Pactiv Corporation F1Q09 Earnings Call Transcript

Pactiv Corporation (PTV)

F1Q09 Earnings Call Transcript

April 23, 2009 at 8:30 am ET

Executives

Richard Wambold - Chairman & Chief Executive Officer

Edward Walters - Chief Financial Officer

Christine Hanneman - Vice President of Investor Relations

Analysts

Tim Thein - Citigroup

George Staphos - Banc of America Securities/Merrill Lynch

Claudia Hueston - J.P. Morgan

Peter Ruschmeier - Barclays Capital

Alton Stump - Longbow Research

Mark Wilde - Deutsche Bank

Chris Manuel - KeyBanc Capital Markets

Al Kabili - Macquarie Capital

Richard Skidmore - Goldman Sachs

Tim Burns - Cranial Capital

Presentation

Operator

Good morning and welcome to the Pactiv first quarter 2009 earnings release call. This call is being recorded at the request of Pactiv. If you have any objections, please disconnect at this time. Speaking in this morning's call is Ms. Christine Hanneman, Vice President Investor Relations of Pactiv Corporation. Ma'am, you may begin.

Christine Hanneman

Good morning. I am Christine Hanneman. Joining me today are Richard Wambold, Chairman and CEO, and Ed Walters, our CFO. Welcome to our discussion of Pactiv first quarter earnings. In the course of reviewing our financial results, some of our comments today may include forward-looking statements. Please keep in mind that actual results could differ materially from those projected. Also, in our press release and this conference call, we discussed our earnings results using some non-GAAP financial measures. Reconciliations of those non-GAAP numbers to GAAP numbers can be found on Pactiv website at www.pactiv.com under the Investor Relations section under Financial Press Release. Richard?

Richard Wambold

Good morning, everyone. Excuse my cold as I get through this morning with this. Let me start of by just pointing out that we did have record earnings per share of $0.69. We posted a significant increase versus last year as a result of favorable spreads as revenue sizes were substantially lower year-over-year. Our volume was down 3% but frankly, that was better than the expected to be in the first quarter.

As we discussed in January with you, we come in the year with lower inventory levels as a result of second downtime on the fourth quarter because we were uncertain about the environment that we face in 2009 but inventory management served us well as we begin to rebuild our seasonally strong second and third quarter inventory levels. Our productivity programs and our focus on cost reductions resulted in improved production cost overall including lower logistics costs from lower fuel surcharges, lower line haul rates and lower warehouse cost.

Overall, we had a terrific quarter and we are managing our business I think very well in a tough environment. With ability to forecast as large as this one, it may be worth the comment on what we did right or maybe more right than what we expected to. Favorable spread was approximately half of the upside and better volume, operational improvements and cost control made up a little bit more than the other half. It was a real team effort with everyone in the Company contributing.

We are also focusing on cash here and we had great success in that regard in the first quarter. After $100 million free tax pension contribution, $50 million cost net of all the tax benefit, we improved our free cash flow to $105 million compared with $2 million last year. We are paying close attention to working capital. In terms of capital spending, we are focused on projects on a lot of next year's volume and will give us shorter paybacks.

Now, let me turn to each of the segments beginning with our Hefty consumer products business. Although the product categories where we compete were impacted by weaker consumer demand in the first quarter, we expanded our margins as resin cost declined and we intended to adjust pricing as necessary through many competitive. We saw a continued good growth in cups and cutlery which partially offset decline that we saw in which back in place. We did see consumers move more towards purchases of private labeled products given the soft economy. In addition, consumers were cutting back some more on discretionary items such as disposable plates.

We expect volume was down in the quarter because our price gap versus private label frankly was out of line which attracts us to bring this more than normal price premium levels and we are seeing meaningful upturn in least back sales in April. In the quarter, we continue to launch Hefty Odor Block, our new waste bag line. It is now available on all of our plan distribution and we are supporting with both advertising and coupons. In the quarter, we also launched Hefty One Zip fresh extend storage bags. That product keeps fruits and vegetables fresher longer. Both of these products offer the consumer better value and the way to save money during this difficult economic time.

Let me move to food services and food packaging. In this segment, our volume declined 2% which is better than what we expected and significantly better than we believe than we see in the overall market. We saw a growth in cups and cutlery both from our new business we have put in place in 2008 as well as the new business gained earlier this year with our acquisition of ClearCups polypropylene business. Our business was held up very well in a competitive environment and we expected to continue to exceed market performance throughout the remainder of the year.

As you have seen by now in our press release, we have adjusted both our earnings and free cash flow outlooks from our January guidance. Let me spend a moment giving you some of the rationale for these effort expectations. First, volume in the quarter was better than what we expected but more importantly the trend of shipments seems to be going in the right direction. We said last year in January and February of 2009 was frankly not that good. Obviously, the stocking distributor is holding out for lower prices and diminished consumer demand all figured into what we experienced in those months. March sales in what we have seen thus far in April showed measurable improvement, no doubt some of these is restocking but we believe that based on the last two months experience, volume could be flat with 2008 levels for the remainder of the year.

This would take us to the slightly negative volume number for the full year and that is what we have assumed in this point of our earnings range. We are trying to give you our best view based on what we are really seeing in this stage and it is a difficult job given the economic climate. We have not factored in the reduction in volume for further decline in the economy or for significantly higher deployment rates. I would like to point out that there are some risks in this assumption but we have not seen a compelling change at this point to include it. Keep in mind also that if some of this year gains we expect will not really begin to shift until we are in the middle to late part of the second quarter so I guess you could say we have some drive power in the volume side to help us.

