Graphic Packaging Holding Co (GPK) 2008 Q2 法說會逐字稿

Good morning. My name is Mindy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Graphic Packaging Holding Company's Second Quarter 2008 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. (OPERATOR INSTRUCTIONS). As a reminder, ladies and gentlemen, this conference is being recorded today, August 7, 2008. Thank you.

I would now like to introduce Mr. Scott Wenhold, Vice President and Treasurer of Graphic Packaging. Mr. Wenhold, you may begin.

Thank you, Mindy. Good morning, everyone. Welcome to Graphic Packaging Holding Company's second quarter earnings call. Commenting on results this morning are David Scheible, the company's President and CEO and Dan Blount, Senior Vice President and CFO.

Before we get started, though, I would like to remind everyone that statements of our expectations including but not limited to the achievement of synergies and debt reduction, pension contributions, capital spending, interest expense, and integration expenses constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements are based on currently available operating, financial, and competitive 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. These risks and uncertainties include, but are not limited to inflation of, and volatility in, raw materials and energy costs, the Company's substantial amount of debt, continuing pressure for lower-cost products, the Company's ability to implement its business strategies, including productivity initiatives and cost reduction plans, currency translation movements and other risks of conducting business internationally, the impact of regulatory and litigation matters and the Company's ability to fully integrate Altivity Packaging and fully recognize the anticipated benefits of combining the operations of Graphic Packaging International, Inc. and Altivity Packaging.

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 these and other risks is contained in the Company's periodic filings with the SEC. And with that, David, I'll turn it over to you.

Thanks, Scott. First, I need to apologize for my voice this morning. I've been battling a tough cold, and this is about as good as I can do this morning. I want to thank you all for joining us today. This morning I'd like to begin my remarks with a brief overview of our consolidated results for the quarter. Next, I'm going to comment on the impact of rising raw material costs and the steps that we've taken to ensure we stay ahead of this cost inflation. Then I'll talk through the progression of Altivity integration and the synergies that we have seen after just one quarter. Finally, I'll close my remarks with a review of our key segments and their performance in relation to general industry trends.

Following my comments, Dan Blount, our CFO, will walk you through our financial results for the period in greater detail. Once we've concluded our remarks, we will open up the call and look forward to answering your questions.

Last night, we reported adjusted net income of $0.01 per share compared to a net loss of $0.11 per share and a per forma net loss of $0.07 per share in the prior year quarter. I'm encouraged by our performance during the second quarter, especially given the difficult operating environment, increased pricing, solid new product commercializations, benefits from our cost cutting initiatives and achievement of integration synergies all contributed to more than offset the negative impact of cost inflation. This is the seventh quarter in a row that we have reported increased operating income versus the prior year period, and our position in the marketplace is strengthening.

As I had mentioned, Dan will discuss the financial results in more detail, and in order to give you more of an apples to apples view, his comments will include comparisons to 2007 second quarter results on a pro forma basis, assuming the combination with Altivity had occurred on January 1, 2007.

At the risk of stating the obvious, the current economic environment has proved to be challenging, and few economic indicators have show sign of much strength. Costs for our key raw materials, such as energy, fiber and chemicals have risen to historic levels and have placed a considerable strain on the business. Between the end of 2006 and the end of the second quarter 2008, the prices of oil and natural gas rose 161% and 145% respectively.

Needless to say, we've be operating under difficult conditions. Overall, inflation had a negative impact of roughly $46 million in our pro forma second quarter results. Similar to the first quarter, the inflationary impact during the second quarter was driven mostly by our increased cost of fiber and chemicals. On average, fiber was up $20 per ton for the quarter, and chemicals were up roughly $9 per ton versus 2007.

Although energy also adversely impacted results, we entered into natural gas hedges in 2007 that have helped mitigate some negative impact this year. On average, energy costs were up about $8 per ton in the quarter. Unfortunately, the second quarter represented the last quarter that we hedged a rate significantly below current spot market. Going forward, we will see more of a direct impact from natural gas during the remainder of the year.

Recently, we have seen some positive trends on the cost side. Crude oil has pulled back from the $140 level to the low $120s, and similarly, natural gas prices have declined from the $13 range to roughly $10 per MMBTU. This pullback is certainly welcome, but there will be some lag for any positive trends for input costs. While we expect our results to be adversely impacted by these higher costs through the remainder of 2008, we believe our margins will continue to improve as we recapture inflation to increase pricing, recognize mergeable (inaudible) synergies and achieve other cost reductions.

