is a policy that the board has been -- we're going to keep the Company above the minimum threshold and without trying to do a dance, we really can't give accurate guidance until we know what the investment returns are.

Oh, yeah.

And I would just say that if the returns are no better in the future than they were this last couple years, we'll probably have some additional cash contributions.

Yeah, yeah. Okay, that's very helpful. And the second question I had was you talked about fuel surcharges and do you have any ability to -- is that just on your non-contract volume? Obviously, we know that you're dealing with some contracts that don't have cost pass-throughs with the beverage customers. Is there any ability to put through -- are you putting through fuel surcharges to those customers or is this just for all of your other volume?

It's principally for all the others. With the contract customers, we have a different discussion, which is how can we lower the cost of freight and transportation by working on a supply chain as a way to mitigate the need to impose fuel surcharges, and as long as we feel like there's legs under that option, we're okay with it as long as we get the same mitigation.

Okay, thank you.

All right.

Your next questions comes from Bruce Klein with Credit Suisse First Boston.

Hi, good morning. I guess just following on the fuel surcharge question, what sort of amount were you sort of trying to achieve and others gone along with it and do we know if this is successful yet, or -- ?

Well, yes, there was a couple things. Oh, I'm sorry. This is David Scheible. Let me answer that question. Did you know on our open market board -- open market sales, we announced a price increase of $35.00 a ton plus a fuel surcharge. Those fuel surcharges are immediate and those are being successful. In our Consumer Products business, we tend to have freight pre-paid in bills. So whatever the freight is, we bill it. The customer either ranges the freight or is paid directly in the process of the invoice.

In some of the other businesses like our Ocean Freight Business, our internal freight, of course, which is not really recaptured through any processes, or as Steve said, in some of the longer term beverage contracts, then we need to work out how to reduce the overall cost and share that with our customers. So where we extended it and allowed to, it has been successful. Other areas take a little bit longer because it is more of a joint cost reduction program.

The good news is that the fuel surcharge has dropped about $0.06 a gallon this week. We've been as high as $0.39 a mile surcharge, and I think once the supply of diesel is replenished -- I've been traveling, visiting our plants and I've been commenting. I look at the local service stations and unleaded regular was averaging around $2.40 a gallon through the Midwest and diesel was at $3.25, which is an unprecedented spread, but it's a reflection of diesel refining capacity has been hit the harder as a result of the storms. So I think as they get that supply back, we can get some relief with the underlying problem, which are the surcharges.

And then Steve, on the energy side of the manufacturing side, I think refresh your memory, you're mostly unhedged for '06?

We put our strips in place through the first quarter. It was a somewhat painful process given the pricing. But we have a policy in the Company that we do normalize costs through forward contracts. We've got about 80% of the first quarter already in. We're kind of holding our hand off the trigger for the balance of the year, and the advisors that we use are expecting and projecting that prices will moderate for the second, third and fourth quarters of next year.

When was the 1Q '06 hedges put in place, recently?

Oh, yes, about 3 weeks ago, 2 weeks ago.

At the very end of September and very early October.

And given where gas prices on the forward curve, I mean I know you locked it in, but I can't imagine that is that much of a benefit, I suspect, right?

The winter quarter is always the most painful in terms of the stock market, at least traditionally. Take out the hurricanes that kind of really hit the market in August and September the last 2 years. So that's a quarter that we think there's more upside risk and that's why we took the positions now rather than hoping that the market might back off some.

And Steve maybe just relate the stops in terms of growth rates or substitution in your various segments, beverage North America, beverage overseas and then food and consumer. I know you had a lot of new products and it's just hard to -- I'm wondering if in your view you if you can remind of us the related stops and what you think growth rates are, whether or not substitutes -- even within the boxboard substrates or outside of them, plastics are having a big impact, positive or negative.

