Graphic Packaging Holding Co (GPK) 2011 Q2 法說會逐字稿

Good morning. My name is Chassidy, and I will be your conference operator. At this time, I would like to welcome everyone to the Graphic Packaging's Second Quarter 2011 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions) As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, July 28, 2011.

Thank you. I would now like to introduce Brad Ankerholz, Vice President and Treasurer. Mr. Ankerholz, you may begin your conference.

Thanks, Chassidy, and good morning to everybody and thanks for dialing into our second quarter Graphic Packaging Holding Company conference call. Commenting on results this morning are David Scheible, the Company's President and CEO and Dan Blount, our Senior Vice President and CFO.

To help you follow along with today's call, we have provided a slide presentation, which can be accessed by clicking on the Q2 Earnings Webcast link on our Investor Relations section of our website, which is graphicpkg.com.

I would 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 relating to recovery of raw material inflation costs, consumer demand and pricing trends, capital expenditures, cash pension contributions and pension expense, depreciation and amortization, interest expense, debt and leverage reduction, performance improvements and cost reduction initiatives, including those related to Sierra Pacific, acquisition and the closure of facilities, 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, cutbacks in consumer spending that could affect demand for the Company's products, continuing pressure for low-cost products and the Company's ability to implement its business strategies, including productivity initiatives and cost reduction plans. 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.

David, I will turn it over to you now.

Thanks, Brad. We're pleased with our second quarter results and our ability to drive significant improvement in earnings in what continues to be a challenging operating environment. Adjusted earnings per share more than doubled to $0.09 with improved EBITDA and lower cash interest cost.

Net cash from operations was $118 million year-to-date. Overall, volume across our end markets in the paperboard industry remains under pressure, particularly in May, as a near record high gas prices and continued high blue-collar unemployment hurt consumer spending in the middle of the quarter. Our business performed in line with expectations despite the challenging economic environment. Sales increased 4.3% as a result of higher pricing from our contract reset mechanisms and board price increases, as we recovered input cost inflation from the second half of 2010. This combined with performance improvements and cost reductions more than offset recent inflationary pressures and led to improved margins.

Our strategy remains focused on driving cash flows to pay down debt and we managed converting downtime in inventories in the quarter to do exactly that. As a result, we remain comfortable with our full-year net debt reduction from operations target of $200 million to $220 million. Debt reduction remains a key objective for us, but we are continuing to make strategic investments in the business as well.

We made significant progress this quarter at our previously announced Perry, Georgia carton facility expansion. This $30 million expansion includes a new 67-inch high-speed flexo press, new cutters and state-of-the-art inline gluers to make six-pack basket cartons for our beverage business. Additionally, we will capitalize on its proximity to the Macon, Georgia CUK mill to create a very low-cost supply chain. This expansion will be online in Q3 and when completed, we will convert almost 275,000 tons of paperboard in this facility.

We remain on schedule with our $80 million biomass project in the Macon mill. This project will significantly reduce the mill's energy cost and eliminate dependency on fossil fuel alternatives. We will be in a position in 2013 to sell green power back to the grid.

Finally, we closed the Sierra Pacific acquisition on April 29. I'm pleased to report the integration is on plan and we continue to target initial synergies at the upper end of our $2 million to $4 million guidance. Craft beer remains one of the strongest elements of the beer market and through the Sierra Pacific acquisition, we are well positioned to capture sales in this important sector. The acquisition provided us with a strategic location to service both our beverage and consumer products customers on the West Coast by leveraging the proximity of our Santa Clara, California recycled board mill.

Looking a little bit at our second quarter results from paperboard, our mill had another strong quarter performing above plan due to improved initiatives in productivity, energy and fixed cost reduction. Tons per day increased nearly 1% and we generated over $8 million in cost savings from our continuous improvement efforts at the mills.