Although we are pleased to see the recent downtrend in cost, we are not going to rely on broader inflation pullback for our results. Our primary tool to combat inflation is through ongoing price increases to our customers. During the second quarter, improved pricing positively impacted our pro forma results by over $29 million. For fiscal year 2008, we expect our pricing initiatives, both contractual and market driven, to offset a little more than half of the inflation impact in our business.

In response to rising input costs of inflation, we have recently announced price increases of $40 per ton on orders of our coated unbleached kraft paperboard, as well as a $50 per ton increase for all of our coated recycled and uncoated recycled board. Both of these price increases will take effect in Q3. Additionally, we are in the process of renegotiating freight and delivery charges with our customers.

On the contractual carton side of our business, at the beginning of the second quarter, we were able to eliminate the last of our fixed cost beverage contracts and incorporate an inflation recovery index into the new agreement. However, generally speaking, our customer contracts reset at the start of each calendar year. As a result, most are tied to the inflationary impact we experience from the prior year. Taking this lag into account, we expect to have the ability to use price to offset more than 70% of our 2008 and 2009 projected inflation by the end of 2009 with further recovery into 2010.

Although Graphic Packaging has a strong reputation for low-cost manufacturing, we determined it was necessary to idle certain older assets, higher cost assets, at one of our facilities. This action was necessary for us to remain competitive and to continue providing high quality, innovative packaging to our customers while also generating positive returns for our shareholders.

As we announced on June 20, we elected to temporarily shut down our number two coated paper machine in our West Monroe, Louisiana mill. As I mentioned earlier, the recent run-up in price of crude oil has translated into higher cost for key mill production inputs like fiber, natural gas and petro-based chemicals. The decision to temporarily suspend production in paper machine number two helps streamline our overall cost structure. Customer orders will continue to be met due to production from our other lower cost CUK machines.

While we are clearly motivated to fight the impact of inflation on our business, we have not lost focus on driving synergies. This is the first full quarter as a combined company. I'm extremely pleased with the progress we have made across the organization. We are well on our way to implement our integration plan. Our leadership teams at all levels are in place and working. We have begun transitioning to SAP across the board. Customer plans are in place and being executed, and our plant optimization effort is ahead of schedule. Our integration team has been at work unlocking the full value of the combination with Altivity.

After only one quarter, I'm pleased to report that on an annualized basis, we have already achieved in excess of $50 million towards our announced goal of $90 million of total synergy. Given the negative impact of unexpected inflation, we have put a greater focus on recognizing synergies and have expedited the timetable for achieving the previously announced $90 million target. We now expect to hit this goal by 2010 as opposed to the originally planned 2012.

As part of our synergy program, we continue to take actions related to the overall realignment and consolidation of our operations with Altivity. On April 23, we announced plans to discontinue folding carton production in our Middletown, Ohio facility and cease lamination operations at our Elk Grove Village, Illinois plant, and on July 10, we announced an agreement to sell the coated recycled board mills located in Philadelphia, Pennsylvania and Wabash, Indiana. The sale of these mills is subject to review by the US Department of Justice. Just to note, the proceeds from the sale of these two mills will be used to pay down our existing debt.

However, we are considering all of our options, not just focusing solely on plant rationalization and closures. We are also actively exploring expansion opportunities as part of our process to realize additional synergies from the combination with Altivity. On July 16, we were awarded economic development tax credits in support of our planned $27 million expansion in our Kalamazoo, Michigan facilities where we operate both a coated recycle paperboard mill and manufacture folding cartons for a wide variety of food and consumer products. We believe an opportunity exists at this facility to establish a company-wide model for efficiency in manufacturing productivity. The Kalamazoo mill and carton complex will convert roughly 400,000 tons of recycled board into cartons in this newly expanded facility. We believe this will represent on of the lowest cost such complexes in the world.

We continue to examine all our opportunities to identify synergies, increase efficiency and offset rising raw material costs in an effort to maximize our ongoing results while not sacrificing quality, capacity or customer service. We are taking the necessary steps to ensure that Graphic Packaging remains competitive during this difficult market environment. In addition to combating inflation with increased pricing and synergy achievement, we remain committed to the concepts of Six Sigma, reliability, center maintenance and lean manufacturing to help improve our processes and remove cost from the production and delivery systems.

