Graphic Packaging Holding Co (GPK) 2006 Q1 法說會逐字稿

Good afternoon. Welcome to the Graphic Packaging First Quarter Earnings Release Conference Call.

[Operator Instructions]

Now I would like to introduce Scott Wenhold, Vice President and Treasurer. Sir, please go ahead.

Thank you operator. Good morning everyone. Thank you for joining Graphic Packaging Corporation’s first quarter earnings call this morning; with me and 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 available to answer questions at the end of the presentation.

I would like to remind everyone that statements of the company’s expectations, including but not limited to the affect of inflation, the company’s ability to implement price increases and savings are forward-looking statements 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 would cause the actual results to differ materially from the company’s historical experience and its present expectations. Undo reliance should not be placed upon such forward-looking statements as such statements speak only 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 can be obtained in the company’s periodic filings with the SEC. Now with that out of the way, I will turn this morning’s call over to Steve Humphrey.

Good morning everyone. Yesterday the company announced first quarter of 2006 results reporting a net loss of $31.5 million or negative $0.16 per share. This was essentially flat to the first quarter of 2005 despite being impacted by approximately $17 million of cost inflation in the quarter and approximately $9 million in costs primarily related to an unexpected failure of a turbine generator at our West Monroe Louisiana mill. In a moment, our CFO, Dan Blount will walk you through the specific items in the bridge of the current financial results to the prior period.

Let me say, however, that I’m pleased with the job that the company did to counter the negative affects of inflation and the negative event at the West Monroe Mill. First the company is now seeing improved pricing when comparing to the prior year quarter. The majority of this favorable pricing is attributable to contractual pass throughs on certain business related to raw material cost increases that incurred in late 2004 and in the first half of 2005. In addition on the non-contract side of the business, the company recently announced additional price increases for both coated and containerboard. Specifically effective with May 1st shipments, pricing on our CUK Board will increase $40.00 per ton. This increase follows the $35.00 per ton announcement that occurred in Q4 of 2005. In addition to CUK Board, we announced a containerboard price increase of $50.00 a ton effective with April’s shipments following a $40.00 per ton announcement that took effect in January of this year.

Also offsetting inflation and the unplanned event in West Monroe was another successful quarter of cost reduction and improved manufacturing performance. All together, cost savings stemming from our continuous improvement programs and manufacturing initiatives totaled approximately $18 million in the first quarter. As I mentioned on the last earnings call we are targeting full year 2006 cost savings to exceed the $50 million level.

In addition to numerous Six Sigma and other continuous improvement projects our investment of approximately $100 million to upgrade the company’s converting assets during 2004 and 2005 is now reaping benefits. In the first quarter, for instance, we experienced substantially lower manufacturing costs for beer cartons versus the prior year quarter. This was in large part due to a change in sourcing from our now closed Clinton Mississippi converting plant to the company’s new state of the art 67-inch Gravure press at our West Monroe Louisiana Carton Plant. Now that the 67-inch Gravure Press is fully operational we can take full advantage of it being the lowest cost press of its type in our system.

On the consumer products side of the business, we set productivity records at several facilities during the quarter. The sheet fed manufacturing strategy is still progressing according to the original timetable. Our Ft. Smith Arkansas facility is starting up two new presses in the second quarter and this represents the final stage of that sheet fed manufacturing project. Like our converting operations, paper board production at both our Kalamazoo, Michigan and Macon, Georgia facilities was outstanding during the quarter. Unfortunately these year-over-year improvements were overshadowed by an unplanned event that negatively impacted operations at our West Monroe facility. To expand on this further, in January we had an unexpected failure at our major turbine generator that caused the coated board paper machines to go down impacting both January and February performance at the mill. In total, this failure resulted in lost production of approximately 4,000-coated tons and lower fixed overhead absorption. In addition, the temporary loss of the generator resulted in additional costs for outside energy as this turbine generates a significant amount of the mill’s energy requirements. Unfortunately this also occurred at a time when energy prices were extremely high. Finally, there were repair costs associated with bringing this turbine generator back on-line.

Now moving to sales on the beverage side total carton sales within North America were down 5.5 percent in the first quarter of ’06 compared to the prior year quarter. While volumes and pricing on the soft drink side were relatively flat to the prior year quarter, the beverage decline was primarily due to a combination of lower carton demand from the company’s three largest domestic beer customers and slightly lower beer carton pricing.

On a positive note, favorable beer carton mix should begin to result from Miller Brewing Company’s replacement of its traditional bottle package with Graphic Packaging’s new Vertical Vender. Miller Brewing began to roll out this new carton in the first quarter and is planning to replace its current package with Vertical Vender for all the brands. The vertical design of this carton not only allows consumers to carry the box with one hand but also offers a consumer friendly refrigerator storage and dispensing solution bottled beer.

