Graphic Packaging Holding Co (GPK) 2008 Q3 法說會逐字稿

At this time I would like to welcome everyone to the Graphic Packaging Corporation Third Quarter 2008 Earnings Release Conference Call. (Operator Instructions). As a reminder, ladies and gentlemen, this conference is being recorded today, Wednesday, November 5th, 2008.

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

Welcome to Graphic Packaging Holding Company's Third Quarter Earnings Call. With me this morning are David Scheible, the Company's President and CEO, and Dan Blount, the Senior Vice President and CFO.

Before we get going though I'd like to remind everyone that statements of our expectations in this call constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements, including but not limited to statements related to declines in commodity prices, availability of the Company's net operating loss and statements regarding our performance and our ability to recognize $90 million of annualized synergies by 2010 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 present expectations.

These risks and uncertainties include but are not limited to the Company's substantial amount of debt, inflation of and volatility in raw material and energy costs, volatility in the credit and securities markets, cutbacks in consumer spending that could affect demand for the Company's products, continuing pressure for lower cost products, the Company's ability to implement its business strategies, including productivity initiatives and cost reduction plans, currency movements and other risks of conducting business internationally and the impact of regulatory and litigation matters including those that impact the Company's ability to protect and use its intellectual property.

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, I'll turn this morning's call over to David.

Good morning everyone and thank you for joining us today. Arguably we are operating in one of the more challenging economic environments in history. It seems on a daily basis there is growing investor uncertainty as well as elevated market volatility with the growing global economy in tighter credit markets. However, we believe we are taking the necessary steps to navigate this environment successfully and position Graphic Packaging for long-term growth.

This morning I am going to start by providing you with a brief overview of our quarterly results and I am going to walk you through some of the recent steps that we've taken to ensure that we stay ahead of our cost inflation while continuing to explore growth opportunities. Next I'll discuss the synergies we realized from the combination with Altivity and continuous improvement cost reductions we made during the quarter.

Lastly, I'll conclude 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 through our financial results for the quarter in greater detail. Once we've concluded our remarks we'll open the call and look forward to answering any questions you may have.

Last night we reported a net loss of $0.04 per share. This compares to a net loss of $0.07 per share in the prior year quarter. The recent pullback in raw material prices did not occur in time to benefit third quarter results, as we experienced significantly higher costs for energy, chemicals, fiber and freight. Higher pricing, continuous improvement, cost reductions and synergy achievement combined to offset some of the higher costs. I expect the decline in commodity prices to begin to benefit us in the fourth quarter.

Despite the slowing global economy, our Pro Forma sales increased more than 3.3% as volumes remained strong. We shipped approximately 30,000 more tons of paperboard packaging and Multi-wall Bags this quarter when comparing to the prior year Pro Forma period. When coupled with higher pricing in all our segments, the top line grew at a solid pace.

As I had mentioned, Dan will discuss the results in more detail shortly. Similar to our practice during the second quarter, we will include comparisons to the 2007 third quarter results restated on a Pro Forma basis, assuming the acquisition of Altivity had occurred on January 1st, 2007. This will give you a more apples to apples comparison between the periods.

Although the nearly 50% pullback in crude oil prices from $130 level to $70 and a similar decline in natural gas prices to below $7 per MMBTU is certainly welcome, costs for key raw materials, such as energy, chemicals, fiber and freight, still negatively impacted our results by nearly $67 million during the third quarter. Some of these input costs like caustic soda, latex and fiber, will continue to drive inflation as global supply in demand dynamics have yet to sort out in these commodities.

As I said in last quarter's call, we are not relying on this broader commodity pullback to drive positive results. Instead we are taking proactive steps to manage our costs, improve our prices and provide innovative paperboard packaging globally to our customers. On July 9th we announced price increases that include a $40 per ton increase on our coated unbleached Kraft paper as well as a $50 per ton increase for all our coated and uncoated recycle board. Both of these increases took effect on all shipments made during the third quarter. In addition to those increases, on October 14th we announced a subsequent $40 per ton increase on all shipments of Pearl-Kote and Omni-Kote, CUK, at $50 per ton for our Aquacoat Carrier Board that will take effect in November 2008.

In addition to open market price increases, a number of our carton contracts will reset on January 1st and throughout 2009. These price increases will be based upon the inflationary impact we are experiencing in 2008. Last quarter I stated that we expected to have the ability to use price to offset more than 70% of our 2008 and 2009 projected input inflation by the end of 2009 and I still believe in that number.

Our integration team has been hard at work and after only two quarters as a fully integrated Company through September 30th we had achieved over $25 million annualized synergies through our announced goal of $90 million in synergies by 2010. Two areas of early focus by the integration team have been the optimization of board sourcing and freight and transportation rationalization.

For instance, on the sourcing side standalone Altivity previously purchased roughly 50,000 tons per year of CUK board and 43,000 tons of CRB board from several competitors. After two quarters we have significantly reduced that outside supply by substituting with Graphic produced board and expect to continue to balance our production into 2009.

On the freight side we are now rolling out the legacy graphic transportation management system to the Altivity locations and we are actively consolidating our freight carriers. To date we have reduced total freight carriers by over 50% and eliminated 9 warehouses and we will continue to refine this even further going forward.

