Graphic Packaging Holding Co (GPK) 2009 Q2 法說會逐字稿

Good morning. My name is Regina and I will be your conference operator today. At this time I would like to welcome everyone to the Graphic Packaging Holding Company second-quarter 2009 earnings conference call. (Operator Instructions). As a reminder, ladies and gentlemen, this conference is being recorded today, Wednesday, August 5, 2009. Thank you. I would now like to introduce Mr. Scott Wenhold, the Company's Vice President and Treasurer.

Good morning everyone. Welcome to Graphic Packaging Holding Company's second-quarter 2009 earnings call. Commenting on results this morning are David Scheible, the Company's President and CEO, and Dan Blount, Senior Vice President and CFO.

I would like to remind everyone that statements of our expectations on 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 relating to debt reduction targets, declines in raw material commodity prices, and expected effect on the Company's results, and additional synergies from the Altivity transaction, consumer purchasing trends, pension contributions and the performance of our Multi-wall Bag business 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, and the Company's ability to implement its business strategies, including productivity initiatives and cost reduction plans.

Undo 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.

We are pleased with overall second-quarter results. This is the second quarter in a row in which we delivered EBITDA growth and significantly higher EBITDA margins. The strong operating performance is resulting in substantial cash generation, and therefore net debt reduction.

Pro forma adjusted EBITDA, which excludes alternative fuel tax credits and expenses related to the Altivity combination, as well as other nonrecurring items, improved to $148 million the second quarter, up from $130 million in the first quarter of this year and $139 million in the second quarter 2008. For the last six months pro forma adjusted EBITDA improved to $278 million compared to $266 million last year.

Pro forma adjusted EBITDA margins have improved to 14.2% in the second quarter, which compares to 12.7% in the first quarter this year, and 12.3% in the second quarter of last year. That is 150 basis point sequential improvement and 190 basis point year-over-year improvement in our margin on lower volumes.

As we have said previously, generating cash to pay down debt and improving our debt ratios remains a top priority. Last night we issued a press release indicating that we plan to redeem and prepay approximately $20 million of principal and interest on our 2011 8.5% senior secured notes at par value.

In the second quarter we generated $121 million operating cash flow, and received approximately $52 million of alternative fuel tax credits. We are ahead of our cash flow projections and are raising our full-year net reduction target to approximately $200 million from operation, which excludes any benefit from the alternative fuel tax credits. We have not built these credits into our debt reduction target due to the uncertainties with how Congress may act on this credit. Our alternative fuel tax credits are averaging roughly $10 million a month.

We continue to drive improved EBITDA performance. In the quarter we generated $25 million in ongoing synergy savings and an additional $30 million of cost reductions from continuous improvement programs and other initiatives. Cost to achieve these synergies were roughly $34 million, resulting in approximately $21 million of net performance improvements in the quarter. As we said on the last call, our merger-related synergies have exceeded $92 million and we have now fa surpassed these synergy goals.

Working capital in the quarter improved $51 million, and we are tightly managing our CapEx as well. Dan will talk more about these in his remarks, but we are planning to maintain the reduction in working capital. Throughout our synergy efforts we have seen significantly higher levels of productivity in both carton and mill assets. And with our two largest individual capital projects, the Kalamazoo carton plant expansion and our IT integration projects winding down this year, we see significant opportunities to continue to improve productivity at overall capital expenditure rates lower than our historical levels.

Our teams are doing a terrific job of tightening our supply chain across the board, and their efforts are clearly showing in our results.

On the input side trends are generally favorable, with most of our major raw material costs being flat to down. So far this trend has continued through the end of July, with the only exception being a modest price increase on OCC fiber used in our recycle board mills. Dan will talk more about input prices in a moment.

On the demand side we saw modest sequential improvements in second-quarter volumes, and this trend has also continued into July. While volumes are still down year-over-year, we remain cautiously optimistic that volume trends are beginning to move in the right direction.

The defensive nature of our core food and beverage business makes it less susceptible to fluctuations in the economy than the Multi-wall Bag business. So our food, our core food and beverage continues to perform exceptionally well in this environment, and it accounted for roughly 84% of our total sales in the second quarter.

Let me take a moment to touch on both our folding carton and Multi-wall Bag businesses. Sales in our folding carton and beverage businesses increased 3.7% sequentially from the first quarter,, but decreased 1.6% from the second quarter 2008. The beverage business was very strong and continues to show resiliency. In beverage we saw particular strength in domestic beer, and sales in soft drink category have begun to improve. On the food side dry and frozen take-home products performed very well.