In addition to the traditional carbonated segments, we’re focusing a significant portion of our innovation efforts on the rapidly growing beverage arena, which includes a wide range of coffee and energy drinks. In the first quarter, for instance, Izzy launched a range of fruit beverages in glass bottles packed in Graphic Packaging produced four packs, and the energy brand Power Trip was also introduced to market in a new four-pack carton. Further growth in the energy market is expected due to the placement of a new Graphic Package manufactured Quickflex 2100 packaging machine with Coca Cola Bottling Consolidated. This machine can run a variety of pack styles, and fridge vender, at extremely high speeds. This machines placement should enhance the growth of all specialty beverages, including energy drinks.

Sales to food and consumer products markets within North America was again strong in the first quarter with an increase of 3.4 percent versus the prior year. The solid growth in this market is due both to increased pricing and significant volume gains with our major customers. We also continue to set the stage for future revenue growth from food and consumer products customers through innovations. Frito Lay Quaker has now moved 100 percent to their Quaker Instant quick oats flexible packaging extrusion requirements to Graphic Packaging. This is a move that will add millions of dollars of opportunity to our barrier innovation. And Kraft Foods launched four foods in Graphic Packaging’s patented Z-flute carton. The products include Kraft’s Wheat Thins, Nilla Wafers, Thinsations, and Lorna Doone Cookies. Graphic Packaging now has 19 different Z-flute packages in the marketplace with Kraft Foods alone. In addition to the first quarter package introductions, our new product line remains full as we are continually looking at innovative solutions to support our customer’s selling efforts.

In summary, despite the first quarter cost of natural gas and the manufacturing issue at our West Monroe Mill, results were relatively flat to the prior quarter. We are now starting to pass through raw material costs to our customers. Our recent manufacturing initiatives have now given us some of the highest quality lowest cost converting assets in the industry. And during the quarter, we were able to reduce operating costs by another $18 million and are targeting to exceed $50 million for the entire year. And with that, I’ll turn it over to Dan for a review of the financials.

Thanks Steve. Good morning everyone. As you just heard from Steve for the quarter we reported a net loss of $31.5 million or $0.16 per share as compared to a first quarter 2005 net loss of $29.6 million or $0.15 per share. As we review operating results I’ll start with net sales then address earnings. First quarter 2006 nets sales were $580.4 million down .4 of a percent as compared to net sales of $583 million in the first quarter of 2005. In our paperboard packaging segment net sales were $560.3 million or $1.3 million higher than the prior year quarter. Within this segment beverage sales experienced a modest decline and consumer product sales increased. The three main factors affecting paperboard packaging include:

One, a 5.5 percent decrease in beverage carton sales in North America. As Steve mentioned, the reduction was primarily driven by weaker demand by the company’s three largest domestic beer customers and slightly lower beer carton pricing.

Two, a stronger dollar than a year ago negatively impacted net sales by 6.5 million dollars. However, international volumes were up approximately 11 percent on the strength of greater open market growth. A large portion of the volume was at Fiskeby, our Swedish Mill. However, per unit price declines at Fiskeby offset the benefits from increased volume. Overall total international sales were 1.8 percent lower than first quarter of 2005.

Three; North American Consumer product carton sales experienced a 3.4 percent increase as a result of both higher volumes and increased pricing versus the prior year quarter.

In our containerboard segment, net sales of $20.1 million were approximately $4 million lower than the first quarter 2005. The reduction was primarily due to producing less linerboard and more coated board. We utilized more coated board in the production of food and consumer product cartons. So in summary, first quarter sales in our paperboard segment was flat to last year’s quarter while unit volume increased slightly. Sales of containerboard declined as we shifted production to coated board.

Income from operations in 2006 first quarter was $14.3 million up from the 2005-first quarter income of income from operations of $12.3 million. The $2 million improvement results from cost reduction initiatives, consumer product price improvements, product mix improvements, and lower depreciation. These were substantially offset by inflation.

EBITDA for the 2006 first quarter was $64.1 million, 11 percent of sales as compared to EBITDA of $64.7 million or 11.1 percent of sales first quarter 2005.

During the quarter, four major factors impacted results. First inflation of $17 million; Increases were primarily related to energy of 12.6 million dollars, chemical inputs at $4.1 million, freight at $2.2 million, and the remainder was labor and benefits. Input costs for fiber, outside board, and corrugated containers were favorable by $3.6 million. As you can see, energy is by far the largest increase and I will talk more about that later.

Two, as Steve discussed in detail earlier, EBITDA in the first quarter was also negatively impacted by approximately $9 million, primarily as a result of the turbine generator at our West Monroe Louisiana Mill.

