Graphic Packaging Holding Co (GPK) 2011 Q3 法說會逐字稿

Good morning. My name is Cody, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Graphic Packaging third-quarter 2011 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions).

And I'd like to turn the call over to Brad Ankerholz, Vice President and Treasurer. Sir, you may begin.

Thank you, Cody, and good morning to everybody. Welcome to the Graphic Packaging Holding Company's third-quarter 2011 earnings call. Commenting on results this morning will be 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 Q3 Earnings Webcast link on the Investor Relations section of our website at graphicpkg.com.

I would like to remind everyone this morning 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 the 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 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 the 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. 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'll turn it over to you now.

Thanks, Brad. Good morning, everyone. We're pleased with our third-quarter results and our ability to continue to grow sales and earnings in what remains a very challenging operating environment.

We grew sales 3% and adjusted net income 40% in the third quarter, in spite of the soft demand and significantly higher input costs. Higher pricing, stronger operating performance, and cost reduction more than offset modestly lower volumes and higher input costs.

Third-quarter pricing increased by $29 million, and we generated a $17 million net benefit from ongoing cost reduction and supply chain optimization efforts. We are still tracking to approximately $70 million of cost reductions for this year, and remain comfortable with our ability to further reduce total costs through our continuous performance improvement initiatives.

A large portion of our cost savings is being driven by significant ongoing investments we are making in the business. Through the first three quarters of this year, we have spent over $108 million in capital, much of which was focused to streamline the business and reduce our long-term cost structure.

Last quarter, I talked about the over $30 million investment in our Perry, Georgia, carton facility. To further expand this state-of-the-art plant, which is now capable of converting over 275,000 tons of paperboard annually, I'm pleased to report that the new press came online in third quarter, and we have successfully transitioned volume from other higher-cost facilities into the expanded Perry plant.

The integration of the Sierra Pacific acquisition, our new West Coast facility, is progressing well, and we're pleased with its performance. The new facility further optimized our manufacturing footprint by providing a strategic location in Northern California to service our West Coast customer, and leverages our Santa Clara, California, recycled board mill. This acquisition has reduced our cycle time, lowered our transportation costs, and better aligned volumes within geographies.

With the added flexibility of this new West Coast facility, along with the delay in the recovery of our end markets, we made the decision to close our La Porte, Indiana, web plant and consolidate the remaining volume into our Northern California and our other lower-cost Midwestern facilities.

These are never easy decisions, but they were necessary to balance our manufacturing footprint with the changing demands of our customer base. We have strategically closed and consolidated the equipment and production capacity of 19 facilities since our acquisition of Altivity in 2008. These consolidations streamline our footprint and operations without diminishing our overall production capacity.

Another capital project that we continue to be excited about is the building of a biomass boiler in our Macon, Georgia, mill. The biomass system will make the mill self-sufficient from an electrical power and steam generation standpoint, thereby dramatically reducing energy costs and dependency on fossil fuel-based alternatives.

I'm very happy to report that, during the quarter, we received our environmental permit for this biomass project. This was the final government hurdle, and we are now officially clear to begin the construction and installation process. Our plan is to have the boiler fully operational by mid-2013.

Two other areas we continue to strategically invest to drive both demand and performance improvement include product innovation and enterprise resource planning systems. On the product innovation side, we commercialized over $80 million of new products versus same quarter 2010. We remain focused on developing new and unique packaging that helps our customers differentiate their products, lower their distribution costs, and improve their sustainability metrics throughout the entire supply chain.

A newly developed solid CUK fiber carton was recently chosen to replace a traditional litho-laminated structure by a major customer within the fast-growing beverage pouch sector. This launch represents the continuation of our participation in this market, as we currently service Coca-Cola for its Minute Maid drink pouches, Faribault Foods for their Swizzlers brand at Wal-Mart, and Target's Archer Farms line as well.

We will start supplying this package late in the fourth quarter and should be at a full run rate by the middle of 2012. In total, this conversion represents over 75,000 new tons of CUK annually. To support this business, we are making a significant converting investment in our West Monroe carton plant, and we are also providing packaging machinery to support the transition.

We believe the superior performance characteristics of a solid fiber carton and the enhanced environmental aspects make for an attractive substitute for traditional corrugated, litho-lam materials in this sector. We're excited about the long-term growth opportunities across the board.

Our strength and barrier packaging portfolio continues to grow, with our customer adoption of new and patented structures to create lower costs and use less fiber and increase consumer convenience. Our Fresh First food service line, aimed primarily at replacing plastic containers, continues to gain traction in the market, adding a number of new customers in the quarter, including Racetrack and Bob Evans, and is being tested by a major food service provider.

New products are not just about selling board, of course, and in our microwave business we had four successful commercial launches during the quarter. Some of these were focused on expanding our reach in the microwave market into new applications beyond our traditional susceptor or Microrite applications. For example, ConAgra restaged their line of Marie Callender's lasagna in pressed paperboard trays. And again in July, the Schwan's Food Company launched a new Asian takeout-style carton that is PET-laminated, made by Graphic Packaging.