Because the mills are the source of a majority of our cost structure, the focus of many of our continuous improvement project teams is on lowering ongoing mill costs. We are making excellent progress in reducing our overall reliance on high cost fossil fuels usage at our mills by expanding our biomass footprint through generating more power and steam from wood. Utilization of these various continuous improvement processes allowed us to take out approximately $18 million in operating costs from the system during the second quarter, bringing our year to date total to over $36 million.

Let's talk a little bit about our segments, first, paperboard packaging. Within this segment are our food and consumer packaging and beverage packaging operations. Historically, the second quarter has been the softest quarter for our food and consumer products divisions, as there tends to be a seasonal lull in advance of the back to school push which we typically start to see in mid July. End consumers have experienced a steady increase in inflation in the food/gas category. For instance, the US Department of Labor reports that in 2008, year to date, inflation for the food and home category is 5.6%, compared to 3.5% for the same period in 2007.

The increase in food and fuel costs are influencing the trends we are seeing on the food and consumer package side. Total industry growth in the major packaged food categories that we track through AC Neilsen has slowed steadily this year to just 0.3-- 0.5% in the second quarter. Some of the major segments that we operate in, such as cereal and frozen pizza, have fared much better, growing at roughly 3% and 2% respectively. Our dry food segment also grew at 2.5% in the quarter while the prepared frozen food category contracted almost 3%, suggesting that consumers may be choosing lower priced products in reaction to inflationary pressures.

Our sales trend suggests that our major branded and private label customers seem to be weathering this current economic storm much better than the smaller players in the space.

Our consumer packaging division had a number of successful commercializations during the second quarter. At Kraft, we commercialized a new Z-Flute package for the Planter's warehouse club product line. We also achieved success at Frito-Lay with our Z-Flute design for Stacy's Pita Chips warehousing club packaging. With the combination of Graphic Packaging in Altivity, GPI gained printed E-Flute and F-Flute capability as additional options for our customers.

On the beverage side of this business, despite industry data indicating US beer buying were flat to slightly negative, and total US soft drink shipments were off nearly 5%, our total beverage sales were up 4% due to increased pricing initiatives, increased trends towards take-home versus on premise consumption and a strong international market.

We began to supply InBev's, Beck's Brewery in Germany with both wraps and bottle carriers, and we successfully introduced the first beer six-pack for glass bottles at Kirin in Japan with a new wrap design for one of its premium brews. Within Brazil, a basket carrier was also the package format chosen by the Nobel brand, making it the first permanent paperboard basket carrier in that market. Overall, the South and Central American markets are showing a lot of potential going into the second half of the year. We are experiencing a migration from film towards paperboard packaging in this region.

Additionally, we continue to have strong success with the energy drink market which demonstrated growth of 7% year-over-year for the quarter. For example, one of our biggest wins during the quarter was the Red Bull energy drinks in Europe for our refrigerator 12-pack designed for export back to the United States.

Our plan to push the top line through innovation continues to be successful. During the second quarter, just for Legacy Graphic alone, we experienced strong new product sales estimated at $21 million for the quarter. These results were led by our strength, new age beverage and microwave platforms. Year to date, our new product innovation sales are slightly more than $40 million for standalone graphic. We continue to push our new product development to deliver value added solutions to our consumer and beverage customers.

Turning to multiwall bag, one of our newly created segments, we made solid progress in the quarter as sales grew significantly from prior year period. Our new multiwall bag management team has improved operating metrics and accelerated price recovery. Additionally, we are seeing favorable substitution trends back to paper-based bags from plastics as rising resin costs have disproportionately impacted plastic manufactures. We have announced significant price increases in this segment, and traditionally, lag time is far less than our paperboard sectors.

In closing, to summarize, we were operating a challenging environment, and are required to constantly reevaluate our business to ensure we are taking the correct steps to limit the impact of inflation and rising raw material costs. We believe that despite the inflationary issues, there are solid fundamentals driving our business. Volume should remain solid with the focus on core food and beverage sector, augmented by continuing success of our new product commercialization efforts. Inflation will remain an issue, but the key inputs of fiber and energy seem to be relaxing from the torrid quarter two rates.

We expect to see increase in price recovery through 2008 and into 2009 with already announced price increases, and our synergy and cost reduction plans are ahead of schedule, which will help drive improvement in margins. We are pleased with the progress that we have made thus far, but we realize that we have a difficult road ahead. We remain focused on generated free cash flow to reduce our overall debt position and are confident in our ability to meet our goals. With that, I'll turn the call over to Dan Blount for a detailed review of the financials. Dan?

