Sonoco Products Co (SON) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Sonoco 2006 third quarter financial results. My name is Danielle, and I will be your coordinator for today. [OPERATOR INSTRUCTIONS]

I would now like to turn the presentation over to your host for today's call, Mr. Allan Cecil, Vice President of Investor Relations. Please proceed, sir.

Good afternoon and thank you for joining us for our third quarter teleconference. With me today are Harris DeLoach, our Chairman, President and CEO, and Charlie Hupfer, Senior Vice President and CFO. Today's conference contains forward-looking statements that are based on current regulations and are not guarantees of future performance. Additional information about factors that could cause different results and about the use by the Company of any non-GAAP financial measures is available on Forms 10-K, 10-Q, and 8-K, as filed with the SEC.

As released this morning, reported earnings per diluted share for the third quarter of 2006 were $0.60 versus $0.46 cents for 2005, constituting a 30% increase. Base earnings per diluted share, which is a non-GAAP financial measure that excludes restructuring charges and certain nonrecurring items, were $0.61 for this year's third quarter compared with $0.38 for 2005, constituting a 27% increase. Our base earnings guidance for the third quarter was $0.54 to $0.57, and First Call's consensus estimate was $0.56. Base earnings for the third quarter excluded after-tax restructuring charges of $0.01 and $0.02 per diluted share respectively for 2006 and 2005.

Along with higher prices and increased volumes, Sonoco again enjoyed a positive price-cost relationship and productivity improvements that were partially offset by higher energy, freight and labor costs. Our third quarter results were also positively impacted by a lower-than-expected tax rate of 28.6%. The third quarter marks the tenth consecutive quarter of year-over-year increases in base earnings for Sonoco and the fifth consecutive quarter of year-over-year Company-wide margin improvements. Charlie will discuss in more detail in a moment the positives and negatives impacting this quarter's earnings.

But I would like to make note that this was also the tenth consecutive quarter of year-over-year increases in earnings and EBIT margins for our consumer segment. I should also say that our businesses serving the consumer markets achieved new product sales, which we define as sales up to two years after commercialization, of $24.8 million in the third quarter. That compares with $19 million in last year's third quarter, which is about a 30.5% increase. For the first nine months of this year, our new product sales for the consumer markets were $65.8 million. That versus about $51.3 million in '05, about a 28% increase. The Company also continued to enjoy year-over-year increases in cash flow from operations during the third quarter, with a 63% increase over the same period in 2005. This increase was driven by our ongoing emphasis on working capital and from improved earnings.

We recently announced a further cost reduction action, principally internationally in scope and mainly in Europe. Earlier this week we completed our previously announced acquisition of Ahlstrom Corporation's 35.5% interest in the European-based Sonoco-Alcore joint venture with Ahlstrom. We do not expect any significant savings from the restructuring program until 2007, and we cannot estimate at this time really the amount of restructuring charges expected in this year's fourth quarter from that restructuring.

Excluding any such charges and assuming that there are no significant changes in volume or price due to any change in general economic conditions, we would expect fourth quarter '06 base earnings in the range of fifty thri -- $0.53, excuse me, to $0.55 per diluted share. You may recall that last year's fourth quarter base earnings were exceptionally strong. We are increasing our 2006 total year base earning guidance to be in the range of 211 to 313, and that included about $0.03 for expensing of stock options and excludes any restructuring charges or additions to environmental reserves, and assuming there will be no significant general economic changes. Our guidance reflects an expected effective tax rate of about 35% during the fourth quarter. As you recall, we last increased our full year guidance for base earning to the upper range of 207 to 210.

I'll now turn the conference over to Charlie Hupfer, our CFO.

Thank you, Allan, and let me begin at the top with sales. Sales were $931.5 million. That's up 5.7% over last year's $881 million. EPS $0.60 versus $0.46. But as Allan mentioned, it did have -- we did have restructuring in this year's third quarter as we did in last year's. In this year's third quarter, restructuring pretax was $1.1 million and after tax, $600,000. So that's comes out to rounded $0.01 per share.

The restructuring in this third quarter was just residual costs related to the 2003 plan. Restructuring in last year's third quarter was $0.02. So, base earnings, which we define as actual GAAP earnings adjusted for one-time incoming expense type of items, unusual items plus restructuring, but there's only restructuring between these two quarters. So base earnings of sales of $931.5 million, up 5.7%, EBIT at $92.8 million, up 18.8% over last year's 78.1, and EPS is $0.61, up 26.7% over last year's $0.48. You'll find a reconciliation, and you'll also find some expanded disclosure about base earnings and why we use base earnings, in the press release in the back section.