While our overall consumption across food and beverage continues to be relatively flat, we are benefiting from a shift towards value-based take-home items. In the current environment consumers continue to eat and drink more at home and less in restaurants and bars. In addition, they are buying more cook at home products from the center of the store, rather than the pre-cooked or prepared meals. As a result, volumes are up on the take-home side of our business and down on the away from home side.

In food the shift continues to be towards items like pasta, cereal and frozen food, and away from items like candy, bakery goods and prebaked items. According to ACNielsen, some of the better performing food categories in the second quarter were dry dinner mixes, up 8.9%, frozen pizza snacks, up 11%, and refrigerated products, up 5.3%.

If you look at beverage and beer, the shift continues towards domestic beers, store-bought take on products and anything inn a can. Year-to-date take-home beer volumes across the industry are up by nearly 3%. On the flip side imports, bar and restaurant products and bottled products are all down.

In carbonated soft drinks the economy continues to have a negative impact on the take-home channel as consumers trade down from branded colas to private label, and tap water, which is up 12% year on year. Although the volume was down, improved pricing index contributed to sales being flat year-over-year in this sector.

Let's look at Multi-wall Bag business. This business is less defensive than food and beverage and more impacted by economic conditions, specifically in the building and construction markets. The Multi-wall Bag business accounts for roughly 11% of our total sales right now. We do expect volumes in this business to improve faster than food and beverage as the economy rebounds.

Sales in our Multi-wall Bag division business decreased 7.6% on a sequential basis from the first quarter and 19.7% on a year-over-year basis. We have taken the necessary steps to rightsize and optimize this business, and we will continue to manage it from a cash flow basis. As conditions begin to improve in the end markets, volume and margins should recover. However, this will likely be a lower EBITDA margin business than our food and beverage.

Even in a difficult market, however, this business generates healthy cash flows and a return on capital above our weighted average cost of capital.

Turning to the mills, they had a very strong operating quarter, improving all performance and integration metrics and exceeding our financial targets. On a tons per day basis, which is a key throughput metric, improved and we look -- we took no market downtime in our core CRB or SUS plants.

The new management operating system at West Monroe, Louisiana Mill continues to yield excellent results in productivity, energy conservation and fixed cost reductions.

Additionally, the Kalamazoo mill started their lean initiative rollout during the quarter, and is making excellent progress. Lean initiatives across the mills system included our Battle Creek, Michigan, Middletown, Ohio, Macon, Georgia, and Santa Clara, California mills, all resulting in improved performance across the system.

With respect to raw materials, we saw favorable variances in energy, wood, and secondary fibers, which helped drive EBITDA and cash generation to strong levels. So far, with the exception of some modest increases in OCC, these favorable trends have continued into the third quarter.

Now partially offsetting these positives where price erosion and lower-than-expected sales volumes, particularly in the non-core container board and uncoated markets. As a result, we took 17 days of downtime on the West Monroe, Louisiana number one media machine and 16 days of downtime in our uncoated mail in Pekin, Illinois. We are quite pleased with the progress and performance of the mills, and believe there are further improvement opportunities throughout the year.

Let's talk a little bit about performance improvement. As I mentioned, we issued $21 million of net performance improvements in the second quarter. The major driver behind this continues to be number one, plant closures and rationalizations, number two, optimizing our mill mix, and three, procurement and transportation improvements.

We have announced the closure of eight converting plants, five in 2008 and three in 2009. All of these plants are scheduled to be closed prior to the end of 2009. In mill optimization to date we have integrated nearly 70,000 tons of SUS and CRB and URB and are operating at around an 80% integration level between carton and mills.

We have been able to successfully integrate tons in each of our business, and the benefits from this initiative has provided a valuable asset to some of the economic challenges in today's marketplace.

On procurement and transportation, our teams are working hard to internalize freight and improve transportation across the entire supply chain. We have been able to markedly reduce the total number of warehouses across the system this year, and expect more reductions in 2010 as we compete -- as we complete the realignment of our converting footprint.

Let's turn and talk a little bit about new products. This has continued to be a good source of growth and margin for Graphic. New product sales were more than $20 million in the second quarter. As we have said before the shift towards more value driven products during the current economic cycle has dampened the new product development side, but this continues to be an important part of our business and differentiating factor.