All right. Yes. Thanks, David. Good morning, everyone.

Before I start, I'd like to remind everyone that this is our first full quarter reporting combined results with Altivity. As we discussed last quarter, financial statements solely prepared in accordance with GAAP are not conducive to evaluating the financial performance of recently merged companies. Specifically, our GAAP results do not report run rate performance very well because they include non-recurring transaction costs and Altivity results only from the March 10, 2008 closing date forward. In addition, our GAAP comparison to prior year is not very meaningful since it only includes Legacy Graphic results. To aid in understanding year-over-year financial performance, we prepared pro forma financial results that assume the combination with Altivity had been completed as of January 1, 2007. We believe the pro formas give us an apples to apples to comparison to the prior year. We will use these pro formas to better guide us in our discussion of Q2 and year to date financial performance. Also, as part of today's discussion, we will reconcile the pro forma results to the GAAP results, so you will be able to clearly tie out the source of our adjustments. As a further aid, reconciliation tables for adjusted and pro forma results were provided as attachments to last night's earnings release.

Now after the operating performance review, we'll provide comments on synergy delivery, cash flow and credit agreement compliance.

First, a couple of comments about the preparation of the pro forma financial results. We used audited financial results from both Altivity and Graphic to prepare the pro formas that combined 2007 company results. The year to date 2008 results are also prepared pro forma to include Altivity results prior to the February 10 closing. Pro forma comparisons will include both revenues and EBITDA.

Now before moving to the Q2 and year to date analysis, I'll highlight our full year 2007 pro forma numbers. With Altivity revenue of just over $2 billion and EBITDA of $173 million, pro forma 2007 consolidated combined company revenues total $4.4 billion and adjusted EBITDA totals $513 million. 2007 pro forma adjusted EBITDA includes add backs for non-recurring costs associated with the sale of our mill in Sweden. On a pro forma basis, the last 12 months, LTM numbers are $4.47 billion in revenues and $530 million in adjusted EBITDA.

Now let's move to second quarter and year to date financial performance. We'll start with a reconciliation of pro forma adjusted EBITDA. Year to date 2008 straight EBITDA calculated from our GAAP financial statements is $205.1 million. As I stated before, this number includes non-recurring transaction costs and partial year Altivity results. After adjustments, year to date 2008 pro forma adjusted EBITDA calculates to $267.3 million. The $62 million of adjustment consists of, one, the Altivity stub period of January 1, 2008 through March 10, 2008 EBITDA of $30.8 million and two, adding back non-recurring transaction related charges of $31.4 million, but the transaction related add backs are net of the $11 million fair value gain on the interest rate hedging contract assumed from Altivity.

For the 2008 second quarter, to get from straight EBITDA calculated from our GAAP financial statements to adjusted EBITDA, we added back net charges associated with the business combination of $9.1 million. This gives us a 2008 adjusted EBITDA for Q2 of $138.1 million.

With those comments, I have completed the reconciliation of the GAAP numbers to pro forma and adjusted numbers. We believe that the pro forma and adjusted 2008 and 2007 financial results we prepared provide a more accurate presentation of operating performance, and therefore, they will be used to describe financial results in the remainder of my discussion today.

On a pro forma basis, reported operating results, considering the high inflationary environment, show strong financial improvement. Here's a summary of our second quarter and year to date results. Second quarter net sales at $1.14 billion is 2.3% higher than 2007. Pro forma year to date net sales at $2.26 billion is 3.3% higher than 2007. Second quarter adjusted EBITDA at $138.1 million is 5.9% higher than 2007's pro forma adjusted EBITDA of $130.4 million. Second quarter adjusted EBITDA margin improved by 40 basis points to 12.1%. Year to date pro forma adjusted EBITDA at $267.3 million is 15.8% higher than 2007's pro forma adjusted EBITDA of $230.9 million. Year to date, pro forma adjusted EBITDA margins improved by 120 basis points to 11.8%.

Given this is the first quarter we are providing pro forma results fully incorporating Altivity, I will focus on comparing the financial results for the first six months of 2008 to the first six months of 2007. By doing so, we will be able to fully capture the second quarter as well as the first quarter numbers. As you know, we were not able to provide a combined company analysis during our last quarter earnings call given that we were still in the process of auditing Altivity 2007 results. Concentrating on the year to date comparison will allow us to catch up with our reporting to you. Should you need additional data on just the second quarter numbers, please reference last night's earnings release, or ask a question during the Q&A portion of this call.