Now in base earnings, interest expense was $1.2 million favorable to last year and that's for a couple of reasons. One, we had some lower borrowing rates in Brazil due to some recapitalization we did in the second quarter. And also our commercial paper interest is down. Although the average rate is up 183 basis points, the average borrowing last year was $172 million on our commercial paper program. This year it was only $24 million. So we'll have more to say about that when we get to the cash flow, because we obviously paid down a lot of debt year-over-year.

And then taxes. Taxes, the effective tax rate this year on a base earnings basis was 28.7% compared with 31.4% last year. In this year's third quarter, we had some adjustments to tax expense as we trued up the tax accrual following -- the following of the September 15 federal and state returns, plus we had some adjustments due to audits and to some statute expirations in the quarter. My July forecast, the one I gave at our last conference call, assumed that we'd have around a 32% effective tax rate. So we had about a $0.03 per share, $3 million favorable tax adjustment relative to what I had built into my forecast. Without that $0.03, which I didn't project or predict back in July, we'd still be on the high side of our July projections.

Now I've got two observations before I get off of taxes. One of them is the way we have to account for taxes now -- and I think it'll be especially true before FIN 48 becomes effective -- we're going to just see more volatility in the tax expense line from quarter to quarter, and probably even more volatility in the third quarters. The other point is that the effective tax rate will likely go back to the 34%, 35% range in this year's fourth quarter. Now our gross profit margin was up 100 basis points, from 18.5% last year to 19.5% this year, and our EBIT margin was 10%, and you have to go back to 2001 to find margins that were at that level. So we had good performance at the operating line.

Now let me turn to the segment reporting, which is the way we report to the financial community. and make a couple of observations before I get to the sales and EBIT bridge. Starting with consumer, when you look at the segment reporting, you see that sales are up 4.3%, and EBIT's up 12.3%. Sales were up largely because of composite cans, and most of that is powdered infant formula conversions, which we've talked about converting form metal canisters into composite cans. Those conversions are continuing and going well. On the EBIT side, we had good price cost, that's especially in the composite cans business, and good productivity, which is both in composite cans and in our flexibles operation. In tube, core and paper segment, sales were up 5.2% and EBIT up 33.6%. We saw strong volume in tubes in the U.S. and in Canada, and we had solid outside paper sales again in the U.S. and in Canada, and I'll give you some specifics in a minute. And EBIT was a combination of really everything. We had good volume, we had strong price cost, and we had good productivity.

Now, packaging services. Packaging services sales were up 6.1%, and EBIT was down 20.5%. In terms of sales, most of that increase is coming from our traditional pack centers, the pack centers that serve Gillette and Hewlett-Packard. On the other hand, EBIT was down due to mix. We had sales driven -- sales driven by the pack centers that really passed through sales, which don't carry with it a lot of profit. And also on our CorrFlex business, we had more assembly sales and less manufacturing sales in this quarter versus last, and assembly sales don't carry the same margins with it. So while sales were up, profits were down and it's largely a mix issue. And then in the all other category, sales were up 13.1%, and EBIT's up 35.2%. There we had solid performances by both our protective packaging and our Baker Reels business. And although the housing slowdown will affect both of these businesses, it certainly didn't affect them in this year's third quarter.

Now let me turn to the sales bridge, and what we're doing here is accounting for the year-over-year change in sales, which was right at $50 million. Volume accounted for $22 million, price cost, $17 million, acquisitions were negligible, and -- and exchange, foreign exchange was a positive 12. So that's 22 volume, 17 price, and 12 exchange. So I'll comment on each of those categories, starting with volume. Volume was generally good across the whole Company. In our tubes business in the U.S. and Canada, volume was up 3.2% compared with last year's quarter. And if you remember, that compares with volume up 0.2% in the second quarter and volume down in the first quarter by 5%. So this was actually an outstanding quarter in volume terms in our traditional tube and core business. And it was really across all product lines. Our paper mill product segment, which is largely paper mill cores sold into the paper industry, were up 5% year over year, film and tape were up 3.4% year over year. textiles was up 1.7. And that's largely carpet and cloth cores, but I think it's the first time I can remember in a while where we talked about textiles being up year over year.