A number of the actions we took during the quarter were also related to the ongoing realignment in consolidation of our operations. On August 12th we announced plans to close several high cost holding carton facilities and transition business to our US operating locations as part of our strategy to streamline our cost structure. The Company's carton facilities in Greensboro, North Carolina and Richmond, Virginia are expected to discontinue production towards the end of 2008. And the folding carton plant in Smyrna, Tennessee is expected to close during the first quarter of 2009.

Additionally, we took steps to reorganize sales and operations in our special inks and coating businesses to further drive the completion of our integration goals by 2010. We closed our Handschy ink and coatings manufacturing operation in Indianapolis, Indiana at the end of August and October 1st we announced plans to streamline our label business in the United States by closing our label manufacturing facility in Saint Charles, Illinois in early 2009.

As we indicated at our last earnings call, we announced the divestiture of two CRB mills, one in Philadelphia, Pennsylvania and the other at Wabash, Indiana to an affiliate of Sun Capital Partners. That transaction received the approval of the US Department of Justice and officially closed on September 17th. With the sale of these two mills Graphic Packaging will manufacture approximately 850,000 tons of CRB in four mills and we estimate our average CRB cash cost per ton across our mill system is now the lowest in North America. We are working very aggressively to successfully integrate assets, streamline our operating footprint and reduce our working capital requirements, which will ultimately make us a more profitable Company that is better able to reduce debt and sustain our competitive positions.

Although we are continuing to announce multiple plant closures as part of our ongoing optimization of manufacturing, this by no means should be interpreted as an ongoing contraction of our global footprint. To the contrary, in the third quarter we announced a joint venture through our Japanese subsidiary, the Hung Hing Printing Group Limited, to invest in an integrated paperboard packaging business in China. The market expected to grow substantially and our long-term strategy includes participating as the leader supplier to our existing customers and further developing a strong customer base in China. By establishing a joint venture with Hung Hing, a well respected and successful company in China, we will have the ability to leverage their strong local presence and build a foundation together upon which to implement our mutual strategies.

Our challenge in what continues to be a difficult operating environment remains the realignment and optimization of our increased scope of operation and making our packaging business the lowest cost in the industry. We rely on our sic sigma and lean sigma processes to continually drive down our costs. We had another successful quarter in managing down our costs across the entire enterprise. Legacy graphic operations reduced operating costs by another $13.5 million, bring the year-to-date total to over $39 million, well on our track to achieve our target of $50 million by the end of the year.

The legacy Altivity operations are also delivering cost reductions, mainly through the use of lean manufacturing principles, which resulted in approximately $13 million of cost reduction on a year-to-date basis. Combined cost reduction year-to-date is $52 million and synergies add roughly $10 million more. So clearly we are making solid progress in this key measurable. In summary, we are well situated to build on the success of our various cost reduction programs as we head into difficult economic environment for 2009.

We also announced a significant new expansion in our Kalamazoo, Michigan mill and carton complex. We plan to spend approximately $27 million over the next few years to reduce the cost of manufacturing folding cartons in that facility. When completed we will consume over 240,000 tons of board produced directly across the street in our CRB mill for products like cereal and other dry foods manufactured in that carton plant. Investments like these continue to reinforce GPK as the lowest cost producer in the industry and will significantly reduce the working capital necessary to run our business.

We are advancing our position on the sustainability of our products as well. On August 29th we announced that we had achieved fiber sourcing certification from the sustainable forestry initiative by achieving SFI certification Graphic Packaging joins a growing community of companies, landowners and socially environmental organizations who are committed to enforce practices on a global scale. Achieving this certification is an important part of our continuous improvement initiatives and commitment to sustainability. We have strengthened our effort to manage our business according to responsible environmental policy and we are well positioned to meet the increasing market demand for responsibly sourced raw materials and environmentally friendly products. Our customers can support their own environmental commitment by the products they purchase with confidence from Graphic Packaging.

Along these same lines, we also are proud to announce that Graphic Packaging has become a partner in the US Environmental Protection Agency's Energy Star Program. We are pleased to be part of this partnership, as every step towards a more efficient use of energy adds improvement to our business.

Let's talk a little bit about segments. Graphic Packaging is focused on the food and beverage end use market segment with over 80% of our sales in this sector. Taking a moment to look at industry trends, consumers, the customers of our customers, saw continuing rise in food prices during the third quarter. The US Department of Labor reported 2008 year-to-date inflation averaged 6.2% in the food at home category compared to 3.9% for the same period of 2007.

Aggregate unit growth in major packaged food categories that we track using A.C. Nielsen data was approximately 1% higher in the third quarter 2008 compared to the prior year period. However, this growth rate has slowed dramatically as unit growth in these categories grew over 4% in third quarter 2007 compared to the prior year quarter. Unit volumes of cereal and dry food grew 1.5% and 5.5% respectively, while frozen pizza and prepared food unit volumes declined 6.7 and 1.7% in the quarter respectively.

The unit volume in all non-food product categories that we track declined compared to the same period last year. The data suggests that consumers are reacting to economic conditions by changing both composition and quantity of their purchases. Consumers are a bit of a moving target right now, as inflation continues to take root and is now further exacerbated by uncertainty in the job market driving a series of behaviors depending upon demographics from eating out less and cooking at home more to moving some commodity purchases from branded to private labels, while overall higher food prices are dampening consumption across the board.

We actively and continuously track these and other consumer trends in our business to make sure we can quickly adjust our manufacturing and sales efforts accordingly. Our converted volume followed a very similar trend. We converted 1.4% more tons of paperboard in the third quarter than in the same period last year and essentially the same tons year-to-date as 2007.

