Graphic Packaging Holding Co (GPK) 2006 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Graphic Packaging Corporation second quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. If you would like to ask a question during that time simply press star, then the number one on your telephone keypad. Should anyone need assistance at any time during this conference please press star then zero and an operator will assist you. As a reminder, ladies and gentlemen, this conference is being recorded today, Wednesday, August 02, 2006. Thank you. I would now like to introduce Mr. Scott Wenhold, the Company's Vice President and Treasurer. Sir, you may begin your conference.

Thank you and welcome everybody to Graphic Packaging Corporation's second quarter earnings call. Commenting on results this morning are Steve Humphrey, the Company's President and CEO and Daniel Blount, Senior Vice President and CFO. David Scheible, our COO, is also available to answer questions at the end of the presentations.

I would like to remind everyone that statements of the Company's expectations, including but not limited to the effect of certain contractual changes, expected cost savings, projected volume increases, expense estimates, capital expenditures and pension funding costs 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. Now with that out of the way I will turn the call over to Steve.

Good morning everyone. Last night the Company announced second quarter 2006 earnings reporting a net loss of $26 million or $0.13 a share. This compares to a second quarter 2005 net loss of $19.6 million or $0.10 per share. In a few moments our CFO, Daniel Blount, will walk you through the specific items that bridge the current period financial results to the prior period. Although we continue to make progress with price increases and cost reduction initiatives, the quarter was marked by continue cost increases for raw material inputs and services, particularly natural gas. More specifically, the Company incurred approximately $23 million of incremental cost increases related to higher prices for energy, chemical based inputs, freight and labor and benefits. The majority of this 23 million was related to higher costs for natural gas, which was purchased during the first quarter of 2006. As I mentioned in prior calls, the Company hedged first quarter natural gas at around $14 per MMBTUs and the product that was sold in the first two months of the second quarter was primarily manufactured in the first quarter, thus carrying with it the $14 cost of natural gas. After the $14 gas rolled out of inventory we saw a dramatic improvement in operating results toward the end of the second quarter as natural gas cost mitigated and cost improvement initiatives continued to deliver.

In addition to the cost reduction efforts increased pricing for cartons, open market roll stock and containerboard also helped to offset higher raw material costs. Most of the favorable year-over-year impact of higher pricing is attributable to contractual pass throughs on food and consumer product carton business related to raw material cost increases that occurred in 2005. In addition, on the non-contract side of the business, the Company recognized substantial year-over-year price increases in open market sales of CUK board and corrugated medium and bag craft. Also helping to offset inflation in the quarter was another successful quarter of cost reductions and improved manufacturing performance. Altogether cost savings stemming from our continuous improvement programs and manufacturing initiatives were approximately $9 million in the second quarter and this brings year-to-date savings to approximately $27 million, on our way to achieving our full year goal of $50 million or more.

Moving to sales, on the beverage side industry data shows that total U.S. beverage canned shipments rose a healthy 3.2% from prior year. This is the second strong quarter in a row for total canned shipments after several years of lackluster volumes. This quarterly increase was primarily driven by a 4.2% jump in non-alcoholic canned shipments as most major bottlers ran significant summer promotions. For the most part our sales followed this pattern as our soft drink volumes, including non-carbonated fruit juices and energy drinks, were considerably higher than last year's second quarter. The increase in the soft drink side, however, was offset by continued weakness in demand from the Company's three largest beer customers. Domestic beer consumption continues to be impacted by growth in wine and spirits as well as imported beer as both these segments increased share of the total alcohol consumption this quarter over the same period last year.

As customers continue to innovate to grow their sales and during the quarter Graphic launched several new products on the beverage side as part of our longer-term strategy to generate top line growth. First, as we mentioned in the Press Release last night, Graphic introduced two new beverage carton designs during the quarter to help capitalize on the recent World Cup soccer tournament. First, Coca Cola Enterprise launched a soccer ball shaped PET bottle in Europe in a new four-pack wrap design and Anheuser Busch, also a major World Cup sponsor, launched Graphic's new Ice Pack Bar Cooler design in U.K. pubs. This package eliminates the need for multiple trips to the bar during a televised soccer game as the hand erected "Icebox" is filled with ice and six bottles of Budweiser.