Three, strong performance with our production initiatives including continuous improvement and our manufacturing strategy that delivered an approximate $18 million benefit. We experienced improvement in operating efficiency, personnel costs, manufacturing waste, overhead, and logistics. As Steve pointed out, we expect cost reductions to exceed $50 million this year.

And finally four, improved pricing mix generated the remaining EBITDA benefits. Increased pricing was principally in consumer products and mix was primarily the result of fewer liner tons and more coated tons.

To complete the income from operations review I have a few comments about changes in other categories. Depreciation and amortization in the quarter is lower than the prior year by $2.6 million. This decrease is primarily the result of the accelerated write off of assets reported in the prior year quarter related to the Clinton Mississippi closure. We expect full year 2006 depreciation and amortization to be in the range of $195 to $205 million. Selling, general, and administrative services were up slightly in the first quarter 2006 versus the prior year quarter 2005 primarily due to the alignment of expense reporting. This was driven by implementation of a common ERP system to merge companies. We’re talking about SAP and this was done in North America.

Next research and development costs increased due to greater emphasis on innovation and packaging machine development. Other expense net is 4.6 million favorable to the prior year as a result of lower asset write downs, particularly at our U.S. mills plus favorable foreign exchange settlements related to the hedging of inter company sales to Europe and Japan.

Net interest expense was $41.3 million for the first quarter 2006 as compared to net interest expense of $37.1 million for the first quarter 2005. The increase was a result of higher rates, which impacted our floating rate Term-C loan and revolving credit facility. Currently our all in effective interest rate is 7.5 percent. Interest rates on approximately 74 percent of our debt is fixed. We utilize swaps to hedge exposure on floating debt. We expect total interest expense to be in the range of $165 to $175 million for the full year of 2006. Approximately $9 million of this is amortization of debt issuance costs.

Now before moving on to the balance sheet, I have a few comments about our natural gas costs. In the first quarter our average costs per MMBTU was $13.90. This compares to an approximate $7.00 per MMBTU cost in the first quarter of 2005. For the remainder of 2006 we are approximately 80 percent hedged at an average rate of approximately $10.00 per MMBTU. We use approximately 10 million MMBTUs of natural gas per year primarily at our three U.S. mills. Recently, we upgraded our program designed to manage risks associated with future variability in the price of natural gas. As in the past, we will continue to use third party experts to advise us of natural gas hedges. The main change in the program is the increased duration over which we will layer in hedge contracts. We believe this change will improve our ability to manage risks. Currently, in addition to our hedge position for 2006, we have hedged 30 percent of 2007 and 5 percent of 2008 projected needs. Depending on price levels, these hedge positions are expected to increase further during 2006.

Now turning to the balance sheet and cash flow. Liquidity remains strong during the quarter and as expected, we experienced the seasonal increase in the company’s revolving balance. Net cash used for operating activities in the first quarter was $42.9 million compared to $35.6 million in the first quarter of 2005. As mentioned in prior calls, as the summer beverage season approaches it is necessary to ramp up working capital by carrying higher levels of inventory.

In addition to seasonality in working capital, the company makes semi annual fixed rate interest payments of approximately $38 million in the first and third quarters. The interest payments are related to the company’s two fixed rate public notes. At the end of the first quarter we had $6.8 million in cash and equivalents and $250.4 million available under our U.S. revolving credit facility. Our total revolver commitment is for $325 million. As of March 31st we had $63.2 million in cash borrowings and $11.4 million in outstanding letters of credit.

When comparing to the first quarter of 2005 total working capital levels were favorable due to improvements in both receivables and payables. These improvements were somewhat offset by increased inventory levels. Inventory increased primarily due to higher costs per unit driven by inflation, and changes in product mix.

Capital expenditures were $15.8 million in the quarter. We expect full year 2006 Cap Ex to be in the neighborhood of $80 to $90 million.

Pension contributions were minor in the first quarter. However, for the year we expect to contribute between $25 and $30 million to the company’s U.S. pension plans. The majority of this contribution will occur in the third quarter. We contributed $17.7 million in 2005.

And finally, total debt at the end of the first quarter was $2 billion 37 million representing a decrease of $62.2 million from total debt at the end of the first quarter of 2005.

Okay, with that operator we’ll open the lines for the question and answer session.

[Operator Instructions] We’ll pause for just a moment to compile the q and a roster.

The first question is from Joe Stivaletti with Goldman Sachs. Sir, please go ahead.

Yeah, hi. I was just wondering if given some of the favorable results here in the first quarter if you had revised your full year ’06 or free cash flow guidance. I believe you had told us your goal was about $65 million of debt reduction for the full year on your last call.

We have not revised our guidance at this point. We’re sticking with the $65 million approximate of cash flow at this point.