However, we converted 5.1% more paperboards for food market in the third quarter than last year and 2% more this year than last year year-to-date. Most of this gain is in major food product customers, such as General Mills, Kellogg's, Kraft, Hines, Sarah Lee and Ralston. The growth with these customers has been in cereal, dry food, frozen pizza and frozen food segments where the volume of paperboard converted was more than the comparable periods in 2007.

Our consumer packaging business has a number of new product commercialization's, both in North America and internationally during the third quarter. Within North America we worked with Nestle to create innovative product utilizing our microwave sleeps technology for their Lean Pocket Calzone. Internationally we commercialized two new products in Spain, including an innovative microwave (inaudible) for [Conan's] cone shaped frozen pizza and a sleeve for fish sticks with CONGALSA. The CONGALSA project is our first successful microwave expansion into the fish category within Europe.

We also demonstrated continued success with our Z-Flute program with two additional new items. One is American cereal with a 10 pound oatmeal package and the other at Kraft Canada, Starbucks with a 3-pack coffee package. Products like Z-Flute are focused squarely on the club store channels. Current trends suggest that if the economy worsens this will be an incredibly important channel. These new products demonstrate that we are focused not on products in traditional grocery channels but also maintain our position as consumer spending habits change.

Finally, we had a number of new product launches and are winning at retail platform including a new customer for our innovative heat transfer labels and the first launch of our Snap2C mobile data interactive packaging with Springer Mountain Farms.

On the beverage side of the business industry data indicates US take home volumes in beer were up about 1.8% during the quarter, a positive change from last quarter when volumes were flat to slightly negative. Domestic brands continued to gain share from imports as a result of consumers moving to lower price points in this sector. Total soft drink take home volume continued its downward trend. It was down almost 3.5% during the third quarter with the expectation that it will continue to trend downward by mid single-digit levels during the fourth quarter.

Although volume from our total beverage group was flat year-on-year, on an overall basis our revenue was up 3%, due in large part to our increased pricing initiatives, non-carbonated soft drink products and a strong international market. Our growth strategy in beverage is to align ourselves with the major global customers and focus our efforts in key growth areas. During the third quarter of 2008 we continued to position ourself as a preferred supplier per InBev worldwide. During the period we completed 100% market supply for InBev in the UK for Stella Artois Boddingtons's and Beck brands. We also supplied InBev Germany export market to the US for Beck's six pack baskets. Finally, we positioned ourselves in China with InBev [Fouzhou] with a marksman wrap machine placement.

However, our success was not limited to international opportunities. In the US we continued to expand our market share of the energy drink category, which showed growth of 3% year-over-year with major commercial rollouts of [Monster and Ant] four packs as well as many new titles, such as [CRUNK], Steve's and brand extensions of our existing customers using a network of co-packers equipped with our Quickflex 2100 energy packaging machine.

Additionally, in an effort to better compete against plastic multi-packs, we are in the process of marketing testing new packaging systems for PET bottles in the southeast. With the reduced paperboard quick print and high visibility on the shelf, this multi-pack solution called [Cap It] is a great opportunity for growth in segments where paperboard was not previously a preferred source. We experienced solid new consumer packaging product sales estimated at $12 million for the quarter. These results were led by our strength in new pack, new age beverage and microwave platforms. Year-to-date our new product innovation sales are slightly more than $50 million.

Turning to our Multi-wall Bag segment, we continue to take aggressive price actions to combat rising inflationary costs, primarily driven by resin in this sector. The structure of our Multi-wall Bag contracts allows us to quickly pass through a high proportion of our inflationary costs and, as a result, we have been able to offset approximately 85% of our year-to-date inflation in this segment. Unfortunately with the global economic downturn, we are beginning to see Multi-wall backlog soften as consumers have elected to use up existing inventories and employ a wait and see approach to the economy. As a result, this could negatively impact our Multi-wall Bag, our bag volumes, going forward. In light of the current economic environment I'm not sure that we can accurately predict all the forward demand but our sales and backlogs for food and beverage based products continue to be strong and we believe our focus in these sectors is clearly the correct one.

Let me conclude by saying that despite what is clearly a very challenging market, our focus on the food and beverage industry has provided some insulation from the economic swings thus far. However, we remain diligent with our cost savings' initiatives and are focused on installing a culture of continuous improvement throughout the organization, which will allow us to recognize ongoing growth and cost saving opportunities. We will continue to improve our price recovery to minimize the impact of input inflation and we will invest in new product activities to expand our margins. In a constricted credit market like the one we are seeing today we remain devoted to protecting our cash position and utilizing that cash only in areas we believe will drive consistent long-term growth or improve our near-term cost structure. Given the initiatives we have in place and the areas we have executed on so far, we believe that we're well positioned to navigate through this environment and beyond. Dan?

All right thanks, David. Good morning everyone. As David discussed, in the third quarter Graphic Packaging made solid progress, as we grew revenues and delivered on integration synergies and cost reduction initiatives. These gains, however, were more than offset by the challenging economic environment, most significantly higher input cost inflation. In today's financial review first we'll cover operational results in more detail and then we'll turn to cash flow and liquidity.

Before getting into the financials, a reminder that in order to provide more of an apples to apples comparison I will use adjusted Pro Forma financial results in my discussion. These results are the appropriate comparative ones to use as a report results as if the merger was completed as of January 1st, 2007 and include add backs for non-recurring merger and integration charges.