In addition to the traditional carbonated segments, we are focusing a significant portion of our innovation efforts on the rapidly growing new age beverage arena, which includes a wide range of fruit, coffee and energy drinks. And supported by the strong growth in the energy drink market, Graphic Packaging recently launched a no top flap carton designed for the Coca Cola brands of Full Throttle and Tab Energy. As I mentioned in the last call, Coca Cola has recently installed Graphic's latest Quickflex 2100 packaging machine capable of running these four-packs at high speed and efficiency for this new format. The flexibility of this new machine has opened the door for Coca Cola to continue future product development in the specialty drink category while maintaining the ability to run larger formats including Graphic's fridge under carton.

On the food and consumer side of the business carton sales were down slightly from the second quarter of 2005 as a result of lower shipments to several major customers. The lower volumes were primarily a result of these customers reducing overall inventory levels during the quarter. The near term outlook for volumes in these markets looks strong as customers gear up for the traditionally heavy season and backlogs in sales were stronger towards the end of the quarter and are currently high on all of our food and consumer product converting facilities. Favorable mix for food and consumer product cartons helped to partially offset volume decline in the quarter. Specifically we are now starting to see traction in the fast growing customer convenient microwave segment as we substituted higher margin microwave packaging for other lower margin cartons this quarter. Continuing to build on this momentum during the second quarter Graphic rolled out its MicroRite susceptor microwave technology for Conagra's Healthy Choice pizza along with an interactive microwave packaging solution for Kraft Foods new Oscar Mayer Fast Franks. This package solution is the first one from Graphic in the refrigerated section and represents a new area of convenience snack food growth.

In addition to microwave, the other packaging solution that I have talked a great deal about is our patented Z-flute substrate. This package is particularly intriguing to us because of its potential as a functional substitute to more traditional corrugated packaging. In particular, Kraft Foods was one of our first customers to make a commitment to using the Z-flute package as a substitute for corrugated and they continued this trend during the second quarter by launching their Premium Crackers Club warehouse package in Z-flute. In addition to Kraft another major customer, Kellogg, has also expanded their Z-flute business with Graphic through the launch of their new fruit snacks warehouse club item. In summary, although comparing to a relatively small prior year base, Z-flute is on track to almost double sales during 2006.

Finally, let me comment on the approximately $6 million of higher manufacturing costs as reported in last night's release. These costs were primarily a result of two items. First, expenses were incurred in preparation for the West Monroe Louisiana mill biannual maintenance outage. And second, the mill had incremental expenses over last year's quarter as a result of an initiative aimed at upgrading the mill's preventive maintenance program. This initiative is a direct response to several negative production events that occurred at the mill in lat 2005 and earlier this year and is aimed at approving overall reliability of the coated paper machines. Since the program's initial implementation, production has steadily improved at West Monroe. Quality control systems have been upgraded with a particular focus on product specifications, integrity of measurement systems and audit functionality. Operating parameters have also been changed in the pulp mill to significantly reduce the variation of fiber flowing to paper machines. Similar to efforts at our Macon mill, the use of hardwood is being reduced and we will initiate trials later this month to eliminate hardwood usage on one of our machines by late September. Finally, the high pressure boiler at the mill will also be upgraded later this month to optimize bark usage and steam generation, which will in turn lower our overall energy costs.

In summary, although expenses were incurred in the quarter to implement these initiatives, I'm a firm believer that Graphic Packaging's reliability center and maintenance program and in the long run investment and commitment to these preventive maintenance programs will reduce the Company's cost. To conclude my remarks cost inflation continues to negatively impact results. In particular, high first quarter costs for natural gas rolled out of inventory during the second quarter but were partially offset by both continued progress from cost reduction initiatives and higher pricing. In future quarters natural gas costs should mitigate and additional cost reductions and improved pricing will continue to positively impact results. And with that I'll turn it over to Daniel Blount for a review of the financials.

Thanks, Steve. Good morning, everyone. As you just heard, for the second quarter we reported a net lost of 26 million or $0.13 per share as compared to a second quarter 2005 net loss of 19.6 million or $0.10 per share. As you remember, we compare to the prior year rather than the prior quarter due to the seasonality of the business. As we review operating results I'll start with revenues, then address earnings.

Second quarter 2006 net sales were 625.5 million, up 0.4% as compared to net sales of 623.0 million in the second quarter of 2005. In our paperboard packaging segment net sales at 601.5 million were 1.2 million higher than the prior year quarter as growth in sales to international markets was slightly offset by lower domestic sales. Overall international sales increased by 2% and represented approximately 18% of total paperboard packaging segment sales. Beverage sales, driven by greater volumes, was the primary driver of the international increase. Lower volumes at Fiskeby, our Swedish mill, and unfavorable exchange rates partially offset the beverage gains.