In fact, to digress a minute, at a recent management committee meeting, we were talking about the business, and business in our tube and core operations still seems to be strong here, as we sit in mid-October. Our paper trade sales were up 5.7%. That's largely sales into the tissue and towel category. Paper Canada volume was up 30%. That's liner board, which has been strong for each of the last two quarters. Tubes in Asia were up 6%, and I believe they were up 10% in China. So generally across this whole segment, we've had good tu -- good volume increases. The only real negative was tubes and cores in Europe, which was down 2.4%, and that's largely in France and in Finland, where we saw year-over-year declines. We did interestingly see some pretty big increases in places like Poland, Turkey, and Russia, but these are smaller operations for us, and they really weren't -- the increases weren't enough to offset the shortfalls, particularly in France and Finland.

Our composite can volume was relatively strong as a result of the powdered infant formula conversions. Our metal end volume and out flexible volume were below last year. Those were two negatives in terms of overall volume. In metal ends, it's due largely to the loss of a major customer where, at the beginning of the year, we just chose not to bid out that business. And in flexibles, we've talked before about that, some shortfalls with a couple of customers that have negatively affected us at the volume line. As I said earlier, pack services volume was generally good. It was up about 6%. But again, this is mostly material pass-through. And then in the other category, protective packaging, volume was good, as well, due largely to the cross brace program, which was a new product that was developed out of protective packaging. And that product is to prevent damage to appliances from forklifts, and it's a new product for us and it's done well and helped considerably to the year-over-year comparison.

Now in terms of price, price accounted for $17 million, and we had price increases in tubes, cores, and paper and in composite. In tube and core in the U.S., we reported year-over-year improvement, and that's largely coming from our February price increase. Very little from the July increase, which should have an impact on us in the fourth quarter. The same is true in Europe, and that's as a result of their March price increase. As in previous quarters, we had good pricing in composite cans. That's largely the result of customer-specific increases and contractual resets at the beginning of the year. And likewise, our flexibles business benefited from a late 2005 announced price increase. And then prices were up in the all other category due to increases in protective packaging; that's largely paper-based increase. And Baker Reels, that's largely a lumber-based increase. And then the last item in the sales bridge is foreign exchange, up $12 million. That's simply the weak dollar against the Euro and the Canadian and Brazilian currencies.

Now let me go to EBIT. The EBIT bridge, where we're accounting for roughly $15 million of year-over-year improvement. And here we see that volume is -- is a negative $1 million, which I'll explain in a minute. Price cost deposit is 16, productivity deposit is seven, and then other a negative seven, and that should add up to about $15 million. So let me start with volume. A negative profit impact of $1 million on $22 million worth of -- of sales volume that I talked about on the sales bridge and it does require some explanation. There's really three things that come to mind.

First of all, we did have an ordinary contribution margin on the tube, core and pro -- and paper volume that I talked about earlier., so the shortfall here isn't coming from that particular segment. The second point is that the majority of our composite can business was powdered infant formula conversion, which didn't -- which carried little incremental profit this particular quarter due to some startup. This is a kind of -- this is a new product for us. It uses a specially designed grade of paper, and we're in the process, as we bring this product on, of learning how to efficiently run it. So with a little bit of time, we expect margins to be fully up to speed in the powdered infant formula segment,, but clearly the year-over-year comparison hurt us with -- with the mix -- mix problem here. And then the third thing, and I've already mentioned that, that's the mix with packaging services. It's the pass-through sales at the pack centers, and it's the lower margin assembly work at CorrFlex. So those were the principal reasons why with -- with significant volume quarter over quarter, year over year we had a -- we did have a slight shortfall in the EBIT impact of that.

Now in terms of price costs, price cost is a positive $15.9 million. And with selling prices up $17 million off of that sales bridge, the price cost is up by 15.9, so it's pretty obvious that material cost wasn't a real big factor for us in this third quarter. We did see some increases. Our domestic furnish cost, and that's largely waste paper, mostly OCC, was up about $4 a ton, but that was offset by reductions in other places. For example, our chemical costs were down in the U.S. Adhesive costs down in Europe. Outside paper purchases down year over year in Asia. So these savings more than offset the -- the cost increases that we saw, particularly in our paper segment. We also saw increases on the consumer side in resins, liner, aluminum, but these were offset in large part by year-over-year reduction in steel surcharges. So when you put it all together, most of the price increase that we had in the third quarter did fall through to the bottom line as a positive price cost.