Well, I'm not attaching a lot of risk for functional substitution in beverage secondary packaging at the moment. I think what's happened in the resin and petrochem world has put a heck of a lot of stress on all of the other substrates, the non-paper substrates that would be possible alternatives. I think that the growth in the non-carb, non-traditional segments is explosive, but it's off a very low base, and it's going to take a few years before that base gets big enough and if that growth rate sustains to be able to mitigate the continuing erosion that we've been encountering in core soft drink and beer take-home volumes.

I guess the comment I would say about growth is that our issue in the beer side of the equation, because as Dan said, that was the really biggest part of our volume shortfall this quarter--- quarter. It’s really more structural in the marketplace and you've seen those things just as I have, that there is a higher percentage of the population drinking wine and spirits versus beer than has been traditional. As Steve said in his comments, our customers have done a lot more promotion, a lot more SKU modifications, different things. But at this point in time, we have not seen a significant impact in beer volume and that is the primary impact. And that is not just in the United States, but also in Europe. There's still a trend in Europe, while not as significant as the United States, still a downward trend. Substitution trends have actually favored us.

As Steve went through the new product avenues, really where in many cases, it's fiberboard replacing corrugated or plastics and films are creating new space in fridge vendors for Gatorade or Izze. So that part of the volume structure is solid. It's this sort of underlying issue that we're dealing with in both beer and of course soft drink that's riding the volume issues.

Make no mistake, we continue to root for our customers to get this relationship reversed, but at least our observation to date is they haven't quite got it yet.

Okay, I'll pass it on. Thank you, guys.

Your next question comes from Jeff Harlib with Lehman Brothers.

Good morning. I was just wondering if you can talk a little bit. I don't expect specific numbers, but you actually had a more favorable year-over-year variance on the cost side than you did in 2Q. Q4 looks like you have higher chemical, energy costs. Can you just talk through those inflationary cost increases over the next couple of quarters and when your contracts allow you to recover those cost increases?

Okay. Well I can do better on the first part. I can repeat on the recovery side what we have tried to share many times, which is in the non-beverage segments. We do have the ability to recover published industry roll stock increases. In many cases, there are windows as to when we can get the price, and in some cases, there are caps or collars as it relates to the amount of any single increase. But we always get it. It may take a little bit of time.

Steve, I guess what I was thinking on that was whether there are ways to any particular quarters, those -- because I remember last year, it was second and third.

I'm going to get to the inflation part. I think our view at the moment, after a very recent and comprehensive canvassing and dialogue with our major suppliers, is that I think that input inflation will become pretty stable with the exception for fuel and energy. I think we're not smart enough and our customers aren't bold enough to predict that the energy equilibrium has been stabilized and natural gas -- we're very large consumers of gas. We have a particularly broad exposure in our West Monroe, Louisiana mill because it is gas intensive. Plus, the electricity that we buy is natural gas fired.

And so, whatever increases in volatility that we're going to experience, as we look at the world today for '06, is largely going to be centered on natural gas and in Louisiana. And if gas goes favorable, it'll be good news and we can't predict. I mean, you can look at the forward curve and see where the shape is for all of next year, month-by-month. But my experience is that curve doesn't look anything in reality like it did when it was forecasted. So we don't really have any specific information that would tell us that any quarter next year is going to be incrementally better or worse, but I am feeling a lot better that the torrent of inflation across almost all of our inputs is subsiding. I think it's going to be more localized in natural gas, purchased electricity and freight, basically fuel.

Okay, can you just address fiber and chemicals?

Well, I think that chemicals, we are in reasonable equilibrium. We've done a tremendous job to reduce usage. We've done a very, very good job to qualify lower cost functionally acceptable alternative chemicals and we've done a pretty good job of broadening our supply base to try to enrich the competition supplier to supplier. So I think that's been very good.

On fiber, the story is really hardwood and fuel. Hardwood is a diminishing supply. As we noted in our last call, we have converted the Macon mill to 100% pine, and are pursuing a -- for coated board -- and pursuing a similar path in the West Monroe, which should be completed some time next year.