North American sales were slightly weaker than the prior year quarter due to a modest decline in food and consumer product sales. Beverage carton sales in North America were relatively flat compared to the prior year as stronger soft drink volumes offset weaker beer volumes. In North American food and consumer product markets price increased and mix improved but weaker volumes drove a slight decline in sales. The mix improvement was the result of increased sales of microwave products. Also, our laminations business continued to grow.

In the containerboard segment net sales of 24 million were 1.3 million higher than the second quarter of 2005. The increase was primarily due to higher pricing for corrugated medium. Overall containerboard averaged sales per ton increased approximately 4% from the prior year period. In summary, second quarter sales in our paperboard segment were slightly higher than last year's second quarter due to growth of international sales. Containerboard sales increased as a result of price increases.

Okay now income from operations for 2006 second quarter was 21.5 million, down slightly from the 2005 second quarter income from operations of 23.6 million, as substantial inflation for production inputs was partially offset by increased pricing, cost reduction programs and lower depreciation and asset write offs. EBITDA for 2006 second quarter was 70.5 million or 11.3% of sales as compared to EBITDA of 77.8 million or 12.5% of sales in the 2005 second quarter. During the quarter we continued to reduce costs and increase prices but higher inflation and short-term manufacturing spending increases more than offset these gains. Inflation negatively impacted earnings by approximately $23 million in the quarter. The vast majority of the inflation was due to energy cost increases experienced in the first quarter. Products sold in the second quarter were principally manufactured in the first quarter when natural gas and other energy inputs were extremely high. Natural gas averaged $14 per MMBTU in the first quarter 2006 as compared to $7 per MMBTU in the first quarter of 2005. During the second quarter natural gas averaged between $9 and $10 per MMBTU. As a result, in the third quarter when second quarter production is principally sold, product costs will decline. We are already seeing this decline starting to benefit operating results.

Higher manufacturing costs of 6 million also impacted the quarter. As Steve described, the additional spending was primarily to continue the upgrade of our Louisiana mill's production capabilities. This increased spending level is not expected to continue and to date third quarter performance is already showing the benefit of improved mill performance. As I mentioned earlier, the quarter also saw continued progress with cost reduction and pricing. Our cost reduction initiatives, including continuous improvement in our manufacturing strategy, delivered approximately $9 million of benefit. We experienced improvement in operating efficiency, personnel costs, manufacturing waste, overhead and logistics. As Steve pointed out, we expect cost reduction of 50 million this year and we have achieved 27 million year-to-date.

Turning to price we saw improvement with cartons, roll stock and containerboard. The majority of the favorable price resulted from inflation recovery provisions included in food and consumer product contracts.

Turning to the remainder of the income statement, I'll provide comments about other changes in other categories. First, depreciation and amortization expense in the quarter is lower than the prior year quarter by 5.2 million. This decrease is primarily a result of the accelerated write off of assets included in the Clinton, Mississippi plant closure. We expect full year of 2006 depreciation and amortization to be in the range of 195 to 205 million.

Next, selling, general and administrative expenses were reduced by 2.2 million versus the prior year quarter. There are several reasons for the reduction but the primary one is the contribution because of the improvement in lower personnel costs that related to the work reduction in force that occurred in late 2005.

Next, other income expense, net was 6.6 million favorable to the prior year quarter. This included the benefit of lower asset write downs and favorable foreign exchange hedge settlements related to the hedging of inter-company board sales to Europe and Japan. And then finally, net interest expense was 43 million for the quarter as compared to net interest expense of 38.9 million for the second quarter 2005. The increase was a result of higher interest rates, which impacted our floating Term-C loan and revolving credit facility. LIBOR increased from 3.1% to 5.0%. The majority of our exposure to interest rate fluctuation is controlled through our hedging program. For the year we expect total interest expense to be in the range of 165 to 175 million with approximately 9 million of this amount from the amortization of debt issuance costs.

Now turning to the balance sheet and cash flow, liquidity remained strong during the quarter. Net cash provided by operating activities during the second quarter was 61.9 million compared to 64.4 million in the second quarter of 2005. At the end of the second quarter we had 7.3 million in cash and equivalents and approximately 288.1 million available under our U.S. revolving credit facility. Our total revolver commitment is for 325 million. As of June 30th we had 25 million of cash borrowings and 11.9 million in outstanding letters of credit.