Our international efforts in microwave resulted in our first commercial susceptor product in China for the frozen pizza category. And we introduced a microwave susceptor sleeve through our joint venture in Japan for the frozen-fish market.

Focusing internally, our investments in SAP and other enterprise-wide systems have allowed us to lean out our back-office functions, improving lines of sight across our asset base and automating the functions on the shop floor. Improved systems have led to better matching of orders with our production facilities, thereby allowing us to optimize our footprint and consolidate our purchasing. New enterprise systems allow for centralization of production planning capabilities and streamline many of the overhead functions.

This has led to consolidation of administrative activities and reduced related back-office work for requirements. As a result, on October 12 this quarter, we announced a reduction in the force which reflects these structural changes in our cost structure. When combined with the La Porte, Indiana, closure, this is expected to generate annual savings in the range of $20 million to $25 million ongoing.

Let's talk a little bit about the sectors. Paperboard production volume in our mills delivered another strong quarter, due to improvement in initiatives, in energy, operating efficiencies, and fixed costs. Tons per day remained relatively flat compared to the third quarter last year, but they improved by 94 tons per day versus our rate of production in the first six months of this year.

Backlogs remained consistent, and we expect to build some board inventory to support the scale-up of the new product work in 2012. Our continuous improvement efforts at the mill generated nearly $5 million in cost savings in the third quarter alone, which included almost $1 million in reduced energy usage.

If you look at the folding carton business, our US business decreased in volume 1.4% in the third quarter. This compares favorably to the overall industry, which, according to paperboard packaging, decreased around 3.4% in the same period.

End-market demand for many of our core consumer products remained relatively weak as a result of continued softness in the economy, low consumer confidence, and sticky high unemployment. Consumption across a wide variety of even staples continues to be impacted by a high level of consumer saving and substitutions.

AC Nielsen estimated that in a key category, cereal and frozen pizza, their volumes were down approximately 5% in the quarter. As economic conditions remain challenging, our consumer products business will continue to focus on innovation and customer service to capture the fast-growing opportunities in the marketplace.

If I look at beverage, industry volume trends across the can market decreased on a year-over-year basis in the third quarter but showed some sequential improvement over the second quarter. According to the Can Manufacturers Institute, total beverage can shipments decreased 3.6% in the third quarter, compared to a 5% decrease in the second quarter. Both canned soft drink and canned beer volumes remained down in the quarter, with soft drink declining 4% and beer declining 2.6%.

We have seen trends flattening for take-home, and our customers indicate they believe we're at the bottom of the curve as we head in 2012. Look, I hope that's the trend, but we are being more cautious with our own internal projections at this time.

Categories that did perform well during the quarter included our facial tissue, dairy, confection, and retail carryout. All were up, year on year.

Looking at flexible packaging, we've seen really little change in this segment, as the weak construction and industrial manufacturing sectors continue to prolong any type of real recovery. Flexible packaging sales increased 4% on a year-over-year basis and was driven primarily by higher pricing from the recovery of paper and resin inflation, and stronger demand for shingle wraps from the spring hurricane and storm damage replacement.

If I look at pricing and inflation, we continued to see significant increases in both pricing and cost inflation in third quarter. Pricing increased $29 million in the quarter, and therefore $89 million over the nine-month period, year to date, this year. Pricing increases continue to be driven by pricing reset mechanisms in our contracts that adjust pricing up and down based on changes in inflationary costs on an approximate nine-month look-back lag. We expect pricing to remain positive in the fourth quarter and carry over into 2012.

Total cost inflation for 2010 in the quarter was approximately $39 million, driven primarily by externally purchased board, secondary OCC, and chemicals. OCC pricing has begun to pull back from recent highs as a result of softening export market. Non-fiber-based inflation was primarily driven by TiO2 and freight increases in the quarter.

Looking forward -- difficult to do, honestly, but our view of the fundamental trends driving our business has not changed. Pricing should remain positive. Inflation costs have begun to abate. And we continue to invest in performance improvement and cost savings initiatives to expand our margins. Commodity inflation has proven to be a major headwind for 2011, but I believe it could soften as we move into 2012, based on difficult global economies. I think time will tell. We'll know more as we move forward. Debt reduction continues to be our primary focus, and we will run our business to optimize cash flows and improve our credit profile.

It's been nearly four years since the current recession first began. I don't think any of us believed that we would be bouncing along the bottom, but that's exactly where we are. The prolonged weak economy and continued high unemployment rate have taken their toll on the American consumer, and they are likely to remain very frugal with their spending, even for basic necessity items like food and beverage.

This is the new reality, and companies that are going to prosper in this operating environment need to be focused on bringing better, faster, smarter, cheaper solutions to the marketplace. That's exactly what we have been doing at Graphic Packaging. This has allowed us to deliver innovative cost savings solutions to our customers and grow our earnings and cash generation at the same time.

I'll now turn the call over to Dan for a more detailed discussion of our financial results. Dan?

Thanks, David, and good morning, everyone. David covered the operational highlights of the quarter. I'll focus on financial results. My comments track our posted presentation, and for those of you following along, I pick up on page 10.