What we pay for cut wood, the stumpage prices has been pretty stable. It's the cut and haul portion that's gone crazy. The cut portion has largely been workers' comp and underlying labor inflation and then the haul is transportation, and it's fuel. So we would expect that as the overall diesel fuel surcharge exposure reduces, that the haul portion of fiber will come back down because, as you know, it's been very stable for a long period of time, particularly in pine.

This is David Scheible. I might also add that secondary fiber OCC recycled has actually dropped during the quarter, so we actually saw a little bit of positive as we went forward to that. The other part of fiber that Dan referred to is fiber that we buy in external boards. So we don't produce all the board that we use to make cartons. But that board resins and costs, but we also recover 100% of those movements through our carton pricing. So they are not a deleterious effect on the net EBIT of the corporation. So the only fiber that really hurts us today is, as Steve said, the cost of getting the hardwood to our virgin mills.

Good. And just on the cash-flow and debt reduction, you talked before about the 100 million being aggressive. I know in fourth quarter last year, you had a very strong cash-flow quarter. Can you just talk about cash-flow prospects and also if you can update us on your CapEx expectations this year and next year?

Yeah, in terms of cash-flow, we follow a normal pattern that that increase is really through the first part of the year and then we have the huge public debt interest payments during the third quarter. And then we get to the fourth quarter and that's when we're generating our cash and primarily paying down our debt. And if you looked at last year, we had $100 million of debt pay down in the fourth quarter, and $20 million of that came out of cash balances. So we generated about $80 million in pay down debt in the fourth quarter of 2004.

Now, looking forward, we expect to pay down debt and generate cash in the fourth quarter of 2005 as well and I don't think the magnitude is going to be as high as 2004 at this point in terms of cash balances. But we are following our normal trend and if you look at our cash-flow statements, you'll see that our trend is consistent with the prior year at this point.

CapEx, we expect CapEx to be somewhat lower because of the point at which we are within the manufacturing initiatives and the sheet-fed strategy at this point. If I put a number on it, I'd say in the $20 million range in CapEx for the year.

We are tracking to something just over 100 million for fiscal '05 CapEx, and we haven't submitted our budget for '06 to the board of directors yet. That happens mid-month November, in a couple weeks. But as Dan suggested, I think we'll be down something in the $80+ million range for '06.

We've done a lot of the major projects we wanted to do that Steve talked about post-merger, which was consolidate plants, get them closer to the mills, create some larger throughput. And you can see in the numbers because we do have less internal freight overall units standpoint because our larger plants are closer to our mills at this point in time. And if you look at the metrics that we use to look at throughput and scrap, as Steve said, one of the reasons we were able to offset inflation is because those plants are operating much more efficiently in '05 than they did in '04, and it's based on a lot of that capital investment. But there's not that necessary need for that big slug of capital on a go forward basis because we've made that investment.

Okay, great. Thanks very much.

Your next question comes from Brandon Holt with Deutsche Bank.

Morning, guys. Pretty much all my questions have been asked. One last one. Any color or granularity on the volume outlook and as we go into fourth quarter and possibly into '06, the best you can do?

I think that we'll just take the seasonality out. I think our presumption for next year is that beverage volumes, particularly in beer, will continue to be soft. Our outlook on the soft drink business is generally more positive, particularly because of the growth in the non-carbonated area. I think in the Food and Consumer Beverage, as we've said many times, we're a mirror image of how our customers perform, and our major customers are selling more this year, and it's reflected on our volumes and they seem to have some momentum, a lot of new product launches. So we look at the domestic non-beverage packaging business as pretty good. I think the containerboard business is going to get soft and get softer and softer as we sell and need to sell less and less there. I think the other area that looks like it's going to continue to show softness next year is Europe, where there is a weak demand notwithstanding the protestations of the ECB. It looks to me like they're in recession, or perilously close, and we can see it in our volumes.