Now productivity, productivity's a positive $7 million. Our productivity was generally good. It was off a little bit from first and second quarter levels. Much of the two foreign paper productivity's coming from Europe, and I talked about that in the second quarter. It's the result of our 2005 consolidations. And then some of the rest of it's coming from Paper Canada, which had a good bit of downtime, actually 17 days' downtime last year's quarter and they ran full this year. In fact, our U.S. and Canadian mills ran at 98% utilization in the third quarter. And as in previous quarters, flexibles had a -- a solid productivity, largely coming from their scrap reduction.

And then the last item on the bridge is other, that's a negative $7 million. That's our catch-all category. It's wages, benefits. I will note that energy costs were up roughly about $1 million year over year, half of that in the U.S. The other half of that in Europe. And freight costs were up about $1 million year over year.

Now let me make a couple of comments about the cash flow. Allan talked briefly about it. Operating cash for the third quarter year to date was $331 million versus $160 million last year, so that's an increase of $170 million. And it's not hard to find where that's coming from. Net income is up $33 million, and then networking capital is favorable by $132 million, and that $132 million can only be the result of our working capital program. In terms of capital expenditures year to date, $88 million year to date this year compared with $92 million last year, and dividends $71 million compared with $67 million last year. So cash after capital expenditures and after dividends was $173 million this year compared with only $1 million last year, so that's a difference of $172 million year over year. And operating cash in the third quarter alone was about $150 million.

Now let me turn to the balance sheet, and we'll see where some of that cash went. Our balance sheet remains strong. We did pay down debt by $51 million since December, and -- and our cash balances in current assets increased approximately $60 million. And then, of course, we had an $80-some million stock buy-back early in the year. So you could see where the $170 million of cash has gone. Our debt-to-total capital dropped from beginning of the year at 35.8% to 33.3%, and again, that's despite buying back the 2.5 million shares earlier in the year. Since quarter end, we have completed the purchase of Ahlstrom's 35.5% of Sonoco-Alcore, so that'll absorb some of the cash that you find on the balance sheet at the end of the quarter.

Allan commented about new products, $25 million in this quarter. A lot of that's coming from flexibles. It's the Snack and Seal, it's [StickPack], it's SonoWrap, and it's the powdered infant formula canister. I will note there, because it's such a good number, Phoenix Metal Ends had about $5 million of new profile ends that dropped off because they passed the two-year mark and the two-year mark is our definition of what's a new product.

And then the reforecast. Reforecast for the fourth quarter is $0.53 to $0.55. That brings the year to 211 to 213. We have not significantly changed our forecast for the year. In fact, if we've done anything, we've upped it by $0.03 from the top side of $2.10 now to the top side of $2.13. Our divisions are re-forecasting a fourth quarter pretty much along the same lines as the third quarter, perhaps with a little bit of falling off in protective packaging and Baker Reels due to just concerns that they have about the housing market. I said it earlier, our fourth-quarter effective tax rate's expected to be around 35%.

And I also said earlier, our July forecast assumed that we'd have a 32% effective tax rate, and I spread it really just between the third and the fourth quarters. So, given the fact that the third quarter rate was 28.7, there's about a 3% swap, the way I look at it, between the third quarter and this fourth quarter and that account for most of the shortfall to last year's really strong $0.58 fourth quarter. The net result and what I'm trying to convey is that our divisions really haven't changed their forecast much at all, and we haven't changed our overall forecast for the year. Allan talked about the restructuring. Allan, I think that's the extent of my -- my comments.

Thank you, Charlie, and with that I think we're ready to open up for questions.

Yes, sir. Thank you. [OPERATOR INSTRUCTIONS] And your first question comes from the line of Ghansham Panjabi. Please proceed.

Hey, guys. How are you?

Hello, Ghansham.

On your tubes and cores business, could you give us color on the margin disparity between the U.S. and Europe. You're obviously going to have a lower cost position once you're done with restructuring next year and I'm just wondering what the margin opportunity is?

Ghansham, the contribution margin on the business is basically about the same between the two locations.

Okay.

We are -- obviously we have taken out a good bit of cost, and this additional restructuring is for some additional cost that we've identified, so we certainly expect some improvement in the operating profits in -- in Europe. It's probably too early at this point to tell before we get through the budgeting process.

And -- and from a quarterly standpoint, is it more back-end weighted towards the back half of the year, or is it equally spread through the year?

What, the improvement?

Yes, the cost savings.

We -- I would expect -- I don't know at this point, but I would expect some cost improvement at the beginning of the year. But it clearly will accelerate through the year.