Okay. I was just wondering also if you talk about, I know these calls frequently focus on the beverage side where some of the issues have been with the contracts but on the non-beverage side it seems like you made good progress in the quarter in terms of your top line and I wondered if you could talk about what’s happening there in terms of pricing and what not just in terms of helping us try to look at our outlook for the rest of the year. You know, what kind of additional pricing initiatives you think you’ll be able to accomplish in the near term.

This is David Scheible. I’ll try to handle a little bit of that. You’re right in the first quarter we did see our consumer products business pricing move up across those accounts about a percent or so. Most of that is a reflection of board increases or pass throughs that occurred last year, that we’re now starting to see annualized. Everybody just talks about pricing delays and we’re starting to see that. I don’t think there’s a tremendous amount more pent up from previous board announcements. However, as Steve said – Joe we have announced additional SUS increase and I believe there is, in fact, a market announcement on coded recycle board out there as well. So those will occur sometime during this year and then of course for ’07 will go through the P&L as well. Some of the upside you saw was just really general sales increase at major accounts like Kraft, and General Mills and Nestle. Their business continues to percolate maybe a percent or a percent and a half up. I think that’s where a major share of that is. I would tell you it’s actually a pretty normalized quarter for that side of the business. Steve also mentioned the new product development activity and actually that part of our business has been very, very positive in new product introductions with a lot more products in holograms, and laminated structures, and promotional activities in Z-flute and that’s real momentum in that business as well; and that also helped the top line on the consumer products part of the business.

Kind of our view is innovation helps us in two ways. One we can expand the addressable market for paperboard solutions or microwave and Z-flute is the strength alternative to litho lamp. Then we can also use innovation to improve mix. Higher value added solutions to customers that deserve and get better pricing and therefore higher margins. So those are really the two engines that we’re working real hard on.

The last question was you talked about when you went through, I think, with a consultant was one of the outcomes was a focus on possibly selling off some non-core assets and I wondered if there was any progress to report there and just sort of whether we should be thinking something in ’06 is likely?

Well there’s no resolution. Specifically so there’s no press release but we are still working on it and I think there is some basis for optimism that some of these assets will, in fact, be monetized yet this year.

That’s correct. We’re currently actively marketing certain assets and the cash flow guidance that we talked about previously would be positively affected by any sale of these non-core assets as we go forward as well. As you know, it’s difficult to actually predict when you’re going to get the price you think you deserve on the assets and when the sale would be completed.

I’d just leave it that there is meaningful activity and resolve to get this done.

Right. Okay. Good luck, thank you.

Thank you

Your next question is from Bruce Kleine with Credit Suisse. Please go ahead sir.

Hi, good morning.

Good morning.

I was just wondering back on the beverage side; I guess maybe I know there’s a bunch of contracts signed in ’02 and ’03 that are five years but maybe you can help us roughly ball park percentages of where the beverage contracts that are actually are up in ’07 and ’08 and the ones that were up sooner in ’06 how have you progressed or how have you gotten the energy or other costs recovered?

Well I think without getting into too much sensitive detail a meaningful portion of the beverage contracts have already been restructured so there is pricing and that’s in effect now. Another significant contract – there’s also been renegotiation on that one. That one will go into effect the first of next year. And then we have a couple of other significant contracts that we’ll be negotiating for late ’07 or early ’08 and that discussion is already in the early stages and I would just say that in addition to optimism based on success to date that there’s a resolve on our part that we’re going to have a more equitable bearing of inflationary risks.

The stuff; is it fair to say -- I’m not trying to put words in your mouth.

Good.

Is its something that you restructured recently? Was the contracts that were up in ’06 or was that actually stuff restructured earlier?

Yes. Those are contracts there were due for renegotiation and they were done and we got the kind of equitable sharing of inflationary risks that we need and we expected.

Okay. So those were…

They’re done.

And did you get -- last question. Did you get anything back looking at costs?

Oh no. I covered that the last couple of meetings. I think that prospective is really the right way to look at this.

Okay. Do you have any sense on the beer business? When is that going to pick up?

Well, this is the wrong call. You’ve got to jab our customers. I think that based on industry data it’s clear that certain of the beer companies are starting to see better fortunes. You know, their sales lead our deliveries a little bit because they’ve got inventory throughout the channel but we would expect that as their sales rates go up we would see improved demand. But I think there’s lots and lots of discussion. We’ve had a struggle losing share to a spirits and wine. I think the general view is it’s more than just marketing and merchandising; that there’s some pricing that they’re working on adjusting. At least what we see in the early data says that this shouldn’t persist.