Volume in our folding carton segment decreased about 2.9% in the quarter. This was slightly better than the broader market, which was down approximately 4% according to Paperboard Packaging Council. A very wet and cold spring, high gasoline prices, rising food and commodity cost, and continued high unemployment negatively impacted demand for consumer goods and as a result, folding cartons. The US consumer is facing some difficult budgetary decisions and that has translated into lower volume even in core staples.

PPC reported industry shipments declined approximately 3% in April, 7% in May and 2% in June. May was really the toughest month of the quarter for us as well, but volumes began to pick up in June. We have seen that trend continue in July, but honestly I've sort of given up forecasting demand trends at this point in time.

Some of the particularly hard hit food categories over the past three months according to A.C. Nielsen were areas that we consider pantry staples. Frozen pizza was down about 7%, even dry cereal was down 4%, and dry baking mixes down about 6%.

Trends in the canned beverage markets were down in the second quarter as well. The can beer volumes across the industry remained somewhat sluggish throughout the quarter, down approximately 2% according to the Can Manufacturers Institute. Can soft drink volumes across the industry were down nearly 7% for the quarter, but much of this negative year-on-year comparison is due to the spike in volume last year with the Wal-Mart promotion. This special promotion was not renewed this summer and we have seen a more normalized volume trend in that space.

Our total beer business outperformed the industry benefiting from continued strength in the craft beer market and its increased share with a few customers. Trends on our international beverage business remained positive in the second quarter. Strong adoption of multi-pack containers in China continues to be a positive driver for new machine placements in this market.

Also on a positive note, favorable product and customer mix has helped to mitigate the impact of softer demand, in particular, our efforts to further innovate our mill production are allowing us to substitute open-market board sales with some higher-value folding carton sales improving the mix.

Turning to our flexible packaging business, the operating environment is even more challenging than paperboard with the reconstruction in housing markets as a base. It's pretty clear the trends in these end use segments may not improve for some time. Quarter-over-quarter volumes in our flexible packaging segment improved modestly on a sequential basis, but were down nearly 4% versus the prior year quarter.

Higher pricing from the recovery of paper and resin more than offset the volume decline and drove sales increase of about 3% over the prior year period. We expect additional price increases as we move into the second half of the year with contractual recovery, but I believe we still will be fighting demand issues the rest of 2011 in this space.

Despite the difficult retail environment, our customers continued to introduce new product offering to drive sales and reduce cost. Our new product sales grew over 10% compared to the second quarter of 2010, and we were successful in new machine placements globally.

Our microwave business had a strong second quarter of commercialized launches in North America and abroad. ConAgra launched a 16-once Marie Callender pie utilizing our microwave susceptibles, which reduces cook time by nearly 30%. We continue to see strong interest in our patented line of microwave products and believe this technology has significant growth potential. Internationally, our susceptor disks were recently adopted by a French producer of chilled pizza slices and a Japanese premium microwavable fish offering by Tokan Kogyo.

Our barrier packaging portfolio continues to grow with our customer adoption of new and patented structures that create lower cost and increase consumer convenience. C&H Sugar is utilizing our woven polypropylene structure. This unique package uses a paper laminated outside to deliver the same print quality as a coated paper structure with higher structural integrity. The fresh fish first service line grew with the launch of a takeout container produced with an inside barrier for coating for Panda Express.

Bunzl Distribution, a St. Louis, Missouri based supplier of paper and food packaging supplies, became the first customer to commercialize our DesignerWare technology. They will use DesignerWare in a tray format for use in their Amtrak food service business. The tray provides improved branding capabilities and utilizes 47% less plastic than a similarly sized CPET tray.

Let's talk about pricing, inflation. Clearly in this environment, pricing, inflation are our core critical metrics. We saw a significant increase in pricing both on a year-over-year basis and a sequential basis in the quarter. Pricing increased $36 million in the second quarter compared to a $24 million increase in the first quarter. This was driven by the pricing reset mechanisms in our contracts that adjust prices up or down based on changes in inflationary costs on approximately a nine-month lag. We expect pricing to remain positive throughout the remainder of 2011.