In the second quarter we launched and won a number of new product programs. In beverage we won a new Z-Flute contact for a new kids drink pouch carton that was chosen because of its ability to highlight Disney graphics. We launched our Z-Flute package for a 10 count Minute Maid pouch from Coke, a private label product at Cott Beverages in the UK that expands our market and takes volume from [Shrink Ville].

We also captured a new energy drink carton for [Brawls], Corona and No Fear. In addition we placed brand-new beer and soft drink machines at InBev in Belgium, Mahou and San Miguel in Spain, and Matt Brewing in the United States, and finally Adirondack in the United States as well.

In the microwave segment we launched a new product that allows customers to crisp their product to their own personal preferences for the Heinz line of Smart Ones flatbreads, a new smart pouch that is -- a new steamy microwave package. A new susceptor sleeve for Nestlé Lean Pockets seasoned crust pizzeria style pizza that provides pizzeria style browning and crisping in the microwave.

We launched a new susceptor product for a branded line of frozen quiches in France and a new product for ALDI, called Kirkwood Wings to Go.

On the strength side we won programs with craft Kraft Nabisco and Avery Dennison that provides increased value by replacing corrugated litho-lam packaging with solid fiber solutions. Finally, on the commercial side we launched a major new package in the shape of a lobster for Yum! Brands' Lobster Bites. And our Snap2C interactive mobile technology on the Colgate Mennen Speed Stick.

I have been encouraged that in this tough environment customers continue to spend on new value-added products, and we are capturing a large share of those incremental sales. Dan will walk us through the details behind the numbers.

Good morning everyone. As in the past, my comments will include operating results comparisons. The only pro forma results included will be to adjust both net sales and EBITDA in the prior year to exclude the two mills that were divested as part of the combination with Altivity. This will provide you with accurate year-over-year comparisons. A reconciliation detailing the pro forma non-GAAP numbers is included with the earnings release.

Since cash generation and debt reduction is a top priority, I will start my discussion by going through our cash flow, balance sheet and liquidity metrics. And then come back to a more detailed discussion around the income statement. The other thing we are doing differently this quarter when appropriate is commenting on sequential changes from the first quarter in addition to the year-over-year changes.

Cash flow. So starting with cash flow, net cash from operations was $172 million in the quarter, an increase of $170 million over the first quarter of this year, and an increase of $81 million over the second quarter last year. Over the first six months of 2009 we improved operating cash flow by $158 million, included in operating cash flow are alternative fuel tax credits.

Through June 30 we have applied for in $62 million of tax credits and have received $52 million in payments. Excluding the credits, operating cash flow increased by $107 million over the first six months of 2009. As David briefly discussed, continued productivity and cost reduction improvements, as well as lower input costs and the alternative fuel tax credits drove the increased cash flow in the quarter and the six-month period.

Now that we have had a year to integrate Altivity, we are starting to see the acceleration in our cash generation that we expected.

One of the key focus areas has been our strict management of working capital, specifically inventory. On a year-to-date basis cash flow from working capital improved by more than $62 million from the same period last year. Since the beginning of the year inventories have decreased $40 million. The major inventory reduction initiatives include, one, supply chain optimization, which increases inventory production cycle times. And two, plant rationalization, which allows us to meet product demand with fewer facilities.

Capital expenditures were $30 million in the second quarter, down from $47 million in the second quarter last year. Depreciation and amortization was $75 million in the quarter, versus $67 million last year. Our balance sheet, leverage ratio, liquidity. We reduced debt by $159 million in the second quarter and ended the quarter with cash equivalents of $161 million.

Our total net debt at the end of the quarter was $2.9 billion, and are net leverage ratio improved to 5.3 times. Under the terms of our credit agreement, we must comply with a maximum consolidated secured leverage ratio of 5 to 1. As of June 30, 2009, our consolidated secured leverage ratio was 3.6 to 1. At quarter end we had $16.5 million drawn on our $400 million revolving line of credit, and our available liquidity was $496 million.

In the quarter we extended near-term debt maturities with the issuance of $245 million of senior notes due in 2017, and tendered for $225 million of senior notes due August 2001. As you saw from our press release last night, we plan to redeem and prepaid approximately $20 million of principal and interest on our 8.5% senior secured notes at par value.

Once the redemption is completed, our earliest debt maturities will be approximately $180 million of senior notes due August 2011 and our bank revolvers runs through May 2013.