Their data that they report to retail really has been more positive than we have seen for a number of quarters. Though as Steve said there’s reason for optimism because those sales will be replaced through the supply chain. You’ll also see a lot more promotional activity than you have seen in this space, which is just another way to talk about price so you’re clearly seeing the large domestic beer guys trying to recapture from, not only wine and spirits, but also from imports, which has been an equally difficult environment for those guys to gain share.

And then the West Monroe issue; is that -- I wasn’t clear what had happened. Is that 100 percent behind you in the first quarter or no?

It’s 100 percent behind us. Production is very strong over in West Monroe and we’re pretty encouraged by what we see. This was one of those events, I guess, in respect to decorum I’ll be careful how I’ll characterize it but a discreet event and we understand exactly what the root cause was. It’s been corrected and things are running pretty smoothly over there right now.

And the Cap Ex budget; is that enough to spend? You used to spend more. I know you had this converting budget for these projects but is 85 a good number going forward or do you think that’s low or high…

Well, I’ve been answering questions like that for nine years and on one side – the answer is unequivocally yes and the reason is that we’ve made huge investments and see real strides in something called reliability centered maintenance. That’s getting the assets you have to be more reliable, less unplanned down time. And a lot of times you wind up putting in assets because you lose capacity because something that you needed to run was on unavailable. And we’ve talked previously about this measure that we use called OEE, or operating equipment efficiency. It applies to every piece of every asset in the company. And the goal is, or what the track record has been is that as that number goes up you liberate capacity that previously was unavailable either because your yields were not high enough. The percent of good production wasn’t high or your machine speeds weren’t really up to what the equipment is capable of; or worse yet you were down for an unplanned reason when you needed the equipment to produce. So we’ve made a significant and continuing investment in reliability centered maintenance and it’s paying dividends for us. So that’s a way that we can feel comfortable with.

My last question was pension expense. I think you gave a cash contribution and I’m wondering if you have any expense for ’06?

Yeah, I think the expense level is between the $20 and $25 million mark. So it’s approximately the same and the contribution.

Okay. I’ll pass it on. Thanks a lot guys.

Thank you.

Your next question is from Jeff Harlib with Lehman Brothers. Please go ahead.

Hi, good morning.

Yeah, hi.

Just looking at your Q1 performance, you know, I think a lot of people were pleasantly surprised and I guess the question I have is inflationary cost increases seemed to be lower than I would have expected given the natural gas run up and other inflationary cost increases throughout 2005. Can you just talk a little bit about that, whether that was below your expectations and how you’re looking at inflation now in ’06 versus ’05 versus where you were, let’s say, three or four months ago?

You know, I’d like to kind of reference back to the last call where I said with the exception of natural gas it looked to us that input inflation was cresting. That there would be a lot of carry forward into the ’06 cost space but the rate of new incurred inflation other than for natural gas looked like it was stabilizing, which I consider to be very positive. Since then we’ve seen crude oil shoot up. You know, as we discussed last year our nominal planning is something around $60.00 to $61.00 a barrel. You know, if it’s at $75.00 that’s going to stress our cost structure. We’re seeing our truckers come in and imposing fuel surcharges. But the other materials that we buy, generally in the chemical complex pricing, is somewhat stable, or reasonably stable. We are huge corrugated buyers and all of those fellows are out looking for price increases so we’re going to try to use a lot less corrugated. But with the exception of natural gas and whatever fuel surcharges it looks to us like inflation is crested.

Okay. And on the cost savings front you mentioned the target exceeding $50 million; and you’re decently above that run rate in cap one. Can you just talk about, you know, it looks like the actions are close to being completed. Can you just talk about what else we can expect there?

Well, we’re not going to increase the guidance at this point irrespective of the run rate. I mean that gets a little bit awkward and maybe in the second quarter if that rate continues we’ll raise the bar. But I think that as we’ve described previously we have a multi part approach to reducing costs. Occasionally we use cap ex as we did in the converting investments in both beverage and consumer products. Most of those investments are in. The equipment is up and running. We’re starting to see the full benefits since that occurred through time there will still be some quarter-over-quarter improvements related to that. Six Sigma is really discreet projects where you take some element of cost and focus in on what’s driving it and take a corrective action; and then there is a more enduring underlying or continuous improvement. The work that we’re doing in things like OEE falls into that category; and you do it in every facility. So there’s kind of an accumulative effect and I think we mentioned in the call that we had some fantastic performance in our consumer products converting and in two of our three mills. So there’s a lot going on. There’s some momentum that has been established and we continue to add to it.