Total cost inflation was nearly $44 million for the quarter, and about a third of that was due to higher-priced, externally purchased board and paper. Our customer contracts allow for relatively quick recovery of increases in externally purchased board and we expect significant recovery of these prices the remainder of 2011. Other input cost that saw increases on a year-over-year basis in the quarter included secondary fiber, chemicals, particularly TiO2 latexes and modestly freight. Dan will discuss the individual components of inflation in more detail during his call.

In the second quarter, we implemented price increases of $45 per ton per CUK and $40 per CRB. When comparing second quarter 2011 against second quarter 2010, [PPW] reports that average transaction prices were $165 per ton higher per CUK and roughly $90 per ton higher per CRB. We expect to see further benefits from open-market board pricing in upcoming quarters.

Our outlook for 2011 remains unchanged. We continue to target net reduction of $200 million to $220 million from operations. Pricing should remain positive through the end of the year. We are comfortable with our cost reduction initiatives to fully realize savings of approximately $80 million.

Volumes across the folding carton sector returned to more normalized levels in June and July, and we expect new product launches and market share gains, international expansion to accelerate the business in the second half of the year.

With that, I'll turn the call over to Dan for a more detailed discussion of our financial results.

Thanks, David, and good morning everyone. David covered the operational highlights of the quarter. I'll focus on financial results. My comments follow the flow of our posted presentation and for those of you following along, I'm picking up with page 9.

Overall, second quarter performance was in line with our expectations, and we continue to track to the full-year guidance we highlighted last quarter. Most notably, we are forecasting total net debt reduction to be in the $350 million to $370 million range. This range includes the $150 million in debt reduction that resulted from the follow-on equity offering.

Starting with our financial highlights, we see continuation of positive performance trends. Revenues, driven by price increases across all business segments, increased 4.3%. Adjusted net income for the second quarter improved 135% to $34.6 million from $14.7 million a year ago. This results in an improvement of $0.05 per share. Adjusted EBITDA for the quarter improved to $150 million versus $145 million in the prior year.

Now, please note that the adjustments to net income and EBITDA that I just referenced exclude non-recurring charges related to acquisitions and early extinguishment of debt. There are no other adjustments. This morning's earnings release includes a detailed reconciliation of the adjustments. When I refer to financial measures this morning, I am referring to measures, including these adjustments.

Now, moving to net income, we see a sizable increase driven by three categories. First, an $8.6 million increase in operating income, as price improved and we continued to drive cost reduction. Second, an $8.4 million or nearly 19% decrease in interest expense, as our debt levels continued to decline and we benefited from last year's bond refinancing that lowered our effective interest rate. And lastly, lower income tax expense of $2.8 million, as we utilize the NOL and reduced other tax charges.

Moving to revenue on slide 10, we see that net sales grew by $44 million or 4.3%. As expected, price benefited the quarter by adding nearly $36 million to the topline. The improvement was principally driven by contractual inflation recovery on our converted products, coupled with higher open-market board pricing. As we have discussed previously, our customer supply agreements include look-back inflation recovery mechanisms. As a result, over the next three quarters, we expect price recovery of current input cost inflation to continue. We will talk more about price cost timing later when we review inflation.

Turning to volume mix, we saw a modest $4.3 million decline for the quarter. Overall, we are pleased with our volume performance, given the challenges in our key markets that David discussed. The majority of the volume mix decline was in our flexible packaging segment where volumes continued to lag in construction end markets. Volume mix in our paperboard packaging segment was consistent with prior year levels. Foreign exchange contributed $12.7 million to the topline, as we benefited from stronger Japanese, Australian and European currencies.

Now, to summarize net sales by segment, paperboard packaging net sales were up 4.5%, principally due to higher pricing. In flexible packaging, volumes continued to lag in the industrial and construction sectors, however, sales increased 2.8% as we continue to recover paper and resin inflation.