Okay. And just real quick, on the Lego contract, the sales opportunity there, and in terms of margin, should we expect some margin compression initially, as you get this business ramped up, or do you see it pretty smooth?

It will annualize. It's not a big -- it's an important contract. It opens up a lot of opportunities for us, but the Lego contract itself isn't that significant. It's about $5 million, and it won't have a significant EBIT impact on us.

Okay. All right. Thank you.

Your next question comes from the line of George Staphos. Please proceed.

Hi, everyone.

Hi, George.

You know, guys, typically the fourth quarter is still a stronger quarter for you in terms of EPS and what you see in the third quarter. And realizing that some of this is just a function of the tax rate, is there anything else that maybe decelerated a bit into the third -- into the fourth quarter, whether it's perhaps volume, maybe it's just your building and conservatism around housing, or is it coming from spread? Can you help us understand a little bit why -- a little bit further in terms of why you see the deceleration from 3Q to 4Q?

George, I think Charlie and I both are going to jump in on this, but let me go first. Traditionally, our fourth -- third quarter is our strongest quarter. And normally, at least five out of the last six years, we've seen a December that is not a very strong December and it started a week or so after Thanksgiving and certainly into December. Last year was the -- the anomaly, and we saw, as I think Charlie, Allan one mentioned, a very, very strong December where we were in the mill system and most of the operating plants with not a lot of holiday downtime around Christmas.

Obviously a day or two, but not a lot. So it was a very strong December. And it resulted in a very, very strong fourth quarter last year, which I think we said in -- in our fourth quarter conference call, was driven by December. We are not budgeting or not looking in this forecast for a repeat of last December. We are looking more at a traditional what we've seen out of five of the last six years of a December.

And I'll go back and check, but you know, fourth quarter I thought your -- 2003 I should say your fourth quarter was stronger than your third.

2005 it certainly was.

Yes. Well,2003, I'll go back and look, but when I looked over history, it looked like fourth quarter was a stronger quarter, certainly relative to what you're saying here.

I don't want to get in a debate. I don't recall that, and it could have been. But normally the fourth quarter is our strongest -- I mean, the third quarter is our strongest quarter. Now you asked about, you know, what conservativism rolling in. The conservativism baked in is we are not looking -- we are not planning on the strength in December that we saw last year.

Charlie mentioned the only conservativism that our businesses really are building in is a little bit of falloff in protective packaging in Baker due to housing. We haven't seen that yet. I do anticipate that we are going to see it, just as they talk to their customers. But the other businesses, the first two or three weeks of -- of October are experiencing good volumes. So hopefully that gives you a little bit of color. Charlie, you want to add anything --

No, I think that's fine.

That's helpful. Now in terms of pricing that you have on the table, have you implemented all of whatever price increases you've already announced to date, or, you know, let's call it tube and core and paper?

I would say for the most part, George, we have implemented those, you know. Some could have actually -- because we have contracts may not have gone into effect until the first of October and I think, clearly, we haven't seen the full impact of the June-announced increase in North America. And we should see some upside for that in the -- in the fourth quarter and rolling into next year, and I suspect there's still some upside on the pricing in Europe.

Okay. So two last questions, then I'll turn it over. Do you or don't you think that perhaps some of the volume strength has been driven by your customers buying maybe a little bit ahead of when the prices are implemented? And then secondly, you've been doing very well on price costs even though cost itself hasn't been that onerous. How long should we expect spreads to stay as robust as they are if, in fact, your input cost inflation remains more tame on a go-forward basis? Thanks, guys.

George, I guess you obviously did ask two questions. And I think the margins that we've seen, you know, I expect continued margin improvement driven by the productivity that we're driving through the system, as well as the competitive landscape today is not -- not that bad.

People seem to be running full, so I anticipate continued margin improvement. [Buy in], our anticipation of price increase, there may be some of that, but there's not a lot of inventory in our customers' plants at any given time. So I doubt there's very much impact of that.

Okay. Thanks, guys.

Your next question comes from the line of Mark Connelly. Please proceed.

Thanks. I wonder if you could talk a little more about the strength in the tube market. Is this -- is this primarily construction again? Could you give us a sense of what the mix looks like?

No -- no, it isn't, Mark. I think Charlie mentioned it was a nice increase year over year in the paper mill segment, but a lot of this is also coming in the high performance film and other film accounts.

That's right, and in textiles, it was rich. Construction would make up a very, very small part of the volume of the tube and core division.

Okay, so I was --

So this is really much more broad based, and really -- really pretty encouraging. Certainly we -- much improved over the second quarter, which was positive, and the first quarter, which was -- which was negative.