With that, let's look at the detail of the year to date net sales and adjusted EBITDA improvement, first, net sales. On a pro forma basis, year to date 2008 net sales of $2.257 billion compares to 2007 pro forma net sales of $2.185 billion. The $72 million improvement was driven by improved pricing, improved product mix and foreign exchange rates. The pricing improvement reflects negotiated and contractual inflationary cost pass throughs as well as price increases in open market paperboard sales. For the six month period, higher pricing contributed $56 million. This price improvement by segment consists of $45 million in the paperboard packaging segment, $8 million in the multiwall bag segment and $3 million in our specialty segment.

Volume mix activity resulted in a net sales reduction of approximately $3 million. This small decline principally resulted from our decision to exit certain low margin open market business in Europe and sales softness in certain consumer product packaging lines. Overall, beer volumes year-on-year were up 2%. The net EBITDA impact from the volume mix sales decline was actually slightly positive. As we have stated before, we continue to actively manage our mix by refocusing our assets towards higher margin integrated packaging business. The remainder of the year to date pro forma sales improvement is from favorable foreign current exchange.

Now we'll cover EBITDA. On a pro forma basis, year to date 2008 adjusted EBITDA of $267.3 million compares to 2007 adjusted EBITDA of $230.9 million. The $36.4 million of improvement results from $56 million of improved pricing, $76 million from improved performance, continuous improvement activities and other cost reduction initiatives. Approximately $40 million of the cost reduction resulted from continuous improvement programs and merger of synergies. The remainder is from improved manufacturing performance and other cost reduction initiatives. Of particular note is the $10 million improvement we are seeing at our West Monroe, Louisiana mill, as investments made in 2007 to upgrade the mill's infrastructure are now paying dividends.

Overall, year to date results show $132 million of improvement from price and cost reduction. Offsetting a substantial portion of this improvement is $95 million of input cost inflation. The current rate of inflation is approximately double the rate experienced in 2007. We believe that inflationary pressure will continue to negatively impact results for the remainder of 2008 at a rate above the rate experienced in the first half of the year.

Energy costs are expected to be the primary driver of the inflationary increase, either through direct purchase or through their impact on other raw material prices. While oil pricing has recently declined, it is still above the first half of the year's average. In regards to natural gas, through June, we benefited from our hedge program and incurred natural gas costs of approximately $8 per MMBTU. For the remainder of the year, we are hedged 70% in the range of $11 to $12 per MMBTU. On an annual basis, we use approximately 13 million MMBTUs of natural gas.

In summary, based on our current view, we expect total inflation to be in the range of $230 million to $250 million for the full year of 2008.

With the high rate of inflation, the most important question is, what does Graphic management expect the net impact will be on 2008 results? As David discussed, we expect price recovery from indexed escalators and sales contracts, negotiated price increases and open market board increases to offset more than 70% of 2008 inflation. The majority of this recovery, however, will be realized in 2009 due to the lag between inflation and price increase. For 2008, we expect full year price improvement resulting from the recovery of 2007 inflation and partial recovery of 2008 inflation to be in the $110 million to $120 million range. The remaining 2008 gap created by inflation is expected to be more than offset by our continuous improvement projects combined with the acceleration of other cost reduction initiatives.

In summary, looking at the cost reduction we expect to deliver and the price we expect to realize, we project full year 2008 pro forma adjusted EBITDA will be improved over 2007 pro forma adjusted EBITDA.

Before turning to cash flow, I'll make a few comments about our integration process and synergy delivery. Through the end of June, synergies of $3.8 million have benefited financial results and we ended the quarter with annualized synergies in excess of $15 million. Our synergy teams are accelerating the timeline for delivering the expected $90 million of benefits. By the end of 2008, we expect to have annualized synergies of $40 million to $50 million. Additionally, we expect to achieve the $90 million in annualized synergies by 2010, two years sooner than the 2012 we originally projected.

I will end my discussion with a few comments about cash flow, debt levels and the divestiture of the two CRB mills. As we communicated last quarter, we are tracking cash flow from April 1 going forward due to the financing of the transaction in March. As of the end of June, we had $319 million of availability under our $400 million revolving credit facility and debt totaled $3.1 billion.

Debt was reduced by $47 million during the quarter. Over the next two quarters, we expect to reduce debt by an additional $70 million to $90 million, which will bring debt reduction since the merger to the $110 million to $140 million range. This debt reduction projection only includes operating cash flows and does not include the sale of the two CRB mills.