Total sales. Moving to the income statement, second-quarter total net sales increased 2.4% sequentially over the first quarter, and decreased 7.1% from the second quarter last year. The $80 million year-over-year decline in total sales breaks down as follows. One, $8 million positive impact from higher pricing. Two, $78 million negative impact from lower volumes, primarily in our Multi-wall Bag and Specialty Packaging businesses. And three, $10 million negative impact from foreign currency.

From a mix standpoint Paperboard Packaging accounted for 84.2% of total sales, Multi-wall Bag accounted for 11.1 person of total sales, and Specialty Packaging accounted for 4.7% of total sales.

Paperboard Packaging segment sales. Sales in our core Paperboard Packaging business were strong, increasing 4.6% sequentially over the first quarter and decreasing a modest 3.4% from second quarter last year. Net tons sold in Paperboard Packaging increased 5.1% sequentially from first quarter and decreased 3.7% from the second quarter last year.

For discussion purposes I will break down the Paperboard Packaging segment into three primary areas. One, North American folding carton, which sells predominantly beverage and food packaging. Two, open market non-converted paperboard, and three, international.

North American folding carton sales, which is the vast majority of the segment, were strong, decreasing a modest 1.6% from second quarter last year. This strength was led by the beverage business, which increased low to mid single digits on both higher volumes and price.

Driving the improvement in the beverage category was strength in beer products, which recorded a high single-digit increase from both volume and price. Soft drink related sales are showing improving trends and were flat with last year.

Food and other consumer product sales decreased low single digits on declines in volume, partially offset by increased pricing.

Open market sales of non-converted paperboard decreased mid-single digits versus second quarter last year, on both volume and pricing declines. The volume decrease is primarily the result of our exit of the linerboard business, which we did by shutting down the West Monroe number two paper machine.

Finally, international sales declined 11.8% from second quarter last year, primarily due to unfavorable changes in foreign currency exchange rates. International carton volumes were slightly better than the prior year.

Multi-wall Bag and Specialty Packaging segment sales. Our two smaller segments, Multi-wall Bag and Specialty Packaging, sell products used in the building, construction and industrial supply sectors. As such, these businesses have suffered double-digit year-over-year sales volume declines. As the economy improves, we expect Multi-wall and Specialty to materially benefit.

Sales of Multi-wall Bag products decreased 7.6% sequentially from the first quarter and 19.7% from the second quarter last year. The sequential decrease was driven primarily by pricing declines, while the year-over-year decrease was driven by volume declines.

Sales of Specialty Packaging products decreased 8.9% sequentially from the first quarter this year and 29.4% from the second quarter last year.

EBITDA, moving to EBITDA, second-quarter EBITDA improved significantly on both a sequential and year-over-year basis. Second-quarter EBITDA of $163 million increased by $48 million from the first quarter and by $33 million over the second quarter last year. Second-quarter adjusted EBITDA of $148 million, which excludes merger related charges, the loss on the early extinguishment of debt, and alternative fuel tax credits, improved by $18 million sequentially and by $9 million year-over-year.

The majority of the $9 million year-over-year increase was made up of the following -- a $21 million positive impact from performance improvements, an $8 million positive impact from higher pricing, a $13 million negative impact from lower volumes, and a $8 million negative impact from inflation.

Second quarter EBITDA and adjusted EBITDA margins increased significantly. EBITDA margin of 15.6% increased 430 basis points sequentially from the first quarter this year, and 410 basis points from second quarter last year. Likewise, the adjusted EBITDA margin of 14.2% increased 150 basis points sequentially and 190 basis points year-over-year.

With Paperboard Packaging making up nearly 84% of our total sales, it is worth pointing out that the Paperboard Packaging EBITDA margins are the highest in the company at around 19%. While Multi-wall Bag and specialty have significantly lower EBITDA margins, both businesses are generating healthy cash flows and have a return on capital above our weighted average cost of capital.

Input costs and product pricing. Turning to input costs for a moment, we generally saw favorable sequential and year-over-year trends in most of our major raw materials, including natural gas, virgin and OCC fiber and chemicals. Now because of the 2 to 3 month lag between lower input costs translating into cost of goods sold, we expect Q3 to have a higher benefit from lower input costs than Q2.

In the second quarter we did experience around $8 million of inflation, primarily driven by employees' retirement benefits.

Through the end of July input costs have remained relatively stable. We have seen a slight increase in OCC pricing, around $15 per ton. Offsetting this, however, are price decreases in other areas such as chemicals and virgin fiber.

Factoring in our hedged natural gas positions, our average blended cost of natural gas per MMbtu was approximately $8.24 for the first six months of 2009. On an annual basis we typically use around 10 million MMbtus of natural gas. If rates remain at the current spot levels, we could realize a significant benefit in 2010.