Okay. In very, very broad strokes, it may be hard to say, the businesses where you've actually initiated price increases, what percentage of your business was that related to overall?

I don't think we want to paint with that brush.

Okay. And I just want to clarify something, Steve, you just said that '06, possibly an $80 million total CapEx number?

Yes, I think that's a range that's pretty good for us.

Okay, very good. Thanks, guys.

Okay, thank you.

Your next question comes from Bill Hoffman with UBS.

Thank you. Good morning. Steve, I wonder if we can try a new brush. Can you just help us? Obviously, added alot of Food and Consumer business, can you just help us get a handle on how much of the sales these days are contract, like the beverage kind, and how much is more open market?

Well, if you go to our website and look at our investor presentations, we say that about 50% of our total Company revenue comes from our top 10 customers, and every one of those, we have a supply agreement with, every one. And there are others, in addition to those top 10, where we have supply agreements. So that's pretty much the norm in our business.

I guess the question is not all supply agreements are created equal, I would assume.

Well, there are some that are more equal than not and they're all big, powerful customers. They're all determined buyers and invariably, they all include some form of sequential price reductions. Sometimes they get it all up front. Sometimes it comes spread throughout the course of the contract. The ability to recover cost, or price increases, varies from segment to segment and contract-to-contract, and that's what we've tried to speak to previously. Our result is that within our lifetime, we will have all of our business, 100%, will have inflation recovery provisions and we still remain firmly convinced that that will happen. And it is happening as we speak.

I think the right commentary there is to say we're not going to talk about individual customer contracts, or when they expire, what they do. What I will tell you is that within our business units, even in those contracts that are beginning to expire in the future, and that do not have escalators, the new versions of those contracts will in fact have a version of contract escalators in them. So we'll have to get to those points, but as they're being negotiated, we are successfully being able to implement that so that so that Steve can avoid that question in the future.

I think that as I listen to or read the transcripts of calls from our competitors, there's a fairly consistent theme of resolve that the world has changed. We've done business for almost a decade with relatively stable input economics and the commercial terms evolved around that model. Now, we're in a period that's got a lot of volatility and the suppliers cannot continue to absorb the kind of hits that we've been taking, just plain and simple. I think our customers get it and this is not a welcome discussion and it's not a friendly or easy one. But I think at the end of the day, it's a constructive discussion and so we'll get there.

Thanks. And of your sort of bigger contracts, and I know you also don't want to quantify this, but is '06 a big contract year or is more of it happening in '07?

More of it is in '07.

Okay. And then the other question was just in regards to the fuel hedging, etc. I just wondered if you could help us quantify somehow the quarter-to-quarter impact. You talked about locking in finally the first quarter, obviously, at a very difficult time in the market.

Painful.

Yeah. Could you step us through where maybe the average prices are or at least give us some indication of percentage increase quarter-on-quarter?

I think what I would prefer to do is maybe give you more of a year-over-year view. And it really gets down to what's the blended projection for Henry Hub pricing in '06. I think that with the nominal forecast or projection that we're using, I would expect that gas prices would be up about 35% year-over-year, if that all materialized.

If we had to look sort of first quarter --

I really don't want to get down to that level of detail.

How about if we just looked at --

I think what you can expect is energy prices in the first quarter of '06 are going to be very painful, OK? Very painful. Alright?

Yes, sir. Thank you very much.

Your next question comes from Ashwin Krishnan with Morgan Stanley.

Hi, good morning. Looking at CapEx as a percentage of depreciation running under 50% right now, how long do you think we can keep running at this rate before the assets become underspent on?

Well, I've made this comment over the years and you may be new to it. When you look at the number of write-ups that the combined Company has undertaken or undergone, you really have to kind of look at the historical tax depreciation rather than book, and we've got, what, $600 million of goodwill. One of the comments or questions that occurred when I joined Riverwood back in 1997 was, is there any hope that you can get a company in this business to a return on capital level? And without trying to be flip, I said, one, we've got to improve the return and I thought there was a way to do that through cost reduction and innovation and mix improvement and that's the path we've been following for 9 years and I think with a lot of success.