As David discussed, we've recently entered into an agreement to sell the Philadelphia, Pennsylvania and Wabash, Indiana mills. The total sales price is $35 million, $28 million to be paid at closing and $7 million payable within two years based on an earnout formula. The two mills combined have an annual EBITDA of approximately $10 million. The proceeds from the sale will be used to pay down debt.

In terms of other cash projection guidance, CapEx is expected to be in the $180 million to $200 million range for the full year. Year to date, we have spend $83 million on CapEx. Cash interest in expected to total $200 million to $215 million. Year to date, cash interest expense was $87.6 million. Pension plan contributions are expected to total $60 million for the year, approximately $40 million more than the non-cash pension expense.

And finally, as you may have noticed, we included a credit agreement EBITDA calculation in our earnings release. We are currently, and expect to continue to be comfortably within compliance with the consolidated secured leverage ratios. And with that, Operator, we'll open the line for the question and answer session.

(OPERATOR INSTRUCTIONS). Your first question comes from Vick Kumar from South Coast Partners. Your line is open.

Hi, guys. Great results. Just wanted to ask about the interest rate swap that you guys mentioned in the press release, and the [collar there]. What exactly is that, and what is the expectation on that going forward?

Yes. What happened there is, is we inherited about a $550 million interest rate swap from Altivity during the merger of the two companies. We did not get hedge accounting on that swap during the first quarter, and that caused us to have to market to fair value, and that resulted in an $11 million gain for the quarter from the fair value mark--mark to market on the swap. Since that time, you will not see a mark to market, as we have qualified for hedge accounting on that particular swap, so it will not really impact financial results going forward.

It'll just be hedging your interest expenses going forward?

Yes. It hedges the rate expenses going forward, and since we get the hedge accounting, the mark to market will go through equity rather than through the P&L.

Got it. And then the last question I had is, what are your thoughts nowadays on the total, I guess, integration expenses to get everything integrated and to achieve your synergies over the next couple of years?

Well as we put out, overall we had guidance of about, I think in terms of overall CapEx, was about $200 million this year. We expect spending next year to be in about the same range, and then we'll come back in 2010 to more of a normalized range in that $150 million to $160 million for CapEx. So overall, in terms of CapEx, that increase that we're experiencing is really the result of integration type activity.

Vick, you may--this is Dave Scheible. You may have seen our announcement on the Kalamazoo expansion, for example, so we spent $27 million in that facility that will allow us to consolidate a number of other facilities, move some process and create a much lower cost overall carton facility, and that's really where a lot of the--those are the kinds of projects that we're spending. In fact, that's probably the single biggest CapEx project we have relative to integration plans, so that's one of the reasons we did it first.

And what about--so that's CapEx, but what about, I guess, through the P&L, are there any additional expenses to think about, or.

Yes. There's going to be additional expenses to the P&L. We've done it in two ways. In the purchased accounting, we were able to put some reserves up for a shut down in some of the Altivity locations and then if it impacts really our Graphic Packaging Legacy location, it will flow through the P&L. But if you look at those overall numbers, there is going to be an impact--you know, I put out a number of $30 million to $40 million from those activities. Also what we need to consider when we talk about the cash impacts is, when we exit a location, that creates a location that is available to be sold, so we should have some additional cash from really the sale of plant locations going forward as well, and additionally, we should have benefits from working capital reduction at the same time. So I don't think the $30 million to $40 million will translate into a actual cash reductions going forward. I think we'll actually be up when we consider all three of those components.

The working capital and then--what were you saying?

Yes. And then the sale of the plant locations we're vacating.

From the sale, got it. Okay. Those were my questions. Thanks, guys.

Sure.

Your next question comes from Mark Kaufman from MLK Asset Management. Your line is open.

Hi. I was wondering if you could comment on the InBev/Anheuser Busch combination and how that might impact you or what opportunities you might get from that.

Well I won't certainly talk much about InBev and AB specifically for what they're doing, but InBev is a large customer of ours in Europe. AB in an important customer here. Really, if you look at our beverage business in the last three years, we've seen nothing but a number of combinations, SAB acquiring Miller, Molson Coors and then now, SAB Coors Molson, and in every one of those combinations, we fared pretty well. As Dan said in his results, beer volume, take home volume was up. Our mix is improved in that space. The combination--so overall, the consolidation in that space has not--has been a positive for Graphic Packaging. I see no reason why the InBev/Anheuser Busch combination won't be the same thing.