Turning to product pricing, year-to-date we have recognized a net increase of approximately $33 million, primarily from contractual inflationary recovery.

Now guidance. Finally, let me summarize a few targets that we mentioned in various places on the call. First, we have raised our net debt reduction target to $200 million. This excludes any alternative -- any amounts from alternative fuel tax credits. If you include these $75 million in tax credits we have earned through the end of July, then our annual net reduction target increases to $270 million -- $275 million this year. While we cannot be certain whether the alternative fuel tax credits will continue through the end of the year, we will apply any additional credits to further debt reduction.

Our capital expenditure target for this year is approximately $150 million. As David said, we see significant opportunity to operate with capital spending lower than historical levels.

Our cash pension contribution for 2009 is set at $65 million. Improvements in working capital driven primarily from inventory reduction is expected to result in $50 million of cash this year.

In closing, I just want to reiterate how focused we are generating strong, sustainable cash flows to strengthen our balance sheet, improve our leverage ratios, and drive shareholder value. Going forward cash flow should benefit from the full impact of the synergies and performance initiatives, lower cash interest costs and disciplined capital spending.

With that, I will now turn the call back to David for his closing comments.

Well, in closing I would like to reinforce strategically I think we are firmly positioned as the dominant value-added packaging supplier in food and beverage sectors. Our global footprint, vertical operations, and efficient operations and ability to create new industry leading products enable us to compete globally on both price and innovation. With the industry likely to continue to consolidate around bigger global consumer products companies, looking for focus and integrated partnerships of packaging suppliers, we think Graphic Packaging is in a great position to grow the business and continue to deliver, improving financial results.

Our strategic direction is really standing on three principles. The first is improving our core business by focusing on improved operating efficiencies and customer metrics. We know which businesses we are in and which ones we are not.

The second key strategic principle is growth. Given our leading market share position in the folding carton, food and beverage markets, our ability to deliver new innovative products and expand our global geographic footprint, we absolutely believe we are in a position to grow and emerge as the stronger player in a global consolidated market.

As mentioned, there are some early signs that volumes are beginning to improve sequentially, and we are cautiously optimistic that demand volumes have troughed in this economy.

The third principle is improving our financial financials, specifically accelerating cash flow to reduce debt to strengthen our balance sheet and improve our leverage ratios. We have now produced two quarters in a row of improving operating EBITDA and delivered over $174 million of operating cash flow over the first six months of this year.

Our EBITDA margins are improving significantly, both quarter to quarter, and year-over-year, and we see further opportunity to improve.

So in closing, let me just say that we like the positioning of the business today. And I know we need to grow the business and drive shareholder value. And we are focused on execution each and every day. I want to thank all of our dedicated and hard-working employees, who are making it happen. Thank you.

We would now like to open the call to your questions. Operator?

(Operator Instructions). Sandy Burns, Sterne Agee.

I'm just wondering if you could remind us, I guess the relationship with the major soft drink companies, given that Pepsi is now buying back in their bottlers, does that really change anything in terms of your relationship, created a new opportunities or issues that you see?

PepsiCo has for a long time centralized their purchasing organization for the bottlers as well. Our relationship will continue to be with the purchasing organization and with the ship to location. So I think it will remain pretty much the same. We will certainly work with PepsiCo as they work their integration synergy targets. It is unknown to us yet and probably to them to some extent if there is going to be any change to the bottlers network. But it shouldn't materially change our relationship with them or our financials associated with PepsiCo.

Great. Just a a second question on the Black Liquor proceeds, you mentioned that you would look at it at about $10 million a month. Yet in the second quarter you had accrued for about $55 million. Is that just more because -- is the $55 million, given the higher number, just because of seasonality or is it $10 million just trying to be conservative for the time being?

If you remember in the second quarter that was more than just the second quarter period. I think we started generating Black Liquor credits in January, and so second quarter was a reflection of what we have accumulated year-to-date through that period.

I see. Okay, great. Thanks and good quarter.

Roger Spitz, Banc of America.

Was the Q2 '09 SG&A high because it included that $34.4 million of cost reductions?

That's correct.

Does the other income of $71.8 million, does that include that $52 million of black liquor tax?

That's correct. We made a management decision to include it in other income and not disrupt gross margins.

Fair enough. That other income number is still fairly high, is there something else in there between the $72 million and the $52 million?