Let's start with the goodwill impairment charge we recorded for our flexible packaging segment. In total, the charge, net of tax benefit, is $80 million. Firstly, I would like to point out that this is a non-cash charge that does not have any effect on our operations, liquidity, or debt covenants.

Flexible packaging, as you probably remember, was acquired in 2008 as part of the combination with Altivity Packaging. As part of the purchase accounting for the transaction, goodwill was allocated to flexible packaging based on 2007 -- we're talking pre-recession -- projections. With its focus on construction and industrial end markets, the business has suffered a 20% volume decline and a corresponding decline in EBITDA. Currently, the business represents 17% of total company revenue and only 7.6% of total EBITDA. With no prospects for a near-term economic recovery in construction and housing, we adjusted goodwill to reflect the business valuation at the reduced volume levels.

Over the past year, we have taken steps to reduce operating costs through plant rationalization, overhead reduction, and capital investment. As a result of these actions, we do expect flexible packaging's performance to improve -- however, not in the short term -- to pre-recession levels. So we impaired the goodwill associated with the business.

Looking forward, we will continue to focus on productivity improvements and further strategic options for the business. Flexible packaging does offer the potential to benefit significantly from volume increases resulting from an economic recovery.

Also, as a side note, we do perform a goodwill impairment test on each business at least annually. And based on our latest review, all other businesses passed the impairment test by a comfortable margin.

With that, now let's turn to our quarterly financial highlights that are adjusted for non-recurring charges. Looking at the results, we see continuation of positive performance trends. Revenues, driven by higher pricing, increased 2.9%. Adjusted EBITDA is consistent with the prior year. However, we are pleased with this result, as the comparison to prior year understates our performance improvement because of two special charges. We will review the special charges in detail when we discuss EBITDA change.

Adjusted net income improved 40% for the quarter and is up 77% year to date. The main contributor to the quarterly improvement in net income is a reduction in interest expense of $9.2 million, largely driven by debt reduction. Year-to-date interest expense is down $23 million.

Also of note is the decline in the income tax rate. Our effective rate dropped to 25%, from 39%, as we continue to monetize the value of our $1.2 billion NOL tax shield. We will not pay US income taxes until the NOL is depleted.

Now let's move on to revenue on slide 11. We see the 2.9% or $30 million improvement that David discussed. Pricing benefited the quarter by $29 million. As you saw, the improvement is largely driven by exercising inflation recovery provisions in our packaging supply agreements. Year to date, we have recognized about $90 million in higher pricing. This recovery has recouped the vast majority of last year's input inflation.

As a reminder, our contractual inflation recovery is based on look-back calculations that lag inflation by about nine months. And given the lag, price should continue to be favorable over the next several quarters as we continue to recover commodity inflation.

Turning to volume mix, we see a modest $6 million decline for the quarter. As David mentioned, our US folding carton volume's modest decline of 1.4% fared relatively well as compared to the overall industry.

Moving to EBITDA on slide 12, we see that the paperboard packaging margin remained consistent at 17%. As I mentioned previously, EBITDA improved even though we incurred a couple of special charges that I will now walk you through.

First, we recorded a $3.5 million charge related to the wind-down of production in the Cincinnati converting operation and the concurrent startup of the Perry, Georgia, production line. Cincinnati is now closed, and production moved to the more efficient Georgia plant. This cost penalty will not repeat next quarter.

Second, the annual maintenance outage at our Macon mill was completed in September. Last year, the outage was completed in fourth quarter. For this quarter, the timing change produces a $5 million unfavorable comparison to last year. Next quarter, we will pick up a $5 million benefit on the year-over-year comparison.

Turning to flexible packaging, we see that the EBITDA margin remained consistent with the prior year. The business benefited from cost reduction. However, price recovery continues to lag inflation.

To conclude the year-over-year EBITDA comparison, a comment about inflation. As we have experienced throughout the year, during the quarter we continued to see commodity inflation increase at a rate of around 5%, the main drivers being the well-publicized increases for purchased paper, secondary fiber, and selected chemicals such as TiO2 and latex.

Subsequent to quarter end, we are observing signs of moderating inflation, most notably illustrated by a pullback in OCC pricing. A pullback in inflation should have a positive impact on operating results. But remember that due to our inventory cycle time, it takes about 60 days before a change in input costs affects our operating results.

Now, before moving on to cash flow, a quick comment about the recently announced La Porte, Indiana, closure and workforce reduction. These reductions were made possible by our investments in information technology and production capabilities. The key point is that the reductions are permanent. We do not expect to add these costs back when volumes recover.

Overall, this initiative gives us a jumpstart on cost reduction for 2012. It is expected to produce an annual savings of $20 million to $25 million, with most of the savings coming in 2012. Now, over the next two quarters, we will record one-time charges of $6 million to $8 million in total as a result of these actions.