Thank you.

(OPERATOR INSTRUCTIONS). Your next question comes from [Kevin Laugherty] from Prospector. Your line is open.

Hello, how are you? Congratulations on the quarter.

Thank you.

Just wanted to talk a little bit more about the nature of the contract resets next January. How do those work on average and what percentile of, you know, overall inflation would you expect to be captured at that point?

Well the--I wont' talk about individual contracts, but I'll tell you in general, the escalator clauses really are made up a couple of different ways. Some of them are directly through board inflations, so as board prices move up, being as board is, you know, over 70% of the total cost, they tend to drive the escalators of the resets. Some of the more recent contracts are actually built on cost, so as our actual costs go up for fiber, energy or chemicals, then with the lag, you know, as the number resets, then the customer--we translate that into an increase in the selling price.

As Dan said, this year, we're averaging a little over 50% recovery of our inflationary impact, and the primary reason is because it's really sort of unprecedented to see the kind of inflation impact we've had in a single year, and so the contracts are really aimed towards sort of a--you know, as inflation rolls up one year, it looks basically the same as the following year, and therefore, you get a high level of recovery. This year, we're only going to see about 50%, but as Dan said, by the end of 2009, we'll see over 70% of the inflationary impact that we'll see in '08 and '09 recovered through pricing, then with continuous improvement results and synergies, you would expect the overall margins to improve as EBITDA will in the first quarter--I'm sorry, in the year to date, is sort of a indicator of what--of the way the inflation will be rolled through our business and price recovery.

About 70% of our business in under contract, some sort of a long-term contract. Now that number, for those of you that follow Legacy Graphic, is down. In the past, we were well into the mid-80s, so it has changed a little bit. It means more of the business is open or it's done on a transaction basis, or it's more open market board, which tends to be not under a contractual environment, so businesses like multiwall bag and some of the open market tend to recover prices faster. We'll have to sort of see what the experience is for that, because some of that's obviously new for this management team.

Okay. Thank you.

Your next question comes from Jeff Harlib from Lehman Brothers. Your line is open.

Hi. This is [Kashur]. Just had a couple of confirmations. The $110 million to $140 million free cash flow number you gave, is that after CapEx? And the asset sale proceeds, can you please confirm those?

Do you want me to repeat the numbers? Like I didn't understand you completely.

Yes. Yes.

Okay. Yes. The guidance I gave is $110 million to $140 million for the year in terms of debt reduction.

(multiple speakers)

After CapEx, that's correct. And the numbers we gave for the asset sale was a sales price of $35 million, $28 million will come upon the closing date. We expect that to happen in 2008. And $7 million will come about based on an earnout formula that could go out as long as two years.

Okay. Thanks.

Our next question comes from Ashwin Reddy from Venor Capital. Your line is open.

Hey, guys. It's Mike Wartell. Quick question, just on your $90 million of synergies, can you talk a little bit about kind of, you know, how that--if that number could actually be exceeded, and in the past if you've ever--you know, when you did kind of Riverwood Graphic, you know, how that went down, and--from your original guidance to where you ended up.

Well, as we reported already, that $90 million was originally expected to be achieved by 2012, and so we've accelerated the achievement to almost two years. Our experience in Riverwood Graphic combination was that we did, in fact, exceed our external synergy targets. You know, it was somewhat a different market at that point in time. We certainly weren't dealing with $120 oil and $11 natural gas. But I will tell you if you look at where our synergies are coming from, some of them are in purchasing, a number of them from overhead reduction, and then also plant rationalization. And those synergies--you know, those synergies have been very solid, and in fact, they've been accelerated. As we have combined the two facilities, there's--or two companies, there's a lot more overlap in manufacturing capabilities in this merger than there was in Riverwood, so what we're finding is, we're operating those plants more efficiently than we originally expected, which allows us, therefore, honestly, to operate less facilities than we originally expected, and so some of the synergies will come from accelerating plant closures and potentially additional plant closures that originally we thought we might need to operate, but based on operating metrics, we just will not need to. So I feel good about the synergy number and the acceleration that we're seeing right now.

(multiple speakers)

And Dave, how much did you exceed the synergies back at the last transaction from the original amount?

We exceeded it by a substantial amount. At the last transaction, it was close to double, actually. But if you look at the way we actually run the synergy program, it's first off, the $90 million is at the low end of our synergy range, and I think we've told you that before. Secondly, the way we operate this, we have a huge pool of synergy opportunities from which to pick, and the $90 million is the projects that are really in process at this point. So, you know, can we go above the $90 million? The answer is definitely yes. And the other--the guidance we'll give you on it is the $90 million is really at the low end of our range.