Turning to slide 11, we see that EBITDA improved $5 million or 3.4%. Second quarter EBITDA does include a couple special charges that I would like to walk you through. First, we recorded $1.2 million of an estimated totaled $2 million charge related to closing the Cincinnati converting operation. We expect to incur the remainder of the shutdown charge in the third quarter. As you recall, we announced the closing of this facility earlier this year. Benefits from the closing include moving production to more efficient plants, reducing overhead and lowering working capital levels.

Second, we incurred $6 million of charges as we took downtime in several converting plants to reduce inventory levels. We came into the quarter with more inventory than was needed due to adverse weather and lagging demand experienced in Q1. The downtime was the appropriate action to take as it successfully reduced working capital levels and allowed us to maximize cash generation in the quarter.

Based on our forecast of business volume, we do not expect further market-related downtime in our converting plants for the rest of the year. However, if business conditions dictate, we will take downtime to probably manage working capital and maximize cash flow. It is important to note, however, that no downtime was taken or is anticipated in our paper mills. The risk of mill downtime is substantially mitigated as we are a net purchaser of board, and demand for internally produced product is significantly greater than production capacity.

Now, looking at Q2 operating performance, excluding the impact of the special charges, we see that $36 million of improved pricing and $19 million of performance improvement offset $44 million of inflation. Since our contractual inflation recovery, like I said, is based on look-back calculations, the timing of price increases to recover input cost inflation is only matched when the inflation rate is consistent from year-to-year.

Since 2011's inflation rate is above 2010's level, additional recovery of 2011 input cost inflation will occur in 2012. Overall, year-to-date commodity inflation has averaged just above 5% with the main drivers being the well-publicized double-digit increases from purchased paper, resin and secondary fiber. Additionally, we have seen recent significant increases in the cost of key coatings, such as titanium dioxide, latex and starch. While inflation is difficult to forecast, we expect inflation headwinds to continue for the remainder of the year and price recovery to continue into 2012.

Moving to performance. Our continuous improvement and other performance initiatives delivered a $19 million benefit in the quarter. The largest contributions came from our mills and our paperboard converting operations. In the mills, capital investment and process improvement continue to drive improvement in operating efficiency, waste reduction and energy usage. As a result of throughput improvement, the mills produced nearly 6,000 more tons in this quarter.

In the converting plants, we continued to optimize manufacturing by consolidating production into our most productive facilities and investing in more efficient assets. The plant closings in Ohio and Arkansas we previously announced are nearly complete and we expect to see cost reduction benefits from these actions beginning next quarter. We are clearly on track to achieve the $80 million performance improvement target we previously communicated.

Now, let's turn to cash flow, debt and liquidity on slide 12. As a result of improved operating performance and reduced cash interest cost, year-to-date net cash provided by operations improved $20 million over the prior year to $117.6 million. Year-to-date capital spending at $70.8 million is in line with our expectations, and our full-year capital expenditure target remains unchanged. As a reminder, 2011 capital spending is expected to be approximately $50 million greater than 2010.

We are making incremental investments to place new packaging machines at customer locations in Asia, Europe and North America. The greatest growth is expected to be in Asia. These machine placements not only drive volume growth, but produce lease revenue as well. Additionally, we are investing in two high-return projects, Macon biomass for a low-cost energy generation, and Perry, Georgia converting plant expansion to consolidate production from closed facilities.

Net debt has been reduced by $190 million year-to-date, $150 million from the equity offering and $40 million from operating cash flows. Our net leverage ratio has improved to 3.9 times and we remain clearly on track to further reduce debt by an additional $160 million to $180 million by year-end.

Our liquidity remains strong with no cash borrowings under our $400 million revolver and $191 million of cash on the balance sheet. Please note that a portion of this cash will be used to fully retire the $73 million principal amount outstanding under our 9.5% subordinated notes due 2013. The call of these notes was issued this month and will become effective on August 15.