In third quarter 2008 add backs totaled $7.4 million and relate to a one-time charges, which include severance related to synergy delivery. As an aid in understanding adjusted and pro forma reporting, reconciliation tables are provided as attachments to last night's Earnings Release. To simplify today's discussions unless I specify otherwise when I refer to net sales and EBITDA I will be referring to the pro forma adjusted numbers.

Turning to third quarter results, first we'll discuss the drivers of the increase in net sales. Then we'll bridge the change in EBITDA from the prior year period. Third quarter net sales of [$1.166 billion] are 3.3% higher than net sales from the third quarter of 2007. Adjusting for the sale of the two CRB mills real sales' growth is approximately 4%. The $37 million sales improvement is primarily driven by higher pricing and improved volume mix.

During the third quarter we realized total price improvement of $25.7 million as pricing improved in all business segments. Approximately $19 million of the increase is from higher pricing from negotiated and contractual inflationary cost pass-throughs. The remaining price contribution is the result of price increases and open market paperboard sales. We expect pricing to continue to improve as contracts containing inflationary price escalation clauses continue to reset. Year-to-date we have increased pricing roughly $80 million over the last year. Most of our contracts will escalate further in 2009.

Volume growth and product mix improvements increased third quarter sales by $10 million. Benefited by product innovation and stable markets our food and beverage product lines delivered solid growth. We did experience weakness in our non-food packaging businesses, which partially offset the gains. Our data suggests, as we anticipated, that consumers are reacting to the economic conditions by preparing more meals at home and cutting back on non essential purchases. Staples like ready-to-eat cereal, cake mixes, breakfasts and dinners demonstrated strong sales. Soft drink sales were down 2% but beer sales were up reflecting more take home consumption. Rounding out the change in third quarter sales is the reduction caused by the sale of the two CRB mills offset by the effect of foreign currency exchange gains. On a year-to-date basis net sales has improved 3.3% as well to a total of [$3.423 billion], primarily as a result of price increases and revenue growth from volume and mix improvements.

Now let's move on to EBITDA. The key issue for Q3, as you heard, was input cost inflation of $67 million. That more than offset the $40 million of improvement resulting from revenue growth and cost reduction. Overall third quarter EBITDA of $131.3 million at 11.3% of sales is $27.5 million lower than the year ago quarter. Let's look at the details.

Revenue growth, which includes price and volume mix, resulted in $30 million of EBITDA improvement. $26 million of the $30 million is from increased pricing. Cost reduction initiatives, which include integration synergies and continuous improvement, delivered $23 million of improvement during the quarter. $6 million of the $23 million is from integration synergies.

Our post merger integration program is ahead of schedule and is currently at a forward annual benefit rate of $25 million. You will see significant synergy benefits coming through the 2009 results. And we are on track to achieve $90 million of annual benefit by early 2010. Partially offsetting the cost improvement were the effects of the Gulf storms, particularly Hurricane Gustav. The storms caused power disruptions, supply disruptions and production issues that drove approximately $4 million of additional costs, principally in our West Monroe Mill Complex.

Now, as I said before, the key issue in the quarter is $67 million of inflation. Input costs to inflation rose by approximately 8% compared to a year ago, as costs for energy, fiber, freight and coating chemicals increased dramatically. Looking at input cost today, we see that costs for many inputs, such as fuel, resin and recycled fiber have receded and may be less of an issue in later quarters. However, costs for other inputs, such as caustic soda and wood chips, remain high. While in the fourth quarter we expect the inflation impact to be somewhat less, it will still be a significant issue.

To conclude the EBITDA change discussion, let me summarize. For the quarter EBITDA improved by $30 million due to revenue growth and $23 million due to cost reduction. The Gulf storms caused $4 million of additional cost and inflation was the key issue with a total impact of $67 million. The remaining EBITDA change is due to foreign currency exchange and the idling of our West Monroe paperboard machine number 2.

On a year-to-date basis EBITDA at approximately $399 million is $9 million higher than the prior year. Benefits from revenue growth and cost reduction have more than offset $160 million of inflation. For the fourth quarter we expect EBITDA to be in line with the prior year.

I will end my discussion with comments about cash flow and the liquidity. As you know, we track cash flow from the Altivity transaction date forward. Through the end of Q3 in line with our expectations $40 million of cash before debt reduction was generated. To date we have completed our pension contribution payments that totaled $56 million and finished the interest payments on our public debt. We expect cash flow generation to accelerate in the fourth quarter and total debt reduction since the merger to be in the range of 110 to $130 million.

In terms of other cash projection guidance, CapEx is expected to be in the 180 to $200 million range for the year. Year-to-date we have spent $126 million on CapEx. Cash interest is expected to total 210 to $220 million. Year-to-date cash interest expense is $152 million.

Now with the condition of the financial markets, liquidity is of keen interest. As you know from past earnings calls, proactive liquidity management is a top priority for us. At September 30th we had strong liquidity availability of $320 million and we were comfortably in compliance with our secured leverage covenant. We reported a secured debt leverage ratio of 3.58 to 1, which is well within our required 5.25 times.

In addition to normal liquidity management, we've taken additional proactive steps to further strengthen our liquidity position. We made additional draws from our revolving credit facility and are now maintaining cash balances in excess of $160 million. None of our lenders had difficulty funding the draws but we will maintain cash balances sufficient to fund foreseeable liquidity needs until the credit market uncertainty subsides. We tightened the return criteria on our capital spending. We are focused mainly on the shorter duration quick payback projects. Since merger integration projects have attracted quick paybacks they remain a top priority.