Yes, there are some proceeds of some really -- really some insignificant assets in there as well that is pushing that number up. And there is some -- there is also some interest.

Last question. Are you making the $20 million redemption on the 8.5 senior notes '11 pursuant to the -- under the credit agreement pursuant to the limitation of payments under Section 8.13?

Yes. Yes, we are. The $20 million I think it mirrors our basket.

That is our basket.

Thank you very much.

Bill Hoffmann, RBC Capital Markets.

Dave, I wonder if you could talk a little bit about some of this interactive business? I am kind of interested that you said you had some placements with InBev, and I just wonder in international markets, what kind of EBITDA margins you get out of that business, and whether you see more opportunity there?

As you know, our international business is primarily beverage. We don't have a large consumer products business. So when I talk about machine placements it is because our focus is really on expanding the beverage business.

Our EBITDA margins in Europe are not materially different than what we get in the United States, but of course there is a higher working capital component, because we make our [board] here and then ship it to Europe, so you've got the transition costs and so on and so forth.

We have struggled in the past in Europe. In the last couple of years we have really made a concerted effort in that business and you can see some of the financial results. I think Dan mentioned, that of course we had a foreign exchange change this year, but that is not a reflection of the actual business, more just the economic conditions.

So we continue to see growth in international business. We signed a joint venture in China last year. That is very much focused on beverage. Our Japan business continues to be -- in fact, they had an extremely solid quarter. So is still a small part of our overall business, but I like very much the trends in that business.

I just wonder with some of the new product growth, let's say $20 million for the most recent quarter, what -- is the international one of the outlets that you see providing you some more opportunity in other regions, even going sort of more Latin America, etc.?

The new product business was a split actually between beverage and food. And some of that new product growth actually was in Latin America, and also in the Caribbean. Some work we have done in baskets, for example, in Jamaica and in Dominican Republic. So, yes, it is a fair split on that.

A lot of the consumer-based products, however, in the United States, they don't necessarily translate quite as well into Europe, for example. The US distribution system, their network is much different. So we can take advantage of [sus] or replacing corrugated here in the United States, but as you well know in Europe that distribution network is materially different.

Microwave is a global product. I mentioned in my notes we have had some new success in Spain and France on microwave. Our Japanese team has created a microwave product for cooking noodles. So you sort of see those kinds of expansions.

$20 million a quarter from a dollar standpoint, not significant, but as I said in the past, those products tend to carry much higher margins, so it acts like a bigger business than it really is relative to the financial results.

Thanks. Just a final question. You also talked about a lot of conversation about your debt reduction and upping the targets, etc. What kind of total debt number are you looking at as a target? You obviously have been able to operate with higher leverage than most of these other companies we follow. At what point do you start to turn more to pushing growth again?

We have a target -- we actually clarify our target in form of a leverage ratio. It is 3 to 3.5 times is our target range for debt. So as we increase EBITDA, as we reduce debt, we are going to start to hit that ratio. And at that point we have different decisions to make in terms of how we use our cash.

Thank you very much.

I guess the only caveat I would say is I don't know that those are mutually exclusive. The question was a two-part question, which is debt reduction with the implication of growth. I would say that that is -- we can grow and still reduce our debt. I think the hard thing to look at right now is the economic impact has a deleterious effect on volumes. But that is not really an impact -- I don't believe that is a harbinger of future growth options, it is just the economic impact.

But we are going to be able to continue to invest and grow in our business and still meet our debt reduction targets. I think we said -- a year and a half ago we built a brand-new facility in Portsmouth, Arkansas to make our Z-Flute cartons. And quite frankly that facility right now is operating five days a week. So we have continued to make capital investments where the growth makes sense and still pay our debt. So I just want to be clear that it is not -- we don't see it as an either/or scenario.

I was more focused on more significant sort of bolt-on type acquisition type opportunities, especially now that you guys are challenged.

I think right now we are 100% of goal on acquisitions stuff. So it is an interesting market. I am not saying we wouldn't ever look at every anything, but right now we are very much focused on that excess cash flow to reduce debt, get our leverage ratios back in areas that make more sense for us long term.

(Operator Instructions). Joseph Stivaletti, Goldman Sachs.

I was just wondering if you could talk a little bit about more about the deflation, the cost deflation? I think you saw, if I remember right, about $240 million of cost inflation in '08. I wondered if underlying your assumptions for the full year what you are thinking you might see for the full year in terms of deflation? It seems like you haven't benefited enormously from that so far.