And as you probably saw, our continued focus on leverage reduction has been positively noted by the credit rating agencies, with both S&P and Moody's upgrading our credit ratings. S&P gave us a one-notch ratings increase to BB with a positive outlook, while Moody's increased our rating from B1 to BA3 with a stable outlook. The improved ratings along with a continued reduction in debt levels provide Graphic Packaging with a stronger credit profile as we work to refinance our senior secured debt over the next few months.

And finally, moving to slide 13, I will summarize our guidance for 2011. As a result of the equity offering and further debt reduction expected this year, our net leverage ratio should end the year below 3.5 times. We also have updated several other components of our guidance from last quarter's call. Capital expenditures will be in the $170 million range. Cash pension contributions will be between $50 million and $70 million. Our pension expense runs around $27 million, depreciation and amortization in the $285 million range, interest expense of $145 million to $155 million, and net debt reduction from operations in the $200 million to $220 million range.

Now with that, I will turn the call back to the operator for questions.

(Operator Instructions) Ghansham Panjabi, Baird.

Can you hear me?

Yes, good morning.

David, encouraging 3Q commentary at least so far in July. Can you remind us how relevant July is for the quarter typically for 3Q? And then also which end markets are showing improvement?

Well, as I said in my prepared comments, I've sort of gotten out of the forecasting business from that process. July, August and September, I don't know that one's more relevant [than] other. You've got different holidays in the process. Third quarter tends to be back to school and beverage markets and so they tend to be our strongest overall quarter of the four quarters from a sales standpoint. And right now, what I would say is we're seeing good -- better trends in food, beverages improved slightly. So we remain upbeat about the quarter, but it's a long way to go.

Okay, and then just finally looking at our dataset CUK versus SBS, I think this is the narrowest price spread since July of '08. Is that something to be concerned about from a substitution standpoint?

Well, the substitution -- I mean, so the separation rate is still pretty high based on a historical basis. We're still significantly below traditionally. And historically, our separation between SBS, CRB -- I'm sorry, SBS -- SUS and CRB has really averaged around $35 a ton and we're certainly not within $35 a ton of SBS pricing at this point.

Okay. Thanks.

Philip Ng, Jefferies.

Hey, morning guys.

Good morning.

I'm just trying to get a better handle on pricing and inflation, how I should be thinking about it going forward? If I look at the run rate for pricing, it looks certainly picked up at $36 million run rate for 2Q. Should we expect [its layer] higher over the course of the year or is this pretty much where I should be thinking going forward?

I think what you need to think about, if you look at our pricing then that we're based on look-back calculations.

Sure.

If you saw we had input cost inflation of about $100 million in 2010.

Okay.

Okay. And I think you can use that as your guide into how much inflation we should recover in pricing in 2011.

Okay, that's helpful. And then in terms of inflation, I think the last time we chatted on the call, I mean, was comps being a little more easier, I guess, because you saw a pretty sizable inflation. Stock prices was [pretty] trying to come down a bit on a year-on-year basis. But certainly, it does look like things picked up a bit. Is that $44 million run rate, how we should be thinking about it going forward? Or how should I be thinking about that?

Well, I think you have to sort of look for on our inflation, on the waterfalls that we gave you, you sort of have to look at the arbitrage between price, inflation and performance, right? Because performance includes not only performance in the mill, but it includes purchasing improvements and those kinds of things. So I think you have to look at all three of those. So if you look at all three of those arbitrages, what I would say is we would continue to expect to see modest improvement in our margins between a combination of price, the inflation we have to do and performance for the rest of the year.

Okay. That's helpful.

The primary drivers of inflation are going to be OCC and chemicals. I think the external board prices, which I think were something like 40% of our input inflation this quarter year-on-year, was really from external purchased board. And those are rolling off of increases from last year. You can see much more modest increases in that area because there's been not very many announcements. The TiO2 and those kinds of latex chemicals, they continue to go up year-on-year, right?