Comparing to the second quarter of 2005, total working capital levels were favorable due primarily to an improvement in accounts payable along with improved inventory levels. Capital expenditures were 15.3 million in the quarter and we expect full year 2006 CapEx to be in the neighborhood of 70 to 80 million. The Company contributed approximately 2.2 million to the Company's U.S. pension funds in the second quarter. For the year we expect to contribute between 25 and 30 million to the pension plans, the majority of which will occur in the third quarter. We contributed 17.7 million in 2005.

And finally, during the second quarter the Company's total debt decreased by 38.7 million to 1 billion 998 million. Total debt was 61.1 million lower than the second quarter 2005 debt balance. And with that, operator, we'll open the line for the question and answer session.

[Operator Instructions] Joe Stivaletti of Goldman Sachs.

I was wondering maybe if you could update us on any additional progress on the renewals of contracts on the beverage side? Did anymore of that happen during the last few months?

It did not, Joe. As we've tried to describe before, these renewals are asynchronous and they occur through time so there was nothing that was completed during the second quarter.

Okay and how about an update on you earlier in the year had announced your interest in selling some non core assets and I wondered if you're still pursuing that and how that might be going?

Well, we are still pursuing it and, as I have tried to characterize it before, it's somewhat episodic so we have nothing specific to report other than energy and effort is still being directed towards that and it's still a high priority for our team.

And the last thing I had was just you had previously shared I believe a free cash flow for debt reduction target for the year of about 65 million. Now that we're more than halfway through the year, I wondered if that was still a number that you were using or if you wanted to adjust that?

Joe, this is Daniel Blount. We're sticking to that estimate of 65 million for the year. Through the first six months we've had a use of $24 million in terms of measurement of free cash flow. Last year at this time we had a use of $35 million so we're actually ahead of our internal targets at this point and, like I said, we continue to project about $65 million in cash flow before debt for the year.

Bruce Klein of Credit Suisse.

I was wondering on the-- I guess the volume side, I guess consumer sounds like it was down slightly. I didn't know whether your-- it sounded like your comments on the beverage side, you mentioned I think the industry was down 3.2? I didn't know-- and then you referenced a 4.2 number. I didn't know what the 4.2 number was firstly. And secondly, if you could share maybe what your-- if you had any thoughts on your numbers for beer versus CSD in the beverage side of the quarter?

Well, I think what we were trying to describe is that soft drink, non alcoholic canned volumes were up year-over-year and beer wasn't and this was a particularly encouraging quarter for the non-alcoholic because I want-- when I say soft drink, it's carb and non-carb. It's the full array of juice, teas, energy drinks, water, a lot of promotional activity this summer and I'm not smart enough to know what the current weather pattern means in terms of continued strong sales of non-alcoholic drinks but a heavy amount of promotion from the traditional soft drink side of the business.

Bruce, what I'd say is that certainly beer continued to be impacted, primarily by wine and spirits but also imported beer. You've seen those numbers as well. That continues to be close to 13% of domestic demand now for imported beer and that impacted our beer numbers. Soft drink was pretty solid, both Pepsi and Coke ran promotions. They significantly reduced the price for 12-pack fridge venders and they sold more. And, in fact, we made almost 168 million fridge venders in June alone, which is an all time record for us, so we certainly saw that volume and the net for us was a pretty decent volume in beverage. In the consumer products side it was sort of a mixed bag. I think you certainly know that earlier in the quarter one of the major retailers announced some inventory adjustments that they were taking and that flowed through our system as well when we sell to guys like Kraft and General Mills and Kellogg's, if they take adjustments to interact to react to the retailers, we certainly felt it. And we saw that in April but as the quarter improved in June, we saw very, very strong demand for consumer products business and continued. The other thing I might mention is that Steve has talked about in the past about mixed management, which is a real core thing that we work on here and actually during the quarter one of the reasons year-on-year reductions occurred is because there are segments of our business, primarily outside purchase board where the returns just are not acceptable and we raised the price to a level that essentially caused us to exit that business and that alone had about a $4 million impact to the quarter in just the consumer products and we're going to continue to do that. The mix overall was much better and that's why there wasn't such a huge impact from the volume but if there are segments that don't make sense to us or we can't make money on them, then we're going to exit them and you'll see a quarter-to-quarter changes on those elements.