But I also said that if this industry doesn't cut its reinvestment rate, I see no hope of ever getting there. So the trick is to be a lot more selective about the assets that you operate, and that's why we've closed over the last 2 years five carton plants, expanded one and built a new one that have better, more reliable higher productivity assets. So we're not replenishing tired, non-competitive assets. And so I think that as I said earlier, I think that $80 million is a very comfortable level for this Company to sustain the mills to continue to invest for productivity, to invest for quality improvements and to invest for some selective additional cost reductions.

Thanks. I had a follow-up question. When you look at your asset portfolio today, are there non- core assets or real estate which could potentially be disclosed to accelerate the debt payment program?

Well, we have said for years that we consider our mill in Sweden, Fiskeby, a non-strategic asset that we'd be prepared to sell at a fair value. The problem is our view of fair value and what others see is so far apart that we're not prepared to fire sale it. I think what you would see in our cash flow is that we've got a very good track record. When we close a facility, after we button it up, we sell the property. And so we are extracting the cash from those stranded assets.

Okay. Thanks, guys.

Okay, thank you.

Your next question comes from Christopher Miller with JP Morgan.

Good morning.

Just want to follow up a little bit particularly on the CapEx number. I mean, in terms of how does that potentially limit your ability in terms of extracting additional costs out of the business? I mean, you've been pretty aggressive in trying to strip costs out of the business over the last couple of years. As we look at '06, do you have some sort of target of what you think you can achieve in terms of additional cost savings?

Sure, we do. It'll be higher kind of our historical -- what we call the Continuous Improvements Six Sigma-type project run rate, but we're going to let the investments that we've made in converting in both beverage and the non-beverage sheet fed come to maturity. We may have some small, additional drop-ins where, rather than rebuilding equipment, it may be much more rational to put in some newer, higher capability assets. But we've got plenty of continued opportunity at the operational level to extract costs from this Company, lots and lots more.

The $80 million, as Steve talked about, is -- a portion of it is ear-marked to do exactly what he said. It's to look at older assets within our facilities and recognize it makes no sense to continue to maintain them; it makes no sense to continue to operate them when we can upgrade by buying newer equipment, a wider format in a better location, geographically, relative to cost to serve a customer. And we do that on a regular basis. It's a very program spend. It's a very specific valuation of where we spend our capital, but we are not out of opportunities for cost reduction at the current capital spending rate.

Okay. And then with the reduced CapEx from a free cash flow perspective. I mean, you've kind of been targeting $100 million of debt paydown a year, and obviously we said that think that's a little aggressive this year. As you then look to '06, does that become a number that you would still be comfortable about -- without making the forecast, but is that kind of generally still the target you would be thinking about as a run rate for debt paydown each year?

Well, it's really directly affected by what the cash from operations looks like and I think that we're not prepared to give you any guidance going forward. As I said, we haven't even presented our budget proposal to the board of directors yet. So I will affirm or reaffirm that debt reduction is still our number one priority, and we get lots and lots if encouragement from our Board to extract cash from the business and use it to pay down debt. So you can presume that it is right at the top of our priority list.

All right, that's great. I appreciate it much.

Your next question comes from Andrew Stein with Kingsland Capital.

Hi. Given the discussion that you've had about natural gas pricing, can you talk more about what you can do to combat it on the cost side?

Sure, use a heck of a lot less of it. No, I'm absolutely serious. We've expended and we are expending, for us, a very significant amount of money with some very capable consulting folks, principally focused initially at our West Monroe Mill Complex to enable us to manage our energy complex better, steam balance, power balance, but also to utilize a heck of a lot less fuel inputs. So that's the number one goal. There are some capital projects that we have looked at. We've engineered them and when gas was at $5 or $6 a unit, the paybacks just weren't there. At the current price level, they look a lot more attractive.