Okay. And if I remember correctly, you guys were talking about energy surcharges, and freight has certainly continued to trend a bit higher. Have you guys been able to implement that into your quarter and for the back half?

Honestly, I've been pretty pleasantly surprised -- or pretty pleasantly looking at freight because we have done a pretty good job in the last year actually of getting more and more of our freight passed on to our customers, and so it's becoming less and less of an impact. We were able to get fuel surcharges recovered in the third quarter, but the more important process really was to get out of the freight business. And over a number of our customers, we're simply exiting the external freight business.

The internal freight is predominantly going to be impacted by virtue of the plant consolidations. As Dan said, by consolidating our Cincinnati facility, we move 80,000 or 90,000 tons of board into that facility that will now be made directly in the converting plant that's on-site with the mill. So the internal freight will essentially evaporate because there is no freight. So as I go forward on freight, I feel better about our projections on freight even though, of course, as you say, there's fuel surcharges and freight coming, additional.

Okay. Thanks guys.

Ian Zaffino, Oppenheimer.

Hi, great, thank you. The $19 million you talked about in cost savings, how much of that -- can you -- as you look into, let's just say, 2012, because I know you gave a number for this year. As you look into 2012, the $19 million, how much of that is really repeatable on a quarterly basis next year? And how much isn't or can we look at kind of $19 million a quarter and kind of model that for the next six quarters or so?

Well, I think what -- I mean -- that may be abridged too far for me to sort of figure out the modeling process. But here's what I would tell you is that we've averaged somewhere around $70 million worth of performance reductions for -- really since the -- if you net out synergies from the Altivity merger. We've made -- as Dan said, we've made significant investments in Perry and in Macon. And those things will start to roll through next year because the facilities, I mean, we don't even start the Perry facility until late part of Q3.

So as I'm looking forward, I believe $70 million a year of sort of performance, overall performance reductions, sort of targets, is a good target for us. And that's sort of been our internal numbers. We've given that guidance and this year looks to me that we're going to be within that area -- within that range.

And just to add to that, Ian, the Macon biomass. I mean, that doesn't come online until 2013. So we're putting an investment today and the return on that is very significant. And that will be second half of '13 where you'll see some of it, but most it will come in '14 onwards.

Okay. All right. Thank you very much, guys.

Sure.

Joe Stivaletti, Goldman Sachs.

The only question I had left was just wondering if you could talk a little bit more about your Sierra Pacific acquisition, how that's going, and if you could tell us what the EBITDA contribution from that business was in the quarter?

Yes. Well, there's two separate questions. The one, Joe, is that the answer is it's been a good acquisition for us already that the craft beer sector in the United States in the quarter was up almost 15%. And Sierra Pacific has the largest share of that craft beer sector. So it was a positive to our overall beverage results. We're integrating those sales and margins into our business, so we aren't really breaking out. We're not running Sierra Pacific as a stand-alone. That business has got both consumer products and it has beverage, and we've already sort of bifurcated that into those business units. So we won't be reporting, as you would, a large acquisition. It's a bolt-on, layered in. It'll just be -- it'll be rolled into the overall results.

I think Dan did report that our synergy targets were $2 million to $4 million. What I would tell you is that we've been pleasantly surprised with what we've seen there and we're certainly going to be in the upper end of those, but again they'll be rolled back through the individual business units. You saw more inventory because we rolled their inventory. Some of the inflation is higher because they had inflation themselves. So the reality is that you're seeing that across the board. We'll manage that as an ongoing part of our business.

Great. Thank you.

George Staphos, Bank of America.

Hi, Dave. Hi, Dan. Good morning.

Good morning.

Good morning.

Apologies, I jumped on late, busy day today with earnings and maybe you already discussed this, I apologize. I guess the first question I had, taking a step back, Dave, as you consider your customers and what they're seeing ultimately from the consumer, is your sense that over the first six months of the year that ultimately the consumers have been retrenching or your customers have been keeping their inventories lower than normal because they're not certain with the way things will play out in Washington and from a macroeconomic point of view? How do you see it at this juncture?