Mark, you asked about construction. It is small, but it is up year over year. Much of the construction tubes is really used in commercial construction and apartment-type instruction -- construction. I'm not sure you've seen quite the fall off as you have in housing starts.

Right. That's really what I was wondering about. Now as you -- you mention that it's still strong going into October, is there a meaningful mix shift that we should be thinking about in going to the fourth quarter?

Probably not.

Probably not. Okay. And second, I wonder if you could just talk about the composite can numbers being down in Europe. That's been a good business for you. Is there anything -- is there anything going on there? Is there any particular customer business moving around?

Mark, I don't think so. It's certainly not moving around. We have one major customer in the UK that I think took some downtime for some inventories. I believe it was in the August timeframe with the holidays there and we expect that to bounce back.

Okay. Perfect. That's all I have. Thank you.

Thank you, Mark.

Your next question comes from the line of George Staphos. Please proceed.

Didn't expect to be back in queue so quick, guys.

[LAUGHTER] You're quick, George.

You know. The -- I guess the question I had, you know, when you look at what's been driving the business over the last year, a good measure of your earnings variance, it's been from your traditional businesses. You know, composite cans have been coming back. Tube and core is doing well, certainly on price cost.

You're getting, you know, nice improvement in -- in new products, but you're not getting a -- as much, I think, incremental margin from those. You know, one, do you agree with that assessment? And two, does it cause you to look perhaps at times that the strategy, as we understand it, which is either grow the consumer side of the business and the nonpaper side of the consumer business over time?

Are you finished, George?

Yes.

No, it doesn't. And I think Charlie mentioned, even on the composite can side, some of these new introductions on the powdered infant formula are different paper grades that we've developed to strengthen the can for a different type of applications or environmental -- geographic environmental factors that are involved, such as high altitude and others. And learning to run that as efficiently through the plants as we run the traditional can has been somewhat of a startup issue, and I think Charlie mentioned that.

Even the successes that we've had with Snack and Seal on the flexible side, that has initially been a more difficult structure to run, and we have not yet achieved all of the margin capabilities of that product due to the changes in certain structures and other things. So, clearly, as we look at these new products, they have the same potential margins, once we get through those initial hurdles, as our other products, so I -- hopefully that gives you a little color.

And our paper-based products, for example, in protective packaging or in powdered infant formula, all have -- all have tran -- are all transferred from the paper segment into the -- into the other segments. So there's a margin that's -- that you really don't see and don't attribute to, say, consumer or other that's in that business, too.

I guess that's all fair, but, again, it would appear that, you know, if you're developing new products for composite cans, again that's a legacy, long-time Sonoco business, and that's what you should be doing in your core businesses. Whereas flexible packaging -- not to go off on my normal, you know, rundown on this -- you know, it still seems to be a problematic business for you, seven years down the road.

No. Of course, you can't see flexible packaging entirely inside this segment. And you would find a significant year-over-year improvement going back probably two years in that particular category. And so, you know, what I was describing wasn't so much the bottom line as the top line, where there's a little sales shortfall.

But good productivity coming out of that business, good price cost, a lot of -- a lot of things going on in terms of making changes. And they are growing the top line. You just didn't see it in this particular quarter in volume terms. So now that -- that's the segment that we can be pleased and proud of.

Are you at 10% now margin, Charlie, in that business?

Probably not quite, George.

Okay.

Closing in.

Okay. Two -- one quickie and I'll turn it over. You know, you had issues with two customers in flexible last quarter. I mean, they were having issues in the marketplace for various reasons. Can you update us on where they stand in terms of working out whatever marketing issues or other issues they have that have been lingering since the first quarter? Thanks.

George, it was -- there were two, but it was one that was really driving it. There were two, but one of really driving it, and I think we are seeing some improvement in their market position at this point. Certainly our volume's up in the quarter.

Okay, guys. Thanks.

Thank you.

Your next question comes from the line of Edings Thibault. Please proceed, sir.

Thanks very much and good afternoon, gentlemen.

Hey, Edings, how are you?

Not too bad. Congratulations on that working capital move and --

Thank you very much.

-- certainly that cash been was a surprise. Hopefully not to you.

[LAUGHTER] No, it wasn't, actually.

Just a couple quick questions. A the Ahlstrom deal, can you give us a sense of what the -- what the immediate benefit is going in the third quarter? In other words, what was the minority interest expense of the 35% stake?