I don't know whether I would give a target for the note, but I think what I would say is that the expanded EBITDA margins clearly are translating from the arbitrage between higher pricing and lower input costs. I think our margins have gone -- what -- 12.3% to 14.7%. So a portion -- a good portion of that is really the lower input costs year-on-year. So I would say that we are benefiting from the lower input costs year-on-year.

I think if you move forward to a third quarter -- if you look at 2008 when did we start suffering from a lot of the inflation? It was in the second half of the year. So if you look forward to the third quarter, you're going to see a much bigger delta in terms of inflation in our numbers on a year-over-year basis. Through the second quarter -- and with our 2 to 3 month lag, you didn't see the significant impact from inflation in the 2008 numbers. You saw it in the second half of the year and you saw it in the first quarter of 2009.

I was referring to that $8 million that you were saying was still in --.

The $8 million has a lot to do with the pension plan. You're aware of what has happened in terms of pension assets. And a lot of that extra expense is the partial recovery, because we have to expense more because we have to recover in terms of the market value of the assets.

The other question I had was just trying, as we look out to the rest of the year, trying to understand how much more in terms of synergies and benefits from your continuous improvement program we should be thinking about versus what was actually reported in your second quarter.

I think our second quarter rate on synergy was around $25 million, which is the highest quarter that we have had. And as we look forward, you will see some incremental improvement in that, but I would think that that is really pretty much what we would expect to see. So you would sort of see $50 million -- the second half of the year you would expect to see $50 million of synergy contribution -- net synergy contribution.

On a year-over-year basis?

Yes, on a year-over-year basis.

That is -- if you sort of do -- I think we started the year, we said we get about $90 million, so if you do that -- you do the quarters on $25 million, we are certainly in that $100 million range.

I think in some ways, we have exceeded our synergy targets in the first years. Most of that is because of the execution in the process. And so what I would say is that I will probably do less talking about synergies and more just to give direction on cost -- net cost reductions, so you can have a better feel for what the business is really performing.

So we will continue to look at that net improvement. But yes, annually we average about $50 million to $60 million a year on our cost improvement targets traditionally. And I see no slowing down in that effort as well.

Right. So the synergy part, the $25 million in the second quarter year-over-year, I understand that, and that will continue through the rest of the year. The continuous improvement was a separate, roughly like you say, $50 million to $60 million a year. Where are you through the first half? Is also the second quarter reflective of the run rate or will it bump up from second quarter levels?

Year-to-date in the continuous improvement, so that include our lean and Six Sigma stuff, we are at $25 million through the -- and actually second quarter was slightly higher than first, so the ramp up sort of $10 million. I think we reported in the first quarter $10 million or $11 million, and this year -- this quarter, $14 million on an ongoing basis, so that gets you to the $25 million. And I don't see any reason why third quarter won't be a similar number.

Right. So $50 million to $60 million for the year.

Yes, exactly. We are definitely on that -- definitely on that case.

And that has been -- as you well know, historically we have been on a combined basis between Altivity and Graphic that is sort of the run rate.

Right. Okay. All right, great, thank you.

[Richard Cass], Jefferies.

Can you remind us of your natural gas hedging activities for both the second half of this year and then the next year?

We are just over 70% hedged for 2009, and that is at around a $9 rate. So our overall natural gas costs are going to be somewhat south of $9. Somewhere between -- maybe around $8 when you consider the effect. We are buying it at $3.50 on the spot market.

For 2010 we are 20% hedged somewhere around the $6 rate. We are currently evaluating our hedge activity for 2010. But as we said in the script, we expect a significant savings on natural gas in 2010 based on where the spot market is currently.

Great. Then I know OCC costs have come up considerably more than the $15 a ton that you guys are talking about. Can you talk a little bit about the differences and what price you pay versus where the spot market is?

I'm not going to give individual prices on OCC for what we pay versus others. But I would suggest, and you know our OCC is an arbitrage number, because it depends upon geographically where you're located. The Midwest, where our three big recycle mills are in Battle Creek, Middletown and Kalamazoo, are in a very good basket. As you know, the Chicago or Midwest basket for OCC is good. And the freight rate -- the freight, which is a big part of that as well, is much lower.

So I -- we will pay a market rate for OCC. And as Dan and I said, I expect it to go up a little bit in the second quarter. I am sorry -- in the third quarter.

Fair enough. Thanks guys.

Jeff Harlib, Barclays Capital.

Just the $34 million charge, can you just talk about what that related to, what actions? I thought most of the Altivity charges had been taken already.