We are aggressively managing working capital and carefully controlling SG&A spending. Inventory reduction is a primary objective. In this regard we have reconsidered restarting our idled West Monroe paper machine number 2 in January, 2009. In the fourth quarter of 2008 we will permanently shut down this machine. This will allow us to significantly reduce inventory levels in 2009 and to better balance our paperboard supply/demand economics. The machine's annual production capacity is 100,000 tons and in 2008 we have produced both coated board and liner board on this asset. Paper machine number 2 is our highest cost CUK machine and shutting it down will allow us to reduce overhead spending and capital spending. Overall we have always operated with a strong liquidity position and these actions will result in further strengthening.

In conclusion, given the difficult economic environment Graphic delivered a solid third quarter. We continue to realize increased pricing and to deliver substantial cost reduction. We made strong progress toward our integration goals and we are well on our way to the $90 million target by 2010. And finally, we took several proactive steps to strengthen our liquidity positions in these uncertain financial markets.

And with that, operator, we'll open the line for the question and answer session.

(Operator Instructions) Your first question comes from the line of Joe Stivaletti with Goldman Sachs.

I was just wondering if you could clarify on the comment you made about your expectation that you expect to offset roughly 70% of '08, '09 cost inflation with higher selling prices if I think that's what you said, but what is that assuming in terms of (inaudible) cost?

Nothing. Joe, if you look at sort of what our inflationary rate for input insulation this year, we're going to end up I think on input inflation $140 million or so and we put year-to-date our pricing has recovered 80 and that by the end of the year probably we're doing more than 25 million this quarter. We'll probably see a similar-- another 20 or so in fourth, so if you look we've probably recovered roughly sort of 60% and so if you look at our input inflation that would be next year on a go forward basis, based on the way things looked and we would expect another 50 to $60 million worth of additional pricing recovery in 2009.

And traditionally for us what we've tried to do is offset our labor benefits inflation with continuous improvement sort of focus in pricing driven to try and recover input inflation and that's sort of where-- that's how we're tracking the business this year and expectations for next year as well.

So I was just-- I guess I was trying to understand if you were in that number allowing or expecting a decent amount of decline in your input costs when you look at things like energy for 2009.

Well, we certainly think-- I guess it's really a tough market to forecast forward in input inflation, as you well know. As Dan said, certainly we've seen a reduction in things like OCC and we clearly have seen a drop in energy prices. Our hedging for next year is certainly below current rates. Some of the chemical prices have come down, which really tough to figure out right now are things like caustic soda. We buy $35 million a year-- or 35,000 tons a year of caustic soda and last year we paid $300 a ton and this year $1,100, so the supply demand economics should suggest that caustic soda will be back more in line in 2009 but right now I'm reticent to predict that.

So what I would tell you is we certainly would expect a dampening of our inflation costs as we head into 2009 but I don't think I am good enough right now to give you a forecast for how that's going to roll through. What I would suggest, however, is that our contracts are based on board movement and embedded inflation and so they'll continue to run through and continue to accrue pricing into 2009.

And the other question I had was you indicated, Dan, that the fourth quarter '08 EBITDA roughly would be in line with the prior year. I wondered if you had a-- could share with us a pro forma '07 fourth quarter EBITDA and also give us some indication of-- you know, all we see is market prices for the commodities and whatnot but I didn't know if you could describe the level of hedges, whether you're hedged on gas and things for the fourth quarter above or below current levels.

The pro forma 2007 EBITDA is about 123, 124 million. It's between those two numbers, so that's currently our expectation I want to just let you know there's a lot of caution in that expectation due to inability to predict what inflationary costs are going to do. I mean it-- so we have embedded in our inventory the higher cost that we've used to produce that product and, as you know, we turned about 6 times, so there's about 2 months of that higher cost to flow through. So right now we're thinking that it should be around the 123 million for the fourth quarter.

And then in terms of hedging going forward, we have had 75% of our gas requirements, our expected gas requirements for 2009. It's going to be higher in the first quarter. It's going to be in that $10 range and it will taper down into the 9s for the remainder of the year, so I think if you use somewhere around a $9.5 mark for an average for the year, that's currently what we're hedged at and I just want to repeat that the 25% of our need is floating right now and we'll look for hedge opportunities with that 25% as soon as we become more certain that we're going to actually use as much natural gas as we've projected.

That's very helpful. Thanks.

Bruce Klein with Credit Suisse.

What was the debt reduction? That was a 4Q thought for 110 to 130 of incremental debt reduction?

That's right and that, the way we're tracking our debt reduction is from the merger debt, so merger date forward so we're talking about a March 10th forward because, as you know, there was a lot of activity in terms of other types of merger related payments prior to that date, so that's from March 10th forward 110 to 130 million.

Oh so it's from the March 10th, it's not from the third quarter.

Third quarter will be approximately in that $90 million range in terms of cash generation. I mean the fourth quarter will be about $90 million in cash generation.

Yes so about $40 million or so in this quarter, in the third quarter and then an additional 90 sort of gives you a full year of roughly what do you say? 110--

110 to 130.

110 to 130 million and since March is the way we're looking at it.

So if you look at net debt, net debt is going to be around 3 billion.