It depends. It's a combination of both. But clearly, if you look in the stores, you'll see some of that, less SKUs than were available a year ago, right? So our customers are trying to reduce, in some cases, the number of offerings to be able to meet a lower consumer trend. It doesn't mean we haven't seen some new product launches, however, and so -- they're very, very focused. Promotional activity is down. We talked about the -- the biggest change year-on-year is the Wal-Mart promotion.

Last year, during this period, we saw [almost crazy fools] trying to get fridge pack and 24 packs into the stores for the Wal-Mart promotion. And this year, we didn't see that at all. So on a comp basis, it's pretty significant difference on that kind of promotional activity. So in that case, you look at the inventory flow in beverage and you look at the STRs in beer, it's a pretty tight supply chain, probably tighter than we've seen. But I don't know that that's going to change or I think we're going to continue to run pretty close higher velocity through that chain because the consumer is very difficult to figure out right now. I mean, their savings rate was up, unemployment for the people that we care about continues to creep up. We spent a lot of time talking with not only our customers, but the folks at Target and Wal-Mart, and they're all saying, "Hey, it's okay, but not great."

Right. Dave, I know you have a pretty good line of sight and it's based on history, but when we go back to productivity, if you are perhaps producing fewer SKUs in light of your, particularly the food customer side, their marketing programs over the rest of the year and it's 2012. Can that maybe make you more productive than that $70 million average longer term since you're not breaking into [year-end] as often?

What I would tell you is that a business like Graphic Packaging has tremendous operating leverage, right? So it's just because of the way the fixed cost base is in there. So we've clearly seen, as you can see in our own numbers, an acceleration in the performance element of our business. So I do believe, George, there's opportunity there. However, the downside of that is that at some point in time, you can't improve the business that you don't run.

So ultimately, we still are dependent upon a certain amount of volume improvement to continue to improve productivity. I've lost count of how many production facilities that we've taken out now since Altivity, but we've got to be close to 10 or 11 facilities and we'll continue to evaluate that same issue because what happens is we're getting very, very productive in the remaining facilities and then the ones that are on the margin, we just don't operate. And so that ends up being what squeezes out. So that also drives our performance and I expect that'll unfortunately be an ongoing contributor as you go into 2011 and '12 -- I'm sorry, into '12 unless you see a real change in the US market.

I mean it's sort of a strange situation. What I have not really seen in my -- what you have is global inflation on input cost, but you have a relatively small or slow demand in your current market. So the normal sort of drivers that you would expect to offset inflation through pricing is not really the same kind of levers that you would normally have because the inflation is driven offshore and your demand issues are onshore. And that's sort of the arbitrage that you're seeing in the business, not just in my business, but the businesses across the space.

So let me guess that you still have to keep spending at a level that you've been spending in capital dollars to keep that productivity. Because that's the only way that you can offset that inflation. Otherwise, you get margin compression.

Otherwise you got the -- yes, you run the potential. And so large, deep, but it's becoming clearly a space of large players, right? Because you need to have enough critical mass in that space to be able to make that kind of investment that you can build a Perry. I mean, Perry's a $30 million expansion with a 67-inch flexo press. And even I swallow hard when we make that investment. But it's a huge cost reduction call, but you have to have enough critical mass and balance sheet flexibility to be able to do that to drive those kind of cost out or otherwise you end up with margins. You end up with a bad margin arbitrage, which we're seeing some of that on some of the smaller -- I mean, we see every potential sale of carton business that's available and Graphic Packaging sees that. We see that book. And clearly, you see some margin pressure in that space, in the converting space, right?