I’ll add to it that one of the big focus areas right now clearly is some of our internal transportation warehousing costs. They’re significant for a corporation our size and it’s really about usage. There’s not a tremendous amount we’re going to do on rates while we purchase a lot on a relative scale. We’re not a huge user of freight so being able to leverage in a rate is difficult but that doesn’t mean we can’t use less energy, less miles, better loading of our trucks. So right now a lot of our focus is on how do we use -- what metrics should we use to drive the use down of those kind of transportation dollars and I think there’s still money in those. But as Dan reported I think our transportation costs were up $4 or $5 million dollars over last year in the quarter alone so there’s opportunity. Those are harder dollars to find but there’s clearly opportunity for us to work on.

And on pricing, I assume your comments on getting some ’06 pricing from your beverage customers, is that a very small percentage of your overall beverage revenues? I always thought it was more ’07 and ’08.

Well, I’m not prepared to get down to that kind of granular detail but I will say I referenced it as meaningful so it’s somewhere between not very much and a heck of a lot. And I feel very confident that we’re going to get a similar outcome on the contracts that will be renegotiated early next year, late next year.

Okay; and when were those effective, those contract, the ’06?

No, no. The ones that are done -- there are some that are already in place. There’s another that will become effective ’07 but it’s done. It’s signed. And then there are a couple more that fall into ’08 and will become effective during ’08.

Okay.

’07, I’m sorry. All right?

Okay; and just a last question on growth. You know, assuming you guys have these price increases and margins start to improve. Your performance starts to improve. How do you look at growth of the company going forward whether it’s Asia, or other areas, acquisitions where you can grow your top line?

I think that as we try to get into more granular detail the revenue line is negatively affected by both rate and price. And I would expect that the price deterioration in the future would be less than it has been in the past because the fundamentals of the market have changed and continue to change. I think the unit growth or rate piece we’re seeing something akin to the more traditional trend in the food side. The beverage side is still a work in process; particularly in the noncarbonated sector whether or not the producers can grow that stuff fast enough to backfill for what they’re losing on carbonated drinks. And I don’t really know how to handicap the beer but that, at best, has been a relatively flat market. Domestically we have made very good progress in innovation.

I think our release last quarter said that we had achieved something in the $40 to $50 million-dollar revenue last year from products that didn’t exist the prior year; and we would expect that that would accelerate again this year. So when we say innovation it’s basically finding new applications, or creating new applications, for paperboard and microwave. We have a business base that allows us to leverage some of those innovations in Europe and in Japan. We think we’ve put a good solution in China. We’ve closed our Hong Kong and Singapore offices. We’ve opened an office in Shang Hai and are already starting to get some traction. I think that it’s fairly obvious that in the long term, buying some revenue is going to have to be part of the mix.

Thank you very much.

Your next question is from Bill Hoffman with UBS.

Thanks, good morning.

Hey Bill.

Just a quick one; can you help us – give us some guidance on where the mix is right now between food and consumer versus the beverage and maybe talk a little bit about the food and consumer growth target. I mean you had some pretty decent growth in that segment in the first quarter.

I really can’t but we did have some strong growth. I think that we are working in all segments to create more growth or more addressable market for paperboard. And as I’ve said many times, I think in the beverage world it’s largely substituting corrugated and addressing non-carbonated growth. I think that the field is much wider in the non-beverage area principally because of microwave, which is a product where we have great technology positions as a company. And there’s a lot of movement at the consumer goods level to take more and more product categories and move them out of the bowl to microwavable or both. And we’ve got some solutions in both of those areas. So I just think that as we kind of look at that field there’s probably – we would prefer more growth potential outside the beverage area.

And one thing that Steve’s talked about earlier and that I’ll just remind you: there is a lot more activity going on in the club store channel than there has been previous. Our customers are big in that and we are big with them in that. Probably if you go to a Costco or you go to a Sam’s Club you would typically think of corrugated packaging but if you start to look closely you’ll see a lot of solid fiber graphic packaging ending up in that club channel. Many of our customers are creating their own internal organizations around that and we’re tied in with those. So if you look at the underling channel growth it’s off a relatively small base but the acceleration is significant and we’re gaining from that as customers are taking traditional products with new packaging and rolling it into their club channel. So I would tell you that we’ve been very focused in the segments that we want to participate in. We continue to be very focused. There are some segments that we do not participate in but those, which we pretty much work throughout the channel and the consumer goods companies within the food sector; and that’s been successful for us.

Is that mix for you, or do you also expect to see certain percentage growth in actual volume?

Both. That’s exactly right. It’s both a mix improvement on things like our seafood cartons but it’s also a net growth replacing corrugated or other packaging and so we’ve seen both. And that’s why you see some of that top line growth in that business.

Any thoughts on how we can quantify the CUK volume growth that you expect this year versus last year?