I understand. And then cost inflation versus cost savings, I guess there was a lot of cost savings numbers I found floating around. Maybe it was not totally clear to me and I was only one but you talked cost inflation was the one I think you said 140 right for '08? And in terms of what was sort of realized in '08 in terms of cost savings could you help with that so we can square what the maybe the negative variance was? I know you're recovering a lot in price, which is a separate topic but is there a cost saving number you're actually realizing between the three buckets? I think you said it was old legacy GPK and then Altivity and then the combined Company? Am I thinking about that right or is there a different way you would advise us thinking about it?

No I think what we said is that year-to-date we're around 50 on a combined, continuous improvement about 50 some, 52 million and so and we're getting about 15 a quarter or so, so that ends up being about 65 so million for the year and then you have to add to that what we believe is to be our total actual synergy that we'll capture this year, which is a roughly 10 million, so you sort of get in full year impact of cost reduction 75 million or something like that, in that range. And so in year-to-date we have the 52 plus the 6 so roughly 60, right, a little less than that maybe.

We got year-to-date 160 of inflation.

Yes he was talking cost reduction.

Cost reduction okay.

I think, right?

I was trying to compare I think cost savings you realized in '08 versus cost inflation.

Yes and so that's the cost reduction and the cost inflation, as Dan said, year-to-date is roughly 160 million. Now that includes all inflation, so that includes not just input inflation but labor inflation as well.

So it was a good mismatch for at least '08?

Yes.

Meaning loss inflation pretty far exceeded by whatever, $80 million or something.

Of pure-- if you're looking at pure costs right, and so that's why you have to really sort of look at the price and cost relationship right? The price, cost reduction relation to your-- to the inflation costs.

And pricing data at 82 million year-to-date in--

So, Bruce, just to summarize, we've got the inflation of 160, okay, the cost reduction is around 91 year-to-date, 91 million.

No.

Isn't it? That's what it says here.

No it's about 52 million plus about $7 million-- it's about 60, 65 million of combined and then 82 million of pricing and that's the way it works out year-to-date.

And remind us how much OCC you buy a year.

Well, we use about 850-- we make about 850,000 tons of CRB, so if you combine OCC mixed paper and all that it's going to be a roughly that 850,000 tons of OCC, of OCC and waste paper, annually. And that takes out the two mills that we sold, so that's our run rate sort of number okay?

Okay got it and then the contracts that are I guess when we think about the percent of your business that's up in '09, is it more-- I mean remind us, you know, a lot of the contracts they used to be medium term in length and now I-- they're a lot shorter is my understanding, so how much of your business I guess is up in '09? How do we think about that?

Honestly I haven't really looked at that. Was a pretty heavy activity year for contracts in light of the merger, so it's going to be a much lower percentage than we saw in 2008 but I'll have to get back to you because I don't have it at my fingertips what the total number is. We don't have-- I will tell you that from a business standpoint we don't have-- no beverage contracts, for example, that are up at all in 2009. Most of our major national account business in consumer products had been renegotiated and extended because of the merger because some of those would have expired by virtue of that. So it was going to be a pretty low year for contract renegotiations just based because this year was the merger year.

But in terms of the contracts and the pass throughs, are they working sort of better than you thought or worse than you thought and is there any--?

Well, I like these contracts better than the ones that they replaced I mean you know because you remember the ones they replaced were either give back contracts or no escalators and, of course, today all of our contracts have some form of reset or escalator clauses, so they're working much better. And that's why we've got an $82 million worth of price recovery. This quarter what did we get like pricing improvement this quarter was 2.3% across our business. I know you can remember back in the days when we were getting 1% on average back, so if you sort of think about the delta in our business it's significant. I realize some of that's driven by the inflationary impact but in the past regardless of what the input inflation was we would have been eating all that and so clearly I like the trajectory better.

Are there-- my last question, are there any legacy contracts that had those not as favorable positions on recover? Are there any left in '09?

No.

They're gone right?

No they-- we took care of those actually if you remember, earlier this year, right. I think our last one was in March or April of this year, something like that.

Sandy Burns with KVC Financial.

Just in looking at the segment information if you take the paperboard packaging segment revenues divided by tons sold, as an approximation for average realizations, it looks like it's actually down both sequentially and year-over-year and just given how you've talked about the positive impact of pricing on your results, can you maybe give a little more color on what may be (inaudible)? Is it product mix, you know the mix between the mill and converting businesses, maybe other issues at play there as well?

Well, you know our mix clearly has, as I mentioned, our mix has clearly been changing because we've been integrating more internally. We've also-- we buy outside roughly 150,000 tons of other board that we do not manufacture and some of those businesses are honestly they're SBS based, right? So it's a higher average board price and we have systematically exited that so if you do year-on-year comparison in the middle of a merger for that kind of thing it's probably not a very good metric relative to overall. Now what I will tell you is that our growth in our core businesses, so our integrated board business, was up 7%. So if we look at the business for us in food or that integrated portion that we want to do, that business is up significantly but that-- but you have to net that against ex-- businesses that we've exited, either here or globally, and in our mix includes a fair amount of business that we do in Europe and outside and in the number of those export board markets we've in light of the inflation or the impact of those businesses we've exited, so too much mix to probably do that math.

And just another question, in terms of starting to think about 2009, any range you can give us in terms of what CapEx may look like as well as the pension contribution, especially given what's happened in the financial markets?

Yes if you look at the CapEx it's-- we expect it to be about the same level as 2008 and that's $200 million range. And in terms of pension contributions, we've been looking at that and there's a couple of sides of that formula but in any event we're thinking somewhere around $60 million in terms of contributions, which is approximated. It's little bit higher than we've made this year but it's in the same range.