And on the gas side it sounds like I think you said 2Q was $9 or $10 and we know 2Q average for you guys is 12 because of the timing and the hedges. I guess 10-- I guess you have hedges I think in the next second half of those 6. Is $9 or $10 a good number, even accounting for the timing in closer?

Yes that's a good number, Bruce. I think there's an opportunity there could be on a blended basis something less than that. We're about 80% hedged for the remainder of the calendar year and if the spot market still stays below the longer-term strips, that's good news but this is hurricane season and who knows what will happen to the market.

And in '07 I don't remember. I think you gave a number last quarter on the amount of hedge?

We're about 30% hedged in '07.

And the credit agreement EBITDA, Dan? I know there's a $7 million adjustment number. I didn't know-- it might be helpful if you had a-- helpful for us anyway, had a breakdown of the 7 million adjustment. I know there was non-cash pension, [OPEB] and some other stuff. Is there any way you can help us with that?

Right, I think if you look at it the difference, we had a-- in terms of credit agreement there's a difference of about 14 million this quarter versus prior year quarter and that's a difference of about 7 million from straight EBITDA, which you commented upon. But if you look at it, it's primarily related to the merger initiatives, that plant closings that are included in credit agreement add backs and not in straight EBITDA add backs and in the merger we're looking at-- we finished up last year in particular the SAP implementation. We had costs from that and those were add backs and then those principally related to Legacy Graphic and bringing them on the SAP system. And then we added back some closing costs, particularly from asset write downs, for plants we closed in Bow, New Hampshire and Centralia, Illinois, so those are the primary differences that add up to the $7 million.

That's the $7 million you quoted. It sounded like that was the variance, correct year-over-year?

Right, there's a difference--

Well, there's two $7 million numbers. One is a $7 million variance year-over-year and the other is just the 70 versus 77 specifically in 2Q '06.

Right, I'm talking about just the second quarter, the variance of $7 million.

Right, maybe I'm-- but of the 7 million in this quarter or the 70 versus 77, do you know is that still also merger related stuff from to get from 70 and 77 or is the bulk of that non-cash pension in [inaudible]? Do you know?

That is all our normal stuff. It's non-cash pensions in there in particular. If you're looking at-- we had a dividend payment from Japan that was an additional amount of 1.6 million, so those amounts are in there as well as the normal stuff of interest, depreciation and amortization.

Lastly, just on the volume, back to an earlier question, I guess nothing was reset in 2Q. Is there initiative to do some of the stuff that's up in '07 and in '08 during the second half of '06 or is that there's no way to sort of project when that's going to get settled out?

Are we talking about customer agreements?

Yes. The beverage contracts that--

Well, what we've said and we are holding to is that we're going to take these contracts as they clock out and, as you might expect, you really begin the discussion with customers well in advance of the dated end and if the customer is agreeable we're prepared to advance the clock given the right outcome in terms of economics. So I think we've noted previously we've got additional beverage contracts that will be completely renegotiated this year and some that trail over into 2007, but we're right on track.

Your next question from the line of Jeff Harlib with Lehman Brothers.

Just on the natural gas costs, you mentioned the $9 to $10, but in other words you were 12 in Q2, I thought you had said on your last call for the remaining nine months it would be about $10 per MMBTU. Wouldn't that mean it would be below 10 for the second half?

I think we've got a metaphor that's mixed. The actual gas payments for the first quarter were a little over $14 per MMBTU, but given our inventory turns two months of the first quarter's production was hung up in inventory and was recorded as sales in the first two months of this quarter, of the second quarter. So you've got what the inventory cost that you're recognizing compared to the price you're paying for new gas. The price we're paying for new gas purchased in the second quarter is between $9 and $10. That'll be the purchase price also for the third and fourth quarters based on what we've hedged to date.

And on pricing improvement, can you talk a little bit about the last open board price increase of $40, if all of that is flowing through and any other pricing initiatives on market board.

I'm going to ask David Scheible to respond to that, Jeff.

Well, of the $40 that were announced already half of that is already flowing through the numbers. We saw about a 4% increase year-on-year in what we would call open market SUS and CRB sales, which has us picking up the rest of half of the year the additional $20 per ton and that work is underway as well. So what I would say is that we were certainly encouraged with the initial response. Our operating rates, as reported, are tight as is the rest of the industry. We continue to look at that pricing opportunity going into the rest of the year as well.