Now turn to slide 13. Let's look at cash flow, debt, and liquidity. Year-to-date net cash provided by operations continues to be strong, as it improved $30 million over the prior year to $199 million. Cash flow from reduced interest and improved operating performance more than offset a $30 million increase in capital investment. As previously discussed, the increased investment is focused on high-return projects, like the Perry expansion, the Macon boiler project, and expanding volume opportunities in China and Europe with the placement of new packaging machinery at customer locations.

Year-to-date net debt has been reduced by $230 million. $150 million comes from the equity offering, and $80 million from operating cash flows. Our net leverage ratio has improved to 3.8x, and we remain on track to further reduce net debt an additional $120 million to $140 million by year end.

Our liquidity position, currently in excess of $500 million, remains strong. Our credit statistics continue to improve as we approach the maturity date of our senior secured facility. With the term loans maturing in May of 2014, we are evaluating refinancing alternatives and are monitoring the debt markets. Our improving credit profile and stronger balance sheet will allow us to access the market when the timing is right.

And now, moving to slide 14, I will conclude by giving you the latest guidance for 2011. Capital expenditures will be in the $160 million range. Cash pension contributions will be between $50 million and $60 million; pension expense of around $27 million; depreciation and amortization in the $280 million range; interest expense of $145 million to $150 million; net debt reduction from operations in the $200 million to $220 million range; and, finally, our net leverage ratio should end the year around 3.5x.

And with that, I will turn the call back to the operator for questions. Thank you.

(Operator Instructions) And your first question comes from Ian Zaffino with Oppenheimer.

Hey, this is Todd on for Ian. Sorry, I jumped on a little bit late, so you may have talked about this, but (technical difficulty) go into the cost reduction programs, the $17 million you had in the quarter, what --

Ian, we can't hear you. Ian, we cannot hear you. I can't hear a word you're saying, bud.

Can you hear me now?

That's better.

All right. Hey, this is Todd on for Ian. I jumped on the call a little bit late. Can you talk about the cost reduction programs, where you got the $17 million from the quarter, going forward, where else we can expect to see some more cost reductions?

Well, we had $17 million this quarter. There wasn't anything unusual. They were more efficient in the plant, so that had to do with better purchasing substitution products. And I think our guidance for the year is that we remain comfortable with our total-year forecast of somewhere around $70 million worth of cost reduction.

As you look at 2012, as Dan mentioned, we've already announced the shutdown of our La Porte facility. We've taken a restructuring, reduction in force, that should generate $20 million, $25 million, so we sort of have a head start on where we're heading into 2012. And so as we look forward, our target in that -- I think we talked about $50 million to $60 million, or in that range, of cost reduction every year seems to be where we're headed towards.

Yes, I just want to point out as well that netted in that $17 million is the two special charges I highlighted, which together they total just short of $9 million.

All right, great. Thanks.

Your next question comes from Philip Ng with Jefferies.

Morning, guys. As you highlighted that due to the lag with your paperboard price increases, can you just help us understand what round of price increases are flowing through at the folding carton level at this point, for second round of last year?

Well, it really depends on the contract. So you have two things going through, right? You have all the inflation that we experienced last year flowing through those contracts that have direct pass-through for input costs. So last year was a pretty significant move in fiber, energy -- not energy. Fiber, chemicals, and freight. And those are manifesting themselves in increased prices whenever those openers occur.

For board pricing, we're still working off of last year and some earlier board prices this year in both CRB, SUS, and -- I can't remember when the last SBS increase was. I think it was late last year. But nonetheless, with a nine-month lag, we've still seen some of those increases flowing through as well.

So those increases will continue into 2012, because we've continued to see input inflation, as well as we had board price increases earlier this year in the marketplace. And with the normal lag, you'll see certainly into first quarter and probably into second some additional pricing flowing through in 2012, based on what's already occurred in the board markets.

Okay, that's very helpful. And then you touched upon how, at least from what you can tell on the inflation front, it's decelerating a little bit. And there's a lot of information on OCC, but what about some of your other raw material costs, whether it's TiO2 or freight costs, going forward?

Yes, so if I'm looking forward in my inflation concern, I'm not overly concerned with energy. We make a fair amount of our own energy, and the rest of it is really natural gas-based for the most part. And I feel pretty good about the forward curves on natural gas.

I think the OCC or OCC derivatives, ahead into 2012, I think the first half of 2012, from what we can see right now, probably moderate some, even what we're paying today. It just seems to be that global slowdown is impacting that global commodity.

But the things that we hit, of course, are freight and chemicals. Now, we've done some things on freight, as you can well imagine. I mentioned two. I have one shutting down our La Porte facility and relocating a lot of that business into our Kalamazoo carton facility, which eliminates internal freight. And our West Coast facility, with the acquisition of Sierra Pacific, again, we just eliminate the freight.

The freight cost that -- we moved -- I mean, Cincinnati was a very large facility. I think it was 75,000 to 80,000 tons of board that we converted in Cincinnati. All that freight needed to be moved from predominantly West Monroe, Louisiana, and now that board, of course, will be right there on site with Macon. So I think freight will clearly -- the incremental costs in freight will go up, but we've done some things to actually take what we call freight miles, if you will, out of our system.