Well I think if you go back to Dan’s comment; during the first quarter we produced more coated board and less liner board on coated capable machines; and we definitely expect that to continue. I’m trying to figure out how to respond without giving a detail that’s too granular. We would expect that the growth in coated board sales would outpace the creep in coated capacity. And we would expect that our integration level, the percent of board that we produce that we cut up into cartons, would continue to increase. That’s a combination of whatever the customer’s growth is, new market applications, plus the continued work that we do to get customers. One, to compete for applications that currently use board that we produce, whether recycled or SUS; or work with customers to get them out of another sub straight into something we make, whether that be bleach board or solid plastic or flexible, or corrugated, or whatever. And the fact of the matter is we’ve been very successful doing it. It’s been one of the great, I think, successes of merging Graphic and Riverwood is our ability commercially to leverage our sub strengths and there is still more opportunity to do that.

Thank you.

Okay.

Our next question is from Christopher Miller with J.P. Morgan.

Good morning, just a couple follow up questions.

Sure.

On the contracts that you’re renegotiating; are these multi year contracts as well or are they single year contracts?

No they’re multi year.

Christopher Miller. Okay. Can you give us any more color on the sort of pricing pass through mechanism that you’re pushing for? Is it tied to the CPI? Just functionally how is that going to work?

I think given the last two years of experience with inflation, we have a stronger bias towards some form of an index-based formula rather than board formula. One of the problems with board pass throughs is you’ve got board only producers who don’t reflect or don’t have the investment and overhead in converting; and it’s just unworkable, in my view, to have contracts where some producer who doesn’t have the same investment and the same fixed overhead and same risk profile really sets the market price. I personally favor some kind of index-base system. And as I say in our company, I generally win all ties.

Christopher Miller. Okay. I know the last quarter you had had meetings with the rating agencies. Have you talked to them recently? Were they aware of these results going into the quarter? I’m kind of wondering what’s your sense is there on the agency front?

Yeah, we went up and visited the rating agencies within the last couple of months and we reviewed with them our plans for 2006 and 2007 at that point as well. So currently our ratings are under review by the rating agencies and in our Q we state where our current ratings are but at this point all I want to say is our ratings are currently under review at the rating agencies. But they’re well aware of our plans and our budget and of our performance as well.

Christopher Miller. Okay. And just one final question on the CUK; can you just remind us if you were to think about a $10 dollar ton change in CUK that impact on EBITDA plus or minus on an annualized basis?

Well, we can’t, or we won’t give you that because it gets down to a level of segment detail. As we tried to say in the remarks, we have increased the price effective for shipments on May 1st, which goes right away to roll stock that we sell to independent converters. And then in the remainder of the business where we sell cartons we’re subjected to whatever contractual pass through amounts and windows; and that varies from customer to customer. I think the way Dave characterized it is the way I would ask you to think about it. We are collecting today price that goes back to late ’04 and ’05 in the carton business as opposed to roll stock. And generally speaking, I think we’ll see prices that go up in roll stock today sometime early next year in cartons. So that’s really not as prescriptive as you’d like but we still have enough roll stock only sales where getting that price implemented will have a positive affect yet on ’06.

And finally, I’m not sure I’ll get you to answer this one either. But when you look at either EBITDA, the credit agreement EBITDA, you did pretty well on your year-over-year comparison. Is that kind of how you’re thinking about the rest of the year? Did accounts get tougher for you? How are you kind of thinking about that going forward from a budget standpoint?

You know, it really gets down principally to what are customers going to require or demand; and what’s going to happen to inflation. After what we’ve gone through in the last couple of years where every time we think we’ve got a handle wrapped around inflation we get hit with something new. We’re just not going to try to second-guess what we’ll get hit with in the remainder of the year. It’s just too big of a swing factor.

And as somebody asked earlier on the call how do you predict how much beer or soft drink or cereal is going to be sold? And with the concentration we have in those large accounts it’s really difficult; and we work with them closely and we look at their forecast but from time to time we end up handicapping what they’re doing based on what they’ve done in the past. So it’s really a difficult – right now it’s sort of difficult to look forward.

I think the one area where we’ve given you lots of color is in natural gas and our total gas spend, natural gas spend, this year will be higher than it was last year. And it looks to me like it could be in the $30-$40 million range. A big piece of that was inhaled in the first quarter but if you go back and look at our prior quarterly releases we had really good natural gas economics through about May of last year where we had put hedges in place in ’03 and ’04 and then the party ended and we had to start buying closer to the current market. Then we got hit with the hurricanes in both ’04 September and ’05; and that’s the time traditionally we had been layering in most of our buys. As Dan explained or eluded to, we have changed our hedging system on natural gas so instead of an 18-month horizon we’re now looking out 36 months and we’re having more of a periodic buy to layer in and factor out some of these market, as one guy I used to work with called, pertivations. And do a better job of smoothing and averaging risks. So natural gas, while the general trend right now looks favorable, is still going to be significantly negative for us every quarter this year. All right?