I think part of the question was, is there anything on the horizon and I would just point that input costs that are common to all manufacturers continue to increase. Recovered material, OCC particularly, looks like it's starting to move up meaningfully and so there's a lot of cost pressure still building on the industry and I would expect sooner or later, and hopefully sooner than later, that we'll recover that in additional pricing.

And then, of course, the other flow through will be in the carton side, as those board prices get reported and they have been reported and confirmed, as our contract triggers come through the rest of this year and into '07 we'll recover those in our consumer business on the carton side as those board prices flow through our cartons.

And just with beer you mentioned it was still soft in Q2, I know Anheuser Busch talked about some recovery in their beer shipments. Are you seeing any indication of stabilization of demand from your customers there as you enter the second half?

It's a mixed bag. The reality is that when Anheuser Busch up then Miller will often report that they had a tough quarter, so for us what I would say is that demand trends have continued to basically show what they have in the past, which is a slight decline overall in packaged beer for us domestically. And then again, imports continue to show pretty good strength in the United States. Import beer is cool.

And, Steve, on the cost savings it looked like Q1 was especially significant year-over-year. It moderated in Q2. Can you just talk about other actions other than normal continuous improvement that you're looking at over the rest of the year?

I think that Q1 is largely timing related. The scale-up of our manufacturing investments, I think for those of you that have followed I think this is my 37th consecutive quarterly call and I can't remember one where we didn't glorify cost reduction and postulate that there's still lots and lots of opportunity and I feel equally as strongly today as I did nine years ago. For all of the good work that's been done we continue to identify additional areas of opportunity. Some are more difficult to get at than others. I think in the last call David mentioned that we see some meaningful opportunities on the supply chain side of the Company, both inter-Company freight warehousing product movements and shipments to customers. It's not just a domestic business. We have a fairly extensive international supply chain and as we've got some other things completed, we now have the capacity and the time to start focusing on areas such as this, so our basic drumbeat is more.

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

Steve and David, I want to go back on the volume question in consumer just to get a better handle on where we are. Obviously, you've made some mix changes and some trying to allocate that, but as we go from the second to third quarter in your normally seasonally stronger periods, are you seeing any pick-up at all in the consumer side or is it actually seeing some--?

No. We are absolutely seeing strength come back into that market.

We don't like to single out customers, but the nation's largest retailer took a fairly significant inventory adjustment in April and it slammed all of our major customers and then they just reacted accordingly back up through their supply chain, but as David has mentioned, the order rate and shipments through the remainder of the quarter we're right on target and our backlogs and plant loadings are very strong in the food and non-beverage packaging right now, so we think we're right on track.

I'm just very curious because anecdotally we're hearing that some of the other retailers are obviously following the same type of strategy and that hasn't necessarily pervaded through yet into some of the other major retailers.

Well, of course, it's a question of size, but the reality is that our customers right now they're getting ready for back to school. There's a lot of new product promotional activity going on. I'm sure you'll see that in the stores, retail as well, and that helps to move volume and mix, but if across the waterfront if you look at our major customer mix we see pretty strong sales order building in shipments in that space, at least as we look forward at this point.

And then just in regards to the pricing initiatives you talked about the pass through into the converted box side, any sense of how much of that has been implemented and how much more potential price recovery you can get in the converted side?

We try to untangle this web it seems every call. What we mentioned in our remarks is that the pricing in the carton side that we're capturing this year is attributable to roll stock increases that were implemented last year in the main, so as we see additional roll stock prices that are implemented in early '06 we'll see some partial recovery of that in carton prices this year, but it's principally an '07 item.

Isn't it--?

We're getting every cent we're entitled to.

Most of that though I was thinking beverage. I was thinking more sort of spot in some of the consumer businesses, which obviously is a smaller piece of your--

Well, the non-beverage consumer, which we don't break out, we have disclosed or discussed many times that we have several large accounts and we have agreements with them and the percentage of our business that's done with our top ten customers is well over 50% and that's a healthy blend of both beverage and non-beverage. So we have a relatively small amount of business in the non-contract food and consumer beverage piece, very small.

What you refer to as spot-- or there's just really-- it's not the space we play in. Our assets and our processes are really not set up to do a lot of that, so we don't really see-- sort of a lot of pricing on the margin. Where we see pricing on the margin, of course, is new product promotions and when customers change. That allows us-- and you saw that in the numbers because as Steve and Daniel both referenced, our mix was improved. It was improved because we did a lot more promotional activity. We did some more organic new product growth, more microwave products and so that allows inner product pricing, but relative to core ongoing product it's mostly under contract and it flows through based on, for the most part, board and GDP movers, escalators.