Yes, we haven't disclosed that, but I did look at it, and frankly, the 35% of what's forecast after interest, after tax, would be a pretty marginal number in the fourth quarter. So it -- it really doesn't -- wouldn't have any significant effect and didn't affect our forecast at all.

Okay. Great. And -- and just getting into this notion of pricing, because that was such an important driver in the quarter, I'm curious as -- Harris, as to why it's a [live] price increase. I know they are implemented over time, but it seems like this one is dragging out at all. Do you have any concerns or, you know, what has been implemented so far, and -- and when should we expect full implementation of that price increase?

You know, we -- Edings, I don't think it was any more different than normal, particularly when we have some of these quarterly contracts. And if you'll recall about 60% of that business, I believe in the range of that, is on quarterly contracts, so some of that was actually pushed in to October 1. And -- so I wouldn't say it was typical, and I would -- not anything but typical, and I would expect it to be in in this quarter.

Yes, and I think that's pretty standard. I know the European one was announced on July 27 to become effective September 18. So there's a lag that's built in between the announcement date and the effective date. And so what we were seeing in the third quarter is really the -- the February and March increases that were just starting to -- that really didn't affect the second quarter at all and rolled into the third.

Okay. So as far -- sitting here on October -- late October, you -- you know, you are implementing those prices increases and they're going through?

Correct.

Yes.

Okay. And then just walking through some of the other businesses, I think you're starting to -- in the fourth quarter, you'll annualize your flexible packaging price increase. Is that accurate, or is that not occuring until the first quarter?

I believe that's right. I think that that was like a -- if I recall, like a November increase, or maybe that's about the time it became effective.

Okay. Baker Reels would be about the same thing, those are annual?

Well, I don't know about that. That was -- I think that was last year was lumber related.

Yes. I'm just trying to get at -- you know, as we begin to see some of these commodity prices ease, you know, historically you've kept a positive price/cost relationship if that happens, but you have seen some impact on top line.

Should we begin -- you know, if we begin to see some of these trends, easing of plastics costs, easing certainly lumber come in fairly dramatically, we should begin to see some price easing from the top line at Sonoco beginning of next year. Is that fair to say?

I think that's fair.

Okay. And then -- and then, finally, you guys did, as I noted, have a very strong quarter. You know, Ahlstrom didn't observe all of that cash. How's the M&A environment looking?

You know, as we say, we're always looking for opportunities. We, at any given time, have got a couple of things on the radar screen and so I think you can draw from that, there are probably some things on the radar screen.

Okay. So you're seeing deals, you kind of at least are worth taking a look at?

Yes.

Excellent. Thank you very much. Good luck in the quarter.

Thank you, Edings.

Your next question comes from the line of Claudia Shank. Please proceed.

Hi, how are you?

Hello, Claudia, how are you?

Good. Thank you. I just have two questions. One is on the working capital issue. If you could just maybe talk about what drove it and how much opportunity is there for you to really improve from here as you look forward?

Claudia, as -- as I think you know, we set a goal of -- of a $75 million reduction in working capital for this year. We will meet that goal. We are in the process of setting a goal for next year.

Our goal is to take somewhere around $150 million out of the -- $175 million out of the working capital of this Company over a three-year period of time beginning the first of '06, and we've gotten $75 million, so we'll have two $50 million goals over the next two years. So I think there is potential for continued acceleration of cash.

Okay. Thank you.

Much of the -- much of the increase came from -- or improvement came from decreased inventories, and accounts payable. In terms of the overall program, it's been pushed into the divisions, and they've made some systemic changes to the way they do business now, and that's what drove much -- and is driving much of the inventory reduction. So there's no reason to think that for a -- a while, a short time going forward that we won't continue to see that -- those systemic changes movement.

Great, thank you. And then, just in terms of the packaging services business, can you just talk about the mix shift issue and how to sort of think about going forward? You know, how the mix might look going for the fourth quarter and then into '07?

Claudia, probably understanding what the mix really is important in this. And the mix is the traditional run-through, the manipulation that goes through some of the [packs] on those and then there are also new launches. And new launches this year with two or three major customers are down some seven, eight, to ten launches year over year, and these are companies that simply did not have the launches in the first three quarters of this year that they traditionally have.

You know, will they have them next year? Certainly I hope so, but I don't know that. Our design projects in house that we sort of -- that we watch, I heard last week we were in the 425, 430 design projects, which is up near the top of where we normally stay. So, the business is meeting our expectations. It's running along well, but it is not nearly as smooth as some of our other projects -- I mean, some of our other businesses, where we have a better anticipation of what's going to come out year over year.