Okay. Thanks so much. I appreciate it.

Thank you.

Your next question is from David Fry with Stanfield Capital Partners.

Thanks guys. Congrats on a good quarter. Just to be painfully clear and I’m sorry I’m so dense on this. The contracts on the beverage side that you have now renewed with pricing mechanisms are those pricing mechanisms implemented earlier than the contract was originally scheduled to expire.

No. It was just a periodic, a timely planned expiration and renegotiation.

Again I was under the impression that the majority of those you had locked into with negative price escalators matured in ’07 and ’08.

I think if you go back I’ve tried to be sufficiently non-specific.

That’s part of the problem.

It’s going to stay that way but we have a meaningful amount. It’s already done. We’re collecting whatever price we’re entitled to in the beverage area. We’ve got another significant one that is now done that will start next year and we’ve got a couple more significant ones that we’ll be negotiating over the next 12 months or so. And we would expect that those would have a similar outcome to the ones that are already done.

Okay.

So, you know, it’s going to be -- you won’t see it but in our total inflation recovery we’ll continue to get better quarter-by-quarter through time.

Terrific. And then secondly on the pensions can you just remind us how the contribution you indicated differs from what’s in the income statement for ‘06?

It’s approximately the same, the contribution level and expense.

Okay. And then just a follow up on someone else’s question. I think you guided to this on the last call. The difference between EBITDA and credit agreement EBITDA would narrow in ’06 I think predominantly due to that…

That’s a major difference we have at that point. There are other differences and there’s always a detailed schedule on the Q that reconciles the two.

Can you give us any guidance on ’06 on what you think that differential will end up being if it’s down about $4 million already this quarter?

I think if you go to the Q and look at the reconciling items based on what we’ve given you guidance on the call here that you’ll be able to figure out that after we get through the third quarter and have a rather sizeable contribution to the pension plan the difference will be relatively minor between straight EBITDA credit agreement and EBITDA.

Right. Okay, thank you very much.

Operator, I think we’ve got time for one final question.

Yes. Your final question is from Jeff Bencik with Jeffries and Company.

All right, thanks. I didn’t know if I was going to get in. Let me beat the horse one more time but in terms of obviously over the last two years the raw material inflation for all of your key inputs has increased rather significantly. Let’s say 20 percent plus. Do you believe that with the renegotiations for your new contracts you stepped up the pricing to fully recover all that price increase and your input costs at this point and then going forward you’ll have new escalators that will benefit you?

No. Let’s be very clear. What’s behind us stays behind us. That’s just the way contract pricing works so there is no recapture of past inflation. And then I’ve said several times over the years that I don’t know of any industry where the sellers are recovering 100 percent or more of the inflationary costs and that certainly would not be my expectation in this business. But what I have said is with our equitable sharing of inflation whatever we recover combined with our cost reduction should at least get us home to recover and hopefully better. And if you look at our track record our last couple of years we were actually over recovering through cost reductions and that’s a viable condition that we can get back to.

Okay.

All right?

And a couple of housekeeping questions. You’re capacity utilization in both your plant and mills currently?

Well, we don’t – we are taking no market down time at the mills so we’re selling everything we can make and we don’t give out that information in converting because we keep some capacity available for surge because of the cyclical pattern. So if you take a plant that has, say, five converting lines you might see three run 24/7 and you’d run the other two three shifts five days so that you’ve got some flex capacity. But with the work that we’ve got to close plants, reinvest, realign the system we’re in pretty good balance on converting supply and demand at the moment.

Okay. And can you tell us what you’re seeing in terms of the ramp in bottled water?

I think if you just look at the industry statistics the growth rate is still good but slowing. What’s harder to get your arms around is what’s the utilization rate of paperboard versus single serve vending machine and multi packs, which traditionally have been corrugated trays with shrink film over wrap. And we continue to chip away and make some headway but as I’ve tried to say previously, at least based on my experience I would expect that paperboard utilization and water will pick up when the market rate slows and the margins get compressed. And then the sellers have to some real brand building. Okay? That’s really what my expectations are. I think if you follow bottled water sales and you look at the margins for the three or four big vendors and they start to go down and brand building, and paperboard it’s basically synonymous with brand building.

I think if you’re looking for paperboard growth in nontraditional sectors then you probably will look more to energy drinks and juice. Those are beginning to come multi packed and they’ve got a larger base. People are not buying single served anymore but they’re buying the energy drinks in multi packs so you’re finding wraps, fully enclosed, dispensing cartons and that’s where we’re starting to get some traction. It’s off a very small base but it’s also growing very rapidly and we built equipment to do that so that customers can do quick change and give an option to use paperboard versus shrink and I think that there’s more traction for paperboard right now than water.