Okay great and just a last question, it's you know you've talked a little bit about the merger synergies and how it's progressing. I was wondering just if maybe with a little more detail if you can talk about any positive and negative surprises you found since you've really been able to go into the Altivity operations and what you're finding there in terms of what you may be able to do? And just given the slowdown in the economy and likely in volumes, does that impact either the timing or magnitude of some of the benefits that you'd expect to really see, at least in the short term?

Well I mean what I would say is that if you look at the acceleration of our synergies versus what we thought when we did the original, we are certainly ahead of schedule and that is really attributed mostly by virtue of the fact that what-- as we looked at the combined Companies we actually saw better advantages than we thought. So a number of the Altivity plants are doing really well and we are able to sort of use that lower cost structure. What I would tell you on a forward basis is that we would not-- we have not walking off of any of the integration numbers we've seen at all. I like very much the trajectory in that business. What-- you've got to remember that 80% of our business, on a combined basis, is in food and beverage right?

And so what I would say is that those businesses are not recession proof. I don't think there is a business that's recession proof but certainly we've seen better insulation in that because we're basically at-- we're at the staples end so we're cereal and breakfast bars and beer and so what we're seeing is pretty strong, continued strong demand in that our backlog and our sales are solid as we move into the fourth quarter in those sectors.

The softness we have seen in our volume side has really been in the non, what we would consider non-core business or to some extent businesses that we've exited. We've shut down our label business in Saint Charles. We've certainly seen a volume decline in that business but that was not a core business for us to begin with, so if in the businesses that we're counting on to product volume and sales next year, at least right now, we feel good about that focused on food and beverage.

Bill Hoffman with UBS.

Dave, I wonder if you could talk a little bit. You went through pretty quickly a lot of the folding carton operations that you've shut and/or rationalized etcetera, just if you could help give us some color on where you are from an integration standpoint and like how the business is operating at this point? And then I've got another one.

Well, the plant closures are slightly ahead of schedule. For example, on our original list, the Smyrna, Tennessee was not part of the list but as you looked at the integration activity, what we found is that we're getting much better productivity in some of the plants, both legacy Graphic and legacy Altivity, which, Bill, in this environment made the most sense to say you know what, keeping a marginal plant, a higher cost plant open just made no sense. We had no real belief that volume was going to necessarily tick up or increase significantly, so we sort of accelerated that. We're doing the same thing across a number of other facilities. We're continuing to evaluate a number of these facilities.

I did announce the investment of the Kalamazoo, right? So $27 million in Kalamazoo investment and that's going to expand that plant materially to what, 240,000 tons I think I said of paperboard that's coming right from the mill. You know, with that acceleration and once those presses get installed there, it's quite possibly, Bill, that we end up running that more effectively than we planned and, if so, what will happen then is higher cost facilities running products that we can make there will come out of the mix.

Now we have a view on what those facilities might be today but honestly it could change in light of where those-- where that productivity has increased. The integration teams are ahead of schedule and what that means is that we're getting in these products transitioned at a much faster rate and so we're getting more efficiency in the actual printing and cutting of these cartons, which means that we need to balance our converting capacity. If we don't need the plant or the capacity, Bill, we're just-- we're taking it out of service.

Right and but how do you quantify like your target integration level and sort of how the business operates that way?

Well, you mean from a-- you mean turning to integration like from a board capacity standpoint or--?

Yes, yes.

Yes, well I mean what we do, we don't use a specific target for how many tons we're going to sell internally versus externally. What we simply do is we balance the book of converted business that we want. We certainly want to be in cereal, we want to be in pizza, we want to be in dry foods and so what we do is we lay that entire business out across those presses and then we blow that back through our board mills and so for the grades and the cuts that make sense on our board mill then we will make those things internally. To the extent that we have products that we need to buy that really don't fit our internal structure, we will continue to buy on the outside, and that's across a number of grades.

To date in realigning, as I said earlier, we've integrated what, 40 some odd thousand tons of board that Altivity bought on the outside before but that doesn't mean we don't continue to buy. It's just what we buy is not a good mix for our mill system and that's the way I'll balance it, so our integration level is not a target. I think that our integration level is probably around 80% or 85 but I don't use that as my target. What we target is what board makes sense for us to convert at the lowest cost within our facilities and then we buy the rest of it.

And then I guess the final comment is if it makes no sense at all, in other words if we don't have a right to compete in that space and there are some spaces we do not, whether it's converting more board, then we'll just exit that space and we have. You know I mentioned earlier our Richmond facility closing. That business was very much dedicated to tobacco. Well, we really did not have a good solid position in converting or in board in that business so essentially we exited that business. So when you start to doing comparators relative to average EBITDA per ton, it's a bad comparative because it looked high on the outside but the reality is that the contribution was pretty low. So it's a non integrated play. We can't make money doing it and we sort of exited the business and that's how we're managing the mix for both board and carton.

That's helpful. The second question is just curious about these price increase initiatives and what kind of response you're getting from the market. Given the time of the year, one where obviously you'll get some seasonal demand, obviously less so in consumer beverage, but demand is softening here and there and we're also seeing quite a pull back in most of the costs, whether it be freight chemicals, energy, etcetera. What kind of push back are you getting on the pricing initiatives?