Yes. Last question, I'll turn over. Dave or Dan, given what's been occurring and the potential as strange it is to think about it for the debt [filling] to not be lifted and for the US into fall, are you doing anything differently from a financial planning standpoint? And are there any issues that we should consider from a cost financing standpoint based on perhaps a pickup in government rates from here? Thanks guys. Good luck in the quarter.

Well, that's an interesting question, George. I mean, actually, we've been trying to figure it out ourselves and we've been going to advisers to help us with that question as well, because we've got a pending refinancing of our bank debt because revolver matures in May of 2013. And we look to refinance that before the revolver gets within 12 months in maturity. So basically, what we're doing is we're continuing to concentrate on what we have been doing, is to improving our credit profile and generating as much cash out of this business without skimping on investments to reduce the debt load. Because we think if we do those two things, we're going to be in just really good shape in terms of refinancing this debt.

And everything we're doing is, we're looking for the right window at which to execute the refinancing activity as well. So if we do those three things, I think we're going to be just fine. And we just concentrate on the things we're good at. The other thing is our lending is LIBOR based, and we have not seen a movement in LIBOR nor are we being advised that there is a potential movement in LIBOR based on the circumstances that are happening in the US at this point. But we'll have to wait and see.

Thanks. Good thought.

(Operator Instructions) Alex Ovshey, Goldman Sachs.

Good morning.

Good morning.

Dave, can you just talk about how you're seeing the [key spot and] demand fundamentals for your two box board grades, where are backlogs today for CRB and CUK relative to history? Where are your current utilization rates at the mills?

Yes, so as Dan said, we're a net buyer of boards, so our utilization rates obviously are pretty high because we're buying those grades that you mentioned externally as well. Our backlogs are -- they're pretty solid in both grades. So our inventories are certainly in line in those grades and I would not -- as we head into the third quarter, which is back to school and end of summer stuff, I wouldn't expect a -- I would expect the backlogs just to remain pretty tight.

Okay, that's helpful. And then you talk about your folding carton business where you have the pricing mechanism that allows you to pass through cost and that nine-month lag. How do you feel about that pricing structure, longer term in the context where it seems like we are in an accelerating inflation environment where in that scenario, that business will typically be behind the curve on passing on costs? Is there a sense of urgency to think about potentially restructuring those contracts where there's a shorter pass-through, especially given the consolidation that we've seen both on the converting side and on the mill side over the last decade in the industry?

So let me get this right. The question is would I like to get my pricing faster? The answer is yes. The fact of the matter is that if you look at where these contracts have been over the last five years, we went from five to 10-year fixed-price contracts to ones that got annual look-backs to now, the contracts are -- many of them are six month and some of them quarterly. So if you look at the acceleration of what's happening in that structure, that's been a high-priority issue for us.

But I will remind you that the guys that we're doing business with are pretty big global players. I mean, they have their own set of options. We are not without potential issues in substitution or other competitive threats, so it is a negotiation. It is not a jam down. So what I would tell you is, we made significant progress in reducing that cycle, which used to be closer to well over a year. And as we move forward, it'll be well inside of nine months. But I do not -- I would be less than honest if I told you it was going to be instantaneous price recovery for input inflation. I just don't think that's a realistic expectation.

And that's very helpful color. Maybe to use a baseball analogy, I mean, what inning are we in from the shift to where before you had these longer term five to 10-year contracts where there's limited ability to pass through, where now you at least have these pricing mechanisms that allow you to do it with a nine-month window?

Yes, so two nights ago, I went to the Braves' game and that was a 19-inning affair. So like a baseball game, what I would tell you it's variable. It will depend upon the end-use customer. It will depend materially on how we sit in an individual segment. I don't think pricing or contract negotiations ever. I mean, that process is never done. And so we've made -- what I would tell you, we've made a lot of progress. It will continue. We will continue to have that discussion, arbitrage with our customers for a long time.

Okay, great. Thanks, Dave.

Thank you. At this time, there are no further questions. Are there any closing remarks?

No. We need to get back to work and make this quarter work. Thanks very much.

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