Okay. That's helpful. Thank you very much.

Thank you.

Your next question comes from the line of David Leibowitz. Please proceed.

Good afternoon.

Hello, David.

Briefly, the restructuring in Europe, how much is that going to impact the income statement over the -- each of the fourth quarters of next year?

Well, in total, we've said that it was a $35 million cost. But what -- you know, the way restructuring works from an accounting perspective, you're not able to record the expense until the liability is pretty well certain. So I think as our plans get -- become more formalized through the course of the year, then the accounting rules will dictate when we take that charge.

I would expect that we would -- that it'll come in lumps, and we may have some, I would expect, in the fourth quarter and then the first, and then it'll roll out through the year. But it's impossible for us to estimate any impact that it would have on any quarter right now.

Okay. Second --

A lot of it -- anything that's severance related you have to really wait until the decisions have been made and the employee group has been communicated with. So, you know, those are a lot of unknowns as to when the actual accounting will take place.

Now Europe has different rules than the United States does in terms of employee terminations. How much of the $35 million is earmarked for employees?

I think we said in the press release that the -- far and away the majority of that $35 million cost is cash cost, and you can assume that the big, big majority of that is employee cost, particularly severance.

Okay. And there will be no residual costs for medical, health, or other things, beyond the severance?

No.

Okay. And a follow-up on the same thought is you still have one other joint venture in Europe right now. If the other side exercises their put rights, are you going to have to take an additional restructuring --

No.

-- once that deal is consummated?

We wouldn't anticipate that, David.

Excellent. Thank you very much.

Your next question comes from the line of Chris Manuel. Please proceed.

Good afternoon, gentlemen.

Hello, Chris.

Chris.

A couple of questions for you. First, can you -- are there any updates or along the lines with Procter and Gamble, and discussions for potentially some additional pack service there?

Chris, yes, there are some discussions. You know, not anything that I can really talk about at this time.

Okay. Would it -- let me ask you a question maybe a different way. When you think about your capacity in existing pack service facilities, do you think -- how would you think of a utilization rate? Could you do a significant amount more business with what you have, or do you think that at some point you would need to add some more facilities? Or I know you've talked about on the West Coast needing a little more presence, but just in general?

Chris, you are beginning to sound like a lawyer when you ask the question a different way all the time. [LAUGHTER] No, I'm just joking.

We have plenty of capacity, and I assume you're talking about our pack centers. We have sufficient capacity in those pack centers to handle additional business. You're right, I have talked about a West Coast, and we will make a decision soon on whether to -- to greenfield something on the West Coast, to do something else on the West Coast, because we're going to have a presence on the West Coast.

Okay. One other question for you, or actually two other questions for you. One is, could you give maybe some sort of your best guess as to what portion of your business would be, you know, related to or susceptible to swings in housing and construction?

So, you know, it's probably parts of your tube and core business with -- I think the Rainguard, SonoTube, or I think of potentially some of your white goods, protective packaging, things of that nature -- but what piece of your business would you estimate?

You know, Chris, I really haven't thought about it like that. Some of our protective packaging business, obviously, and appliances, it would be tied to housing starts. The Baker Reel business, there's a building wire component of that that would be that.

The construction tube is -- is primarily used in commercial and apartment applications and not individual homes, but in the tube and core side, as Charlie mentioned, a certain amount of that is -- would be carpet cores and that would go into houses, but that also has an apartment and commercial side of it. Charlie, you have a feel of what percentage might be indirectly or directly affected?

You know, I really don't. The all other segments, where it's principally Baker and protective packaging, and that's a little bit less than 10% of the whole. And then when you get into things like carpet cores up in tubes and cores, I think the answer -- no, I would expect it --

Negligible, but --

-- it would be not a very significant number. Probably it's just more a question of what it means to the general economy than what that specific sector mean to our business.

Okay. Thank you. And the last question I have is, Charlie, do you -- can you tell us where you're at with -- with hedging for energy next year?

You know, I -- I actually could. We've got an energy -- our price, I don't have the numbers with me, but I did look at them for our audit committee not long ago, And I believe that our 2007 costs will be right around [$7.30, $0.35, $0.40].

Okay. Very good. Thank you much.

Which I think is, you know, pretty much what the average for next year might -- might look like, if just look at the -- if you just look at the curves.

Okay. That's what I needed. Thank you.

Okay.

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