Now, to the extent that we handicapped the race and say that gas will structurally stay above $8 or $10 a unit indefinitely, we'll take on some of those capital projects. But they'll basically use a lot less. The other area is we got some product areas that we've talked about candidly for a long time, like containerboard, where the financial contribution is not that attractive and it may make sense just to produce a heck of a lot less of it and just forego the energy requirements.

Given that 35% year-over-year increase you mentioned before, how much of that do you think you could chip away at?

Well, I would say in the short term, probably not a hell of a lot. I mean, if we could get 20% of that, I'd say that would be very, very good work on our part.

I will tell you that one of the things we're doing, as Steve said, we have a very sophisticated cost reduction program, including using black belt six sigma at the mills, and one of the things we're doing right now is we're focusing very significantly those resources on energy conservation and just pure unit reduction. And as Steve said, our primary energy concern or our best opportunity is within our West Monroe Complex. So we are reallocating some resources to the organization to focus on. That’s because it has the biggest opportunity for improvement. And I don't mean capital projects as much as just sort of operating by the guidelines, running different rules of how you take a machine down and how you bring it back up and the escape of energy in terms of steam and utilization throughout facilities. So we have some significant pricing. I think Steve is right, our target is to take a 20% whack at that number and we're actually pretty decent at taking costs out. So I'm optimistic that we'll get some of those unit costs down. And if the price of natural gas mitigates, we'll have some upside then.

I think the last comment that David just made is the one that's most important. I don't have a tremendous ability, and I don't think anybody else does either, to predict what the unit price of gas is going to be quarter-by-quarter in the future. I know what the curve looks like. I know what the consultants that we retain tell us about insertions and demand and distribution. But things can change. So, it could be worse or it could be better. But what we're trying to describe is our nominal planning envelope.

Okay, thanks.

All right.

Your next question comes from Keith Chan with Merrill Lynch.

Yes, can you give us the income from operations for third quarter between the two businesses?

What two businesses?

Paperboard packaging and containerboard that you recently put report in the Q, do you have those numbers?

Hang on just a second. We do have those numbers. The document search is occurring.

Okay. Also, can you talk about, while you're looking, in terms of what the maintenance CapEx would be like --

Hold on a second. I think we've got the answer to your first question.

Income from operations from containerboard is going to be a -$3.9 million for the 3 months ended September 30th, 2005. Okay?

And paperboard packaging?

Paperboard packaging is $64.7 million positive income from operations for the quarter.

Okay. And the difference would be the elimination, right?

The elimination and corporate expenses.

Okay.

$16.7 million.

27 you say?

$16.7 …. corporate.

Now, your question about maintenance capital, I would suspect that companies might define that differently. But what I used to suggest when it was just Riverwood, that it was about $40 to $50 million a year, largely concentrated in the mills but not exclusive to the mills. And I don't know if that number has changed dramatically over the years. Not all of that is capitalized. So that's when you say maintenance capital, I'm not sure what's the definition, but if the question is to get back to what's the reinvestment rate that is required to not liquidate the Company's productive capability, I would think it's in the $40 to $50 million range.

Yes, that's what I'm looking for.

You've got some buckets. We have spending that's required for health, safety and environmental. It's always spent. We never push that off. We just take it as we need it. Then you have your -- actually, it's wearing out and it could be equipment or it could be the facility itself, the rust, rot and repair. And I would add in '05 and even '04, we had some environmental Mack-2 spending for ground stock washers in West Monroe for almost $25 million. Those will roll through every now and then.

And then the rest of the spending is really to improve capability. It's to break bottlenecks. It's to improve quality attainment on certain attributes, and it's to reduce costs. We're not spending a lot of capital to create new capacity. We get that through our normal productivity operating effectiveness. So that's kind of the story on CapEx.

Operator, I think we have reached the time limit for the call. Michelle?

I think we're just going to call it to a close and thank everybody for joining and we'll talk to you next quarter. Thank you.