Chemicals are the biggest concern. I mean, you looked at that, and certainly, I think latex costs have moderated somewhat for us. But TiO2 is a global commodity, and you probably have just as good, if not better, insight for me on what TiO2 is going to be on a global basis. Fortunately, it's only a small part of our overall cost, but nonetheless, I expect TiO2 to see the greatest single individual increase on units. But it's not particularly leveraging when you think of things like fiber, energy, and latex.

Okay. That's very helpful. When you quantify that, looking forward, do you think we're going to get to price cost neutrality going forward? It sounds like you still have a lot of momentum on the price side and inflation's at least moderating on the margin.

Well, what I would -- I mean, don't you think a lot of that really depends upon what you think the view of 2012 is in the global -- I mean, we are a business predominantly that buys our raw materials on a global basis, so we compete with Brazil and China and others for raw materials. But we predominantly sell our products in North America, which is a tough demand market. So pricing structure becomes difficult no matter what, and you're buying raw materials on a global basis. Do I believe there's a better opportunity for a match of cost and pricing in 2012? Right now, I would say yes, certainly better than 2011, because we don't expect to see the kind of inflation that we saw this year.

Okay.

But that depends upon the global recovery. So you probably -- you can call that as well as me.

Okay, very helpful. And then I guess last question for Dan. Do you have a sense of what free cash flow is going to look like next year, just some of the moving pieces on pension contribution? And then CapEx, how's that going to look like in light of this recent win that you have on the paperboard side?

Yes, right now we're staying pretty consistent with what we've seen in 2011. So we're forecasting that $200 million to $220 million range.

Don't forget we've got the predominant expenditure on the Macon biomass project next year comes due. So if you sort of look at the flows, I think Dan and I would say we believe $200 million to $220 million is the right range for 2012.

Okay.

Yes. We've got some pretty attractive investments we're looking at. And as you can see, our costs in terms of the cost of money, particularly with the debt reduction, is going to generate some additional cash for us as well.

All right, very helpful, guys. Good luck in the quarter.

Your next question comes from Ghansham Panjabi.

Good morning, it's actually Matt Wooten sitting in for Ghansham today. My first question relates to paperboard and folding carton volumes. They've clearly outperformed the industry in some of your competitors. Would you attribute this to market share gains, your business mix, or both?

I think most of it just has to do with business mix more than anything else. I mean, the thing about shares is they move around. You gain a little bit; you lose a little bit. That's just the nature of the business. What I would tell you is, the predominant driver for us has been the new product stuff. It's helped to offset the declines. I said we had $80 million of new products in the quarter, year on year. That's helped offset some of the declines in the core business. So our focus really has been more around new product activity and then just focus on the right mix in our business. I think that drives more volume than anything else.

Okay, thanks. And then, lastly, if you would provide us with an update on the possibility of some curtailed production at the West Monroe plant based on river flow. I know that -- I think the last we had read, some additional river flow had been put in. But any update would be helpful.

Well, right now, with the structure -- the pond structure that we have in West Monroe, we have a fair amount of freeboard on the process. The situation is getting a little better down there. I'm very hopeful, believe it or not, that the hurricane blowing through the Gulf ends up raining in Louisiana and Arkansas, as it's projected to do. But at this point in time, we project no real curtailment of our paperboard operations in West Monroe.

Okay. Thank you.

Your next question comes from Joe Stivaletti with Goldman Sachs.

Good morning. Just following up on a couple things. I know it's very tough to forecast input cost inflation for next year, but is there -- would it be possible for you to give us a little bit of a feel for what the catch-up is on the pricing side that would flow into 2012, just based on what we're seeing here in 2011 on the cost side?

Well, I tell you, for the most part, Joe, we get predominantly the recovery of our input inflation in about a nine-month lag. So if you sort of look at what our inflation's blown through this year, you'll see input recovery for the most part at that rate. So that's sort of what we would look into for 2012.

Okay. And --

And I think year to date -- I can't -- a number -- year to date, what was our inflation? About $130 million or something? Maybe -- $117 million year to date, I think, because you're probably going to see it pretty slow down in the fourth quarter. So we'll probably be targeting -- if I'm talking to my operating businesses, I'm saying -- hey, guys, we should be targeting $100-plus million of the price recovery as we head in 2012, right?

Okay. The other thing, Dan, I was wondering if you -- you mentioned your debt reduction target for next year. Embedded in that, can you just mention what you're expecting on the CapEx and the pension side?

We're expecting CapEx to be slightly greater than the $160 million we're projecting for this year. So we're in the $160 million to $180 million range for 2012 on the CapEx.

Which includes the biomass -- the reason he's telling is because the biomass investment is pretty heavy. It's a one-time, large $85 million project, and predominant spending is 2012.

Right.

That's correct. And your other question --

Pension.

-- was in pension. And in pension, we're in that $60 million, $80 million range in terms of cash contributions to our pension plans. I mean, we're on a program to get to a point where we're fully funded within three to four years, and that's the amount that we're currently targeting.

We're over -- I mean, we're spending -- we're doing greater than expense or minimum contribution --

Yes, our expense is running around $30 million a year in pension, and our contributions is -- depending on how the pension valuations come out, is in that $60 million range.