One more question for you guys. Now Dave, you had--we had talked to you guys about just kind of the transition from kind of the cardboard containers that were holding beer bottles to kind of the CUK packaging and just kind of increasing just overall volumes and market share because of that. Do you think you could talk a little bit about the progress for that, kind of how you foresee that continuing over the next couple of years?

Well the--certainly, we made progress in this quarter. Of course, it is interesting, because when we started all those projects before, Graphic Packaging only made CUK products and didn't make--as you said, the corrugated construction, but of course, one of the manufactures of some of that corrugated volume ended up being in Altivity. So we sort of had an improvement in mix and an improvement in gain on the CUK side, but that business in corrugated, part of it was in our mix, so we sort of swapped that out.

But I will tell you what we are seeing in the trends, and I mentioned it, is that the plastics right now, both films and other core petro-chemical based plastic alternatives, we've seen a much higher rise in their costs. In ours, too, from that perspective. We buy a lot of film and resin, and that side of our business has seen unprecedented increases, and so what that translating to is you're seeing more demand in fiberboard as customers are looking at transitioning from plastics to fiberboard. And I mentioned in my comments that, even in Latin America, which has traditionally not been a huge fiberboard market, certainly in beer, you're starting to see new packages show up in fiber. So I think our trends are going to be really more around a fiberboard transition from film as far as a long-term driver versus just sort of moving from solid--from corrugated to solid fiber.

I did mention in the quarter that outside of beverage and Z-Flute, we saw additional transitions, and that's basically the same phenomena. That's moving from a corrugated, laminated structure to a Z-Flute which is a solid fiber, and we had great progress in that, so that trend continues, but I think at this point in time, we're also seeing the underlying trend of plastics being incrementally disadvantaged, if you will, to fiberboard inflationary impacts.

And just finally, can you just repeat if you'd already done so, just the capacity utilizations that you're seeing in CUK and CRB right now?

Well you mean ours--actually, our CUK mills are pretty tight from a capacity standpoint. Our operating rates are well in the upper 90s, and in our CRB mills, in light of some of--you know, some of the capacity takeout that's occurring and customers adjusting for that, that capacity utilization has also moved up dramatically. I'm encouraged by CRB because the lead times are going out, the backlogs are building, but that--you know, that, we'll watch that pretty carefully as we go into the second half of the year. I'm certainly not declaring victory on the CRB side of the equation, but our capacity utilization has been very, very strong.

Thank you.

Your next question comes from Vick Kumar from South Coast Partners. Your line is open.

Hi, guys. I just wanted to ask a follow up question which is, I want to--I guess I want to get a sense for your contracts. Let's say inflation in 2007 had been similar to 2008, what sort of percent of inflation would be cover? I know you said this year it'll be 50% because inflation's a lot higher, but I want to get a sense for what they are in a normalized basis if inflation is similar from one year to the next.

Well it--you know, it--if you track our results over the last couple of years, you're seeing increased recovery from pricing. You know, we used to really--in many--back to 2004, 2005 time period, we actually have price reductions and inflation going up, so our recovery was well below 20%.

Right.

We've been averaging over 50% in the last couple of years, and as Dan and I said, going forward, we think in 2000--by the end of 2009, we'll get over 70%, so our price recovery is accelerating with the new structure in those contracts.

So do you think of 70% as sort of a normalized what we should expect going forward?

You know what, talking about normalized is difficult in this economic environment, so I mean, what I would--is based on what I think--we think our inflationary impact, that's a good number, but, you know, oil's $120, today it was $147, and I got people telling me it could be $200, so, I mean, it's really difficult to hone in. What I would say is, right now, based on what we believe inflation will do, we're looking at 70% plus recovery of our inflationary costs in pricing by the end of '09, and that's about as good as I can do at this point.

And does that assume something like oil could go up to $200, or. .

No. I think--you know, I--no. I mean, I'm not planning by business on $200 oil.

Right.

But I'm certainly recognizing where oil has been, and recognizing that we have to be able to deal with oil at--you know, at elevated prices.

Okay. Great. Thanks.

At this time, there are no more questions.

All right, Mindy. Thank you, everyone for joining us on Graphic Packaging Holding Company's second quarter earnings call. Thank you.

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