Right. I guess the thing I was trying to get to is whether with the volume softness maybe trying to push more into the spot markets.

As David said, our assets are really focused for a different application and other than this inventory adjustment that came kind of out of nowhere early in the quarter, our volumes are really quite good and so we just don't have a lot of open capacity for cartons and non-beverage cartons that we're scouting to try to fill up.

Your next question comes from the line of Christopher Miller with JP Morgan.

I just want to follow-up on a couple small points. As you see the decline on the beer side and the wine and spirits picking up, give us any thoughts in terms of where you are on new products? Is there an avenue that you can start to capture some of that volume or is that kind of a lost space for you going forward if that trend does continue?

I think that one, the beer customers are following somewhat behind, but they're following the pattern that we've seen in soft drinks, which is a tremendous amount of new product innovation and introduction. So I don't think that they have accepted that these volume losses are structural. David also noted that in the soft drink business volumes were strong because there was a tremendous amount of promotions and discounting this summer, so at least my view is that our customers can pretty well dictate the volume based on how they promote and how they price. I would also note that paper board demand in beer has grown through time, as the customers have moved out of some corrugated packs into solid fiber and there are still some very high volume beer packs that are in corrugated that we think are good candidates for conversion to fiber and that, if it were to happen or as it does happen, would meaningfully add to the demand for paper board and that's been a pattern that I've observed over the last almost ten years, so I think it'll continue.

And then on the working capital front you noted-- I mean so far your performance for the first half of the year has been better year-over-year. Is that an expectation that you think you can continue that through the second half of the year? Obviously it's usually a fourth quarter event, but how are you thinking about that?

I'm thinking that this is a new level that we need to stay at and then improve from. Going back to the comments that I made about our supply chain, we think that there are opportunities to improve our turns, which will allow us to take some inventory out. Of course, there'll be some absorption whack as we do that, but that's another area of opportunity to drive down the use of working capital.

We actually saw a quarter, second quarter '06 versus second quarter '05, an improvement in turns overall and in overall dollars in inventory. And the dollars was especially welcome because there was a lot of inflation in terms of our product costs that are in the numbers for the second quarter of '06, so our efforts have generated benefits so far this year and we're expecting further benefits as we move through 2006.

And then just one last question, you mentioned 25 to 30 million pension contribution this year. Any initial thoughts on how you think that shakes out in '07?

Well, a lot of it hinges on pensions reform, which I think is widely publicized as still up in the air with Congress, but depending on what they decide our contributions for 2006 are going to be at an amount, which will minimize contributions in 2007 at this point, so we're looking in terms of our projections going forward about the same magnitude of contribution in 2007 versus 2006, but I want to put that qualifier in there. A lot is going to depend on what Congress does in terms of pension reform.

And what-- forgive me I forget. What is your say percent under funded status?

Well, it depends on what assumptions you use, but if you use the actuarial method, we're above 90% in all three plans. If you use the IRS methods we're somewhere in the 70%s up to the 80%s in the plans and in the IRS method they use a discount rate of 5.1%, which is substantially below the investment returns that we're getting with our plan assets, so we think it's an assumption that needs to be revised and Congress is concentrating on that.

Your next question comes from the line of [Robin Russell] with [Emerets].

I was wondering if you could just comment on the 13D that was filed yesterday by the Coors family and kind what the intention there is in your opinion?

This is Stephen Hellrung. My understanding from the trustee is that this is simply a consolidation of the various holdings that the family holds through a variety of trusts. It's a consolidation of those holdings and a centralization of the administration of those trust assets.

Because when I read through the filing I kind of got the impression that there was some sort of goal in terms of asset sales or consolidation or so forth, that there was maybe some sort of initiatives that he was thinking about.

Well, that filing obviously speaks for itself, but I can't shed any light on that.

Your next question comes from the line of [Zach Zitters] with [Gradient Partners].

My question has to do with the natural gas costs. Most of it's been addressed, but I'm curious whether as natural gas spot pricing has come down over the first half of the year, notwithstanding the recent spike, whether your price increases to your customers will be effected because of that and whether, even if you're going to be at $9 to $10 for the rest of the year, your margins might be squeezed from the top-line coming down?