Okay. Thank you.

Your next question comes from Alex Ovshey with Goldman Sachs.

Good morning. Dave, can you comment what you guys are paying for OCC now relative to the peak levels earlier this year?

Well, of course, I won't give you exact OCC pricing for Graphic. I think there was a chart on there. What I would say is that if you look year on year, if you look at where we -- in the second quarter, we were probably $40 or so on average a ton higher. And if you look at our charts versus what we were paying the year before, in the third quarter it actually spiked up because the differential got greater as you moved into the July/August timeframe. But then as you got towards the end of the quarter, the separation got significantly less. We sort of saw a peak of maybe $60 a ton that then dropped pretty quickly to $40, and I think our forecast in the fourth quarter is to be significantly different year on year for OCC.

So you think the weakness that we're seeing for OCC pricing in China finds our way to our shores --

Well, we've already seen it finding -- the thing that Dan reminds me, and my accounting people continue, before I get too exuberant about the process, is that we turn our inventories -- we have 60 days' worth of good news tied up when we have lower-cost purchasing raw material costs. So if you sort of look at our business and realize that August was probably the single highest delta that we paid year on year, and then in September we started to see a significant drop, maybe one of the lowest deltas in the year. As you flow through the fourth quarter, we'll see those kinds of activities. As you get into the first quarter of 2012, what I would expect to see is all that low-cost OCC starting to blow through our P&L.

So what's the right way to think about the benefit to GPK? I mean, you guys buy a million tons. And let me just take the change in the price and --

I mean, I guess the question --

-- multiply it by about a million?

I guess, Alex, the question is if you're trying to do quarterly numbers or annual numbers. So if I would look over a long period of time, I would say, as you well know, the margins will expand in the short term as you get pricing greater than that inflation because you're working off the previous flows, and then it'll go the other way when it turns around. So I like to think of it over the long period of time. We don't really make a lot of money in pricing on raw material flows. What we try to do is to make sure we don't give away margin on input flows. But quarter to quarter, dislocations -- it's not really helpful or useful to really think of the business in that way. We don't think of it that way. You could think of it any way you want. But that's not how we look at the business.

No, that's helpful. I would think you probably do get at least six to nine months of that benefit, given the lag in the way that the cost structure is ultimately passed through to the customer in price.

Sure, but we're kind of hoping for longer-term investors than six months. So yes.

Absolutely. Absolutely.

So for those people, absolutely. But if you look for the long haul, it pretty much works its way out. You know what I'm saying?

Yes, absolutely. Helpful. Can you comment on what Sierra contributed in EBITDA during the quarter?

Here's what I'll tell you, is that we have not broken out the Sierra Pacific, because now it's completely integrated into the business. What I will tell you is that we have been pleasantly surprised with the growth in the EBITDA contribution from the Sierra Pacific acquisition. And even I was surprised on how good that ended up being.

Do you think it's fully in the numbers, or is there still optimization --

No, no, it's not completely in the numbers.

No, no, no, no. No, no, it won't be completely in the numbers. We'll need a year-on-year lap to be able to do that, but it's clearly contributing.

Okay, and just two more final questions. On the incremental 75,000 tons of business, does that mean you're going to have to buy more board on the outside market, or do you have opportunity to just increase production within the existing mill structure?

What I will tell you is that we're building some inventory now to manage it. I think we'll be pretty balanced on board on -- this is all SUS. I think we'll be pretty balanced on SUS, but certainly we will look to acquire, in our international operations if necessary, alternative board substrates to make sure we run our converting businesses.

But what I'm hedging for, Alex, is I don't really have a good feel for what the overall demand in the marketplace is going to go. If demand peaks back up or stays flat, then I think it's all additive. If in fact demand continues to slide X, Y, and Z, then it's a great positive. It keeps us moving forward. It outperforms the industry. But I don't know that I would plop it on everything we're doing, because I just don't have a good enough feel for what pizza, beer, soft drink is going to do in 2012, not worse than today.

Got it. Yes, that makes a lot of sense. And one last question for Dan. Just on the corporate line, that number went up, I think, $4 million sequentially, if we have it entered correctly. What's the right way to think about that corporate expense line for '11, and maybe if you have any insight on '12, it would be very helpful.

Well, when you think about it, inflation affects it a lot. Particularly when you've got employee benefit inflation, it affects that number quite significantly. Also, some of our incentive plans, as you see, our performance improved. Our incentive plans affect that number as well. We do not put incentive compensation into cost of sales at all. It's all in that corporate line, and it predominantly resides in the corporate office and on the business units.

Okay. Thanks very much for taking my questions.

Your next question comes from Richard Kus with Jefferies.

Hey, guys. Most of my questions have been answered. But you guys have been doing a great job reducing debt, and it looks like you're going to have a bunch of free cash flow again next year. At what point do you guys focus on something different from debt reduction?