Well, I rarely get a letter from one of my customers telling me thanks for the price increase so we'll start with that. On the other hand, you've got to remember that our customers, they honor their contracts as we honored ours and as we got behind the curve in some of the inflationary impacts we honored that but when it changes they do as well. So if some of that embedded-- some of you-- we'll get some margin improvement if raw materials continue to drop, if pricing will not necessarily follow that. I think the key thing for Graphic Packaging, as Dan said, is that we need to make sure that we're not making products we cannot sell. We really, as we looked at paper machine number 2 CUK board off of that machine we made I think we used roughly 40,000 tons of board, roughly, in 2008 off that machine. As I look forward we just say we don't need that demand so we're shutting that machine down, right? And so that will help sort of balance what we're doing appropriately from a working capital standpoint. Our operating rates are much like the industry. On CUK and CRB we're in the upper 90s on those board substrates right now and that seems to be where the market is. And while there is certainly a demand drop, it isn't necessarily in some of these food based products. Right now ready to eat cereal is growing, is still growing. And it's still a better deal than eating out on the way to work, so that buying continues as we look into the fourth quarter to be solid, as is pizza, beer and those kinds of substrates.

Right no thank you. I appreciate that. And then I guess sort of final question, with regards to the mills that you sold, will you give us an indication of what the EBITDA generation is, the mills were, some idea of what valuation came out of that?

Well, David, I think David talked about the cash received. In terms of the EBITDA from those mills based on their current run rate in 2008 we expected them to be about 10 million for the entire year.

Because it seems like a pretty low multiple.

Well, I mean I don't know how to factor a low multiple for a business that is sold under DOJ restrictions, right? I mean it wasn't as if it was an open auction that allowed us to sort of think through the process. We sold it because it was required by the federal government to close the merger and we did that and so what I would tell you is that we had ongoing supply agreement with them. We are glad to get the asset sold so we can consume-- you know, consummate the business. I will tell you we like the four board, CRB board mills that we have left in our business. If you think of Kalamazoo, Middletown, Battle Creek and Santa Clara, if you look a the average cash cost in making CRB in those four board mills, I'm pretty sure that's by far and away on average the lowest cost of the entire industry, so taking Philadelphia and Wabash out of our mix from an overall cost standpoint didn't hurt us by any means.

All right thanks. It's a shame to see those un-intending consequences.

That's the price of the admission.

[Beau Hunt] with Bank of America.

If you would, I'd like to talk just a little bit more on the contracts, particularly I am wondering how long does it typically take to realize price increases from contractual pass throughs and then inflationary cost. I mean I realize this probably differs by contract, just trying to get a feel for the average lag period there.

Well, you're-- in any ways you answered your question. It does depend on individual contracts when they-- not only when the escalators go through but on what products. It also talks about when the expiration of that contract or the next period for that contract may occur but if you look at where we're doing, right, we're average-- year-to-date we're $82 million a year, $82 million year-to-date on pricing recovery. And in this quarter I think Dan said we're roughly 25 million, right?

So you can sort of see an accelerated rate in that process but I think for the most part it sort of smoothed out the business from a pricing standpoint. And, as we said earlier, I would expect in carry over pricing probably another 50 to 60 million in pricing just based on what we sort of know now. Having said that, with everybody-- all the lawyers in the room, and the answer is I don't know what the economy is going to do and I don't know where inflationary input will go exactly but that's roughly my over the transom sort of look on pricing for what I know in '09. Beyond that I don't really know how to lay it out any better.

Okay all right, so there's not any specific-- we haven't escalated the triggers at the end of the March 31 quarter and three months later we have X, XYZ price increase, that's not the way it works?

Generally not. I mean generally it is based on a previous board price movement or a reset for some economic figure and then when that calendar time hits it goes up. A board price increase that rolls through after [ROCE] reflects it and then it rolls through our percentage of the cost of the board and I mean there's just all sorts of different escalators. As many contracts as we have, we have different levels of escalator. Every customer has their own preferences in the process. I think in most cases you end up at the same place but nonetheless it is a-- it's sort of all over the map.

Okay understood and then so when commodity prices are falling you do experience the exact same lag time. You get to enjoy the full benefit of the decline?

That's right.

And then does it work out generally? You had already spoken before about expecting to recover whatever, it was 70, 80% of your '08 and '09 cost inflation. Do your contracts generally call for a partial pass through over time or is it 100% pass through over time that just takes a while to fully reflect itself?

Again, every contract is different and that's why we're saying that it all really depends. Some of them or depending upon which raw material costs are going up or how that structure is, whether it's based on board movement or direct inflation. Some of them are based on economic expansion, you know [GDP] deflators and so on, so forth, so what I would say is we typically from input inflation we have ultimately eventually get it but it takes a while is what I--

I should have known better there actually and then just last thing on this, roughly what percentage of your contracts would have automatic pass throughs and in the case of contracts that do not do they tend to behave roughly the same except it's on a more of a negotiated basis?

Really I don't know of any contracts that we have that don't have-- that do not address escalators. If we have a contract that's one of the reasons we have it, right, and so-- and a majority of our business is under contract. Those that don't have contracts then the pricing is done at almost on a transaction basis, right, on an order by order or shipment by shipment basis. That's a small percentage of our business, as you can imagine. We're not doing business with Kraft or General Mills or Anheuser Bush on a call it up and we'll price an order but in the some of the smaller businesses it tends to be transactional based.

Understood, that's very helpful. Thanks, guys.

I think we're done. We want to thank everybody for joining us on our third quarter call.

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