The answer is no because gas is higher-- the blended average actual cost of gas for '06 is higher than '05, as it was higher than from '04, so I don't see any scenario where we would be responsive to a discussion with anybody that the spot market ought to dictate and gas is an important part of our total cost, but other inputs are also up dramatically.

And I want to make sure and clarify, we do not have any contracts triggered towards any open discussion on any raw material movement-- or I'm sorry, any movement on natural gas, so it would be-- there is no trigger that would make us respond to that.

Your next question from the line of [Adam Mussel] with CRT Capital Group.

Yes. I just have a quick question on the income from operation. In the release it said 6 million of higher manufacturing costs basically to upgrade the West Monroe Louisiana mill, their maintenance program.

Yes.

I wanted to know, is that a one-time cost?

Yes.

And is that something we could add back to EBITDA?

Well, you can add it back, but we can't. We don't do pro-forma work here. It is a one-time cost.

Your next question comes from the line of [Michael Scott] with [Venner Capital].

Hey guys, most of my question have been answered but, Steve, more specifically looking at capacity utilization on your beverage business, I listened to the Mead call yesterday. They seemed to state that their capacity was approaching 100%. What are you guys seeing in terms of where you're at today? And then if you could elaborate a little bit more on sort the cannibalization of beer products away from corrugated? They seem to be a little bit more bullish on some of these new larger scale beverage packages, really improving volumes so even though that you've seen domestic beer volume down, potentially you could see some increases as a result of product shift away, maybe if you could just dive a little deeper?

Well, as I noted in the almost ten years that I've been in this business, I have watched the major beer customers convert away from corrugated to fiber and generally the explanations they provide is that the lines fill faster and that they have a little bit more price stability in solid fiber than what they've experienced in corrugated. And I think that that there is a case to make that there's more room for those kinds of conversions. I really have no comment about what another competitor's characterization of the opportunity, other than it's generally consistent with what I've observed. I think the other thing, the capacity, the demand in beverage flexes significantly in the second and third quarter. You do about 60% of your business in those two quarters, so if you're not busy now it's going to be a tough year and then as we've described previously to try and smooth out some of those lumps the particular impact is on our mills, so we start building roll stock inventory late in the fourth quarter early in the first quarter so that we've got the raw material to support the flex-up in carton shipments in the second and third quarters.

Right. So where would you say today your CUK utilization rates are?

Well, let's put it this way, we are taking no down time on our coated board machines and as is always the case in the second and third quarters coated board supply is very tight and that's a good thing.

And in terms on the recycled board side given the capacity reductions pro forma for what Cascades has done with [ Caruastar and Simpkins] when are you guys-- when do you plan on seeing tightening in that space?

Well, I think the announced plans are that the affected mills will largely be taken down during or by the end of the third quarter. We would expect that there would be some inventory, roll stock inventory, that would probably last another quarter so by year-end I would think we would get to whatever the new equilibrium is.

Your next question comes from the line of [Charles Robe] with [Zylone].

I just wanted to touch on your net tons sold data that you gave to us in the release and the volumes in Q1 '06 versus last year were pretty similar. I don't know if there's anything we can read into the difference between this quarter Q2 '06 versus last year's Q2 '05, anything we should look at there? And then just kind of wondering what kind of a trend we should think about for Q3 and Q4 going forward, does that likely look similar or would there be any differences versus '05?

In particular you're looking at the net tons paperboard packaging of 491 versus the 477?

Yes. That's correct, exactly right.

I think there's two things to look at there and the first one is where did the tons decline and we already commented that that's principally in food and consumer products. And then the next question is what type of tons are there and I can tell you that these tons are tons that we purchased from the outside. They're not integrated tons from our mills. The integrated tons from our mills remained consistent with the prior year. We used 100% of our output out of the mills, so when you're looking at this ton figure a key point is that since we purchased the tons from outside this is lower margin business for us in our converting operation. And then the other comment I might add is that, as Steve and David have already pointed out, we're seeing a pick-up in the food and consumer product business and we saw that in June and it continues at this point through the third quarter, so we're making up ground on that number.

Operator, I think we have time for one more question.

Your final question will come from the line of [Bill Jenquin] of [Jenquin & Board]. Sir, you're line is open; please proceed with your question. That question has been withdrawn.

Well, thank you, operator.

Thank you, operator, and thank you everyone for joining us this morning. We'll talk to you again next quarter. Thanks.

Ladies and gentlemen, this concludes today's conference. You may now disconnect.