Well, that's a great question for Graphic. You go back to those charts and, look, we started this enterprise at 6.5 or 6.8 leverage, so that's been our focus. I still think we have some work to do in 2012. If you look at our forward projections and you do the math, our ratios are clearly going to be -- they're going to be in very good shape as we head into 2012. Dan mentioned we have some good projects we're working on. I love the Sierra Pacific bolt-on acquisition. I believe -- and our focus is to be able to find those kinds of things that we can comfortably do within our business that adds both profit growth and cash flow. And so right now, that is our primary focus on the business.

I want to be careful right now. We've still got -- it's a tough debt market, for sure. And we've still got a fair amount of debt to -- even when we get done, we're still going to be refinancing, Dan, what, close to $2 billion of debt in 2013 at worst case. So we're going to be pretty -- we're going to be smart about what we do there. But clearly, our focus on cash has paid off. It will change somewhat as we head into 2013.

I will tell you this, our internal metrics, as we move into 2012, we're focusing on ROIC as predominant metric for the management team. So we are going to make even a shift internally to recognize that sort of a need for shareholder value really comes from EVA or ROIC improvement.

Okay. All right, great. Thanks, guys.

Your next question comes from George Staphos with Banc of America.

Hey, good morning. It's actually Benjamin Wong filling in for George. Can you review trends in your beverage end markets and maybe why you feel deterioration and volume trends have slowed?

Well, predominantly we're take-home, right? And so the trends in the beverage business that seem to have slowed the most have been on premise. I think that's just a reflection of the economy, right? They've continued to be difficult, and there is more of a tradeoff to take-home, which is what we care about -- cans and bottle pack and the overall process. So I think it's more of a mixed thing than anything else. It's just the realization in the economy is there.

I will also tell you that it's not in no small part -- with the acquisition of Sierra Pacific, we ended up a much bigger player in the craft beer sector, right? And craft beer is growing. It's still growing 12% to 13% a year. So that's had some positive influence on our volume numbers, and will on a go-forward basis as well.

But I won't -- I don't think anything's necessarily structurally changed. You do hear Coke and PepsiCo talking about North American volume in more positives, certainly that they want to drive those trends better. And you do see some additional promotion around the Super Bowl and those kinds of things already starting to flow through.

But I'm just trying to be cautiously optimistic, because there's a lot of this -- a lot of the forecast by our customers on volume improvement all year has just not materialized. So let's hope they're right and it starts to turn around. But I think we've got a plan for a different environment, and hopefully we'll be pleasantly surprised from an operating leverage in 2012.

Okay, thanks. And the Macon biomass boiler project is pretty attractive. Do you have similar opportunities at your other mills?

Really don't. I mean, the reality is that -- well, I should rephrase that. We do in West Monroe, if natural gas gets somewhere around $7 -- $7.50 to $8. But West Monroe is a very efficient energy mill, relatively speaking, and it's all natural gas-based. So in Macon, we're based on coal and, increasingly, nuclear. And while those, in fact, may be great sources of energy, they are expensive. And so the Macon biomass facility is a very quick payback project, for sure. West Monroe is a little more difficult when the natural gas-based. So when natural gas sort of trends to $7 or $8, that makes sense. But at $4, very difficult to get a payback on biomass.

Okay. Thank you.

Your next question comes from Mark Kaufman with Rafferty Capital.

Mark, you there?

I had it on mute. Hi. Been following the Company, oh, I guess about five, six years now, and I've got to say you've done a terrific job battling. First it was $12 natural gas, and then OCC prices, transportation prices, etc. And I guess maybe I'm following on from an earlier question. It seems you've always been nine months behind the curve, because you've never gotten a break on inflation. And not looking at it per se on a quarterly basis, but as a long-term investor, it could affect in a positive way the investment, and that being -- what if all of a sudden you got into that position where you had a flat inflation environment, the additional cash that it would generate that you could use then to, well, either pay down more debt or pay down the -- excuse me, pay a dividend of some sort. So I'm just asking, on a philosophical question, on a what-if, that you finally got a break on the inflation side?

Well, here's the deal. I mean, I'm not big on hypotheticals. I don't let my business unit managers do the hypotheticals for me either, because that sort of gets away from direct accountability. What I will tell you that is if you look at the margin arbitrage that occurred in 2009, we saw exactly the phenomena you're talking about. I don't know whether we see that phenomena again, wherein in that year you saw a drop-off in raw material cost, but pricing flowing through from an extremely high 2008 inflation. So you saw margin expansion, right? But you know what? It's fleeting, because then by the time 2010 rolls around, the raw material costs come back up, your pricing is pretty flat from the previous year or declined, and therefore the margin.

So as Dan and I think about margins in our paperboard business, we sort of look at that 17%, 18%, saying that's sort of where we end up on a long haul unless we materially change the new products or we materially change the mix in the -- or we're more successful in some of the emerging markets in the overall process. And that's a little difficult to forecast.

Vis-à-vis what we do with extra cash -- I think I've made this comment before, but as you well know, in our current bank structure, we are precluded from making any payments other than debt reduction. And right now, even though we've created -- Dan, we created an additional basket to pay down our high-yield debt, everything we could really pay down in high-yield has been paid off. So really, all we can do with increased cash flow between now and until we refinance that debt structure is to go to bank -- is to pay down bank debt. And I don't have the exact rates, but we are sub-3, I believe, on bank debt. Dan, is that fair?