Well, we had a lot of activity in the second quarter in particular. Some of our initiatives were in regards to spare parts inventory and consolidation of that and taking some of those benefits. I think overall we will see the benefits of that resulting in lower cost of spare parts as we consolidate to buy, as well as us being able to operate with lower net inventories.

In regards to the $34 million, $20 million of that, there is really nonrecurring charges for the write-down of assets. And the remaining is ongoing synergy activity in terms of moving machinery around, severance benefits, IT training and those types of things that we have incurred in the integration.

So I think the key is how close are we to completing these nonrecurring charges that are appearing in the P&L? I think $34 million in the quarter -- second quarter, is going to be the highest we are going to see this year. And based on our activity, if we look forward, we are expecting to have maybe around $20 million for the remainder of the year in terms of nonrecurring charges. And then our current plan is that that will be the -- that we will discontinue the practice of adding those back in 2010, even though we might have some straggling activity going on at that point as well.

I mean a lot of it is related to the plant closures. We have accelerated, as I said in my part of the script, some of the plant closure up to the first part of the year -- up to this part of year that we will had planned later. In fact, some of them were in 2010. And as you start -- as you do plant closures there are some cash and write-offs associated with that process. But most of those things are behind us at this point in time.

That does not mean that we won't continue to evaluate our footprint -- our converting footprint. I think that is less of a century or integration effort than it is simply to say, look, we are operating a lot more efficiently than we thought we were. If you looked at the throughput on our mills, and you looked at the converting metrics, we don't -- we haven't needed all the assets that we thought we would need in the integration activities because of the throughput. And therefore we will continue to evaluate those high-cost plants.

But as Dan said, I think that is going to be more ongoing, continuous improvement objectives which we have done year in and year out. And that is the way we will probably try to characterize those as opposed to getting them confused into integration or synergy. I think it gives you a better picture.

Okay, that's fine. So the $20 million write-down, was that more just excess assets or was it spare parts inventory? I didn't catch that?

It was a combination of both. It is excess assets and excess spare parts inventory as we consolidated the buy.

Okay, fine. What was the downtime you said you took? You said you took medium and then you took some other downtime. What types -- what mill was that or what types of products?

We have a very small uncoated mill in Pekin, Illinois. And we took downtime in that because the uncoated market is struggling, and we had not fully integrated our own purchases from that mill. Now subsequent to second quarter we have been able to do that. But the impact on EBITDA from paper machine number one and the uncoated was deminimis, quite frankly in the process.

The key for us in watching downtime, as you well know, is watching our sus and TRB mills, which we took no market-related downtime in. I will tell you, we will continue to manage inventory and cash flow, so if the markets don't do what -- we will take downtime in those mills, but right now we need to operate the mills to fill our carton demand.

Where do you stand under your multiyear contracts, your beverage contracts? I know you renewed them a few years ago. When do they mature, and any discussions on renewals?

They expire over a number of years. I won't go into individual contracts, but we are in negotiation on some customer contracts almost continuously in beverage or in consumer products businesses. Even if they don't expire until the end of 2010 or' 11 we start talking about them. So that seems to be like an ongoing plan. But I am not going to talk about individual customer negotiations.

But it is safe to say though there aren't a whole slew of major contracts expiring this year that you need to renew or --?

No, there is not a whole bunch expiring in 2009. There are some that expire in '10 and some in '11. There are some that we have renegotiated already in 2009, but I don't have the complete customer list of expiring contracts.

Then just any additional color on food and consumer, which is tracking a little weaker than beverage. Is that just the market? Any color on that and if you have seen any improvement?

Well, the -- if you -- it is interesting, because our food and beverage -- our food business that is tied to what you would consider center of the aisle stuff, so dried food and frozen, that is really us. But we have a portion of our food business that is really tied to things like food service or quick service restaurants. And some of that business has really been very, very soft, because it relies on people eating away from home.

So in the mix we are down about 1.5%. But in what you would think about what is consumed at a -- in an Albertsons or a Wal-Mart or a Kroger or a Publix, that has been -- that is doing really well. In fact, I was in Centralia, Illinois not too long ago, and I will tell you that we have been running a press down there since January making macaroni and cheese, seven days a week, and we are not caught up. So what I would say is those kinds of products continue to sell very, very well in this economy.

There appear to be no further questions at this time. Are there any further remarks?

Operator, thank you very much. We will wrap up this morning's call. Thank you.

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation. You may now disconnect.