That's correct.

So we're paying down, as you can well imagine, pretty cheap money, but we do not have a -- we have a covenant restriction that would allow us to do anything other than that, which is why we continue to pay down debt. Or put it on the balance sheet right now, because I think at the end of the quarter we're up to almost $160 million of cash on the balance sheet.

Well, it's not a bad thing. It certainly gives you options.

If you don't have enough cash, nothing else matters.

Thank you.

Your next question comes from Phil Gresh with JPMorgan.

Good morning.

Good morning.

I hopped on late, so I apologize if any of this is redundant. But for the new customer, how quickly do you expect to ramp up that capacity?

So we'll start -- we've already started shipping some moderate volumes, but it'll probably be late first quarter/early second quarter before we sort of get it at an annualized run rate. We were supplying equipment to the customer so that they could make the transitions, and machine modifications and those kinds of things. So I think certainly by middle of the second quarter, we should be pretty much at a full run rate.

Okay. And then just on the bleached board, there were attempted price increases there that didn't go through, and it seems like the volumes are a bit challenged there. So I'm wondering if you think that there's any possibility you could see reductions in prices there, in terms of your input costs?

Who knows? I can't talk about individual customer or supplier pricing contracts. Certainly, there's opportunities across our entire supply chain to be able to adjust. But I will tell you that -- you got to remember that, as bleached board pricing changes up or down, we pass that back to our customer pretty quickly. So a bleached board pricing change really has virtually no really even quarterly impact on Graphic Packaging. For the most part, it flows through very, very quickly, up or down.

Fair enough. Okay. And then in terms of the productivity for next year, I just wanted to clarify -- the savings that you announced recently, the $20 million to $25 million, is that part of essentially your annual guidance there, or is that a potential source of upside? How should we think about that?

I would think -- we would think of it, for the most part, in our normal annual numbers. We do these kinds of things on an ongoing basis. As I said, since 2008 we've shut down 19 manufacturing facilities, so that's all part of our mix. Our guidance for next year still remains sort of in that $50 million to $70 million range in cost reduction. Dan, is --?

We normally put out $60 million, $80 million as our guidance there.

So we'll probably be pretty close. I mean, we haven't finished our 2012 internal guidance, but that would be where we're headed.

Okay, so should we be thinking the $60 million to $80 million, or something slightly less because of the volume potentially declines?

No, I would stick to the $60 million to $80 million range.

I think that makes sense. I mean, the problem with CI -- and you guys know the continuous improvement -- is that there is a certain volume impact. If we run more products, we make it more effective. So we're not trying to be cute; we're just trying to hedge the fact that it's very difficult to get a forward trend on volume. So if I don't have a feel for volume, it's really difficult to have perfect numbers on continuous improvement because it's a lot around throughput.

I do believe we sort of seem to be at the bottom of the volume stuff. That's what our customers believe. But I'll tell you what, guys, until I see a quarter of so of it, I'm not calling any victory or any improvement on volumes to drive Graphic Packaging financials. I'd love to. It's incredibly leveraging to our cost structure. But it's hard for me to look forward and believe that's a driver of margins.

Okay. Excellent, thanks a lot.

And your final question is a follow-up from Alex Ovshey of Goldman Sachs.

Hey, guys, just a couple of quick ones here. As I listen to everything that you said, why wouldn't 2012 be an up year for you from an earnings perspective? It looks like you're finally seeing pricing catch up to inflation, and inflation is tapering off. You're still targeting $60 million, $80 million of productivity. And on the volume side, well, who knows? It seems like the volume declines, at least the second derivative, has flattened out. So as we think about '12, are we missing anything if we think about it being an up year for you next year?

I think the thing that all of us -- I mean, for the most part, we're making folding cartons and paper, which is still a base materials business. It's tremendously leveraged towards volume in the business. It's leveraging on the upside and leveraging on the downside.

I think in this quarter we had something like $5 million worth of EBITDA impact from carton plants that we took down to manage volumes so that we didn't build inventory -- $5 million in the quarter alone from carton volume. So it has an upside if volume changes. If volume continues, then we have ongoing costs in that process.

So I believe 2012 is a better year. I always believe the next year is going to be a better year. But quite frankly, I've given up forecasting volume trends in my business, because my customers are struggling to understand it, and I'm once removed from them. So that's sort of the 900-pound gorilla in the room. So whatever you sort of think of general economic recovery, or unemployment, consumer spending in staple products, that's probably a good indicator where you think Graphic Packaging will be up or down.

Understood. And last question is, where do you see your utilization rates at the converting level right now?

We have plenty of upside potential, because converting's pretty easy to flip on and run some overtime. We don't even think about it in terms of a utilization-to-converting business. It's not a useful number.

Okay, thanks.

Okay.

And at this time, there are no further questions.

All right. Well, we appreciate it, everybody, and we'll talk to you next quarter.

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