The second assumption that we have made that can meaningfully affect our actual versus forecast results involves what might happen to resin cost. On average, resin costs have increased about 11% from the low point earlier this year, much of this increase occurred late in the first quarter. The Chemical Manufacturers Association is forecasting that pricing will decline for resin during the second half of the year. Despite softer overall resin demand than they originally forecasted, work capacity additions as well as production coming back after maintenance take it out.

In addition, crude and natural gas prices are lower than they originally expected because of the global recession and the export market for resin which has been strong recently is expected to dissipate. The Chemical Manufacturers Association believes all these factors will start to push pricing downward or at least cap it at present levels. The low end of our range anticipated that today's resin prices remain intact throughout the year. We operated in the range assumed at lower prices assumed in the forecast prevail.

Let me point out that we have not incorporated any resin price increases incurred levels in our outlook. A stronger economy, higher energy cost or a constrained supply scenario can all lead to higher prices. We have considered these factors and in total, recognize that they do cause some risk on our performance but we think the lower end of our earnings range represents that view of the risks involved.

In summary, we had a solid quarter and anticipate good performance going forward. We recognize that the economy could move in the wrong direction as resin could be will be greater negative than we currently anticipate. For our conclusion is that we have accounted further appropriately in the rates that we have given you. We are so proud that we continue to hang for our stock valuation is the potential impact of funding our pension plan. The storm cloud still remains at this point but it has not strengthened as many feared that it would during the quarter. As Ed will explain, we have a fair amount of flexibility regarding the timing of future contributions. This is important because it gives the market more time to work on our behalf and it creates a good buffer from which to manage our liquidity.

Let me turn it over to Ed to go through some of the financials and then we will come back and take the questions.

Edward Walters

I would like to begin with an update on the pension plan. In January, we announced our intention to contribute $200 million free tax or $130 million after tax to the plan in 2009. You know there is no requirement to do so because it was likely that will be required to make a large contribution in 2010. We contributed $100 million in February and contributed the other $100 million in April, all funded out of free cash flow. Due to the allocation of the $200 million contribution between tax years 2008 and 2009, approximately $50 million of the total $70 million cash tax benefits fell under the first quarter and the other $20 million benefit will come over the remainder of 2009.

After the April 21^st, we estimate that plan assets had a negative 4.5% return since the end of 2008. Our funding discount rate increased 49 basis points to 7.44% at the end of March compared with 6.95% as of December 2008. In our 2008 10-K, we provided a way to estimate 2010 cash contributions to the plan based on your assumptions for return of planned assets and discount rate movement during 2009. I would like to clarify that those estimates assumed an 80% funded level which is necessary to avoid certain benefit restrictions. In fact, as long as we are at least 60% funded, those benefit restrictions do not really impacted in a meaningful way. This means that we have more of flexibility in timing of funding than may be apparent from our 10-K disclosure.

To summarize, tax and funding is a manageable issue for us. We have plenty of liquidity and strong cash flow which we expect to be adequate to invest in our business fund the pension plan and repay debt.

Now, let me turn to the first quarter performance. Sales were $766 million, down 5% of last year driven by 3% lower volume, 1% lower pricing and 1% unfavorable foreign exchange. Earnings per share from continuing operations were a record $0.69 compared with $0.26 in 2008, excluding a charge of $0.07 per share related to a restructuring program first quarter of 2008 earnings per share with $0.33. The year-over-year EPS increase primarily reflected improvement and described between selling prices and raw material cost as well as improvement and logistics cost and productivity which offset lower volume and higher advertising and promotion expense.

Gross margin was 38.3%, up significantly from 26% last year. Operating margin was 21.8% compared with 9.8% on a reported basis and 11.5% excluding the restructuring charge in 2008. SG&A expense was $80 million for the quarter; $9 million higher than last year as the result of higher advertising and promotional expense largely in support of our Hefty Odor Block waste bag launch as well as lower pension income. The effective tax rate was 36.8% in the quarter compared with 34.3% in 2008.

After a $100 million pre tax contribution to the pension plan and related favorable cash tax, the tax free cash flow in the quarter was $105 million compared to $2 million in 2008. CapEx was $23 million in the quarter compared with $47 million last year. There were no share repurchases during the quarter. The average number of diluted shares outstanding as to the end of quarter was 132.5 million, slightly higher than a year ago. At the end of the first quarter, $118 million was drawn down under the Company's account receivable securitization facility, down from a $130 million at yearend.

At the end of the quarter, gross debt was $1.35 billion and net debt totaled $1.2 billion. Net debt to capital was 61.6% compared with 65.9% at the end of 2008. Since our acquisition of Prairie Packaging in June 2007, we have repaid $355 million of debt. There was no additional debt reduction in the first quarter as we focus on pension funding. Leverage which is debt to EBITDA was 1.9 times. Interest coverage for EBITDA with the multiple interest expense was 7.1 times. We are in full compliance with our debt covenant.

With respect to liquidity, we are in excellent shape. We fund our day-to-day cash flow needs through cash on hand, used with the asset securitization program and through our revolver which offers day-to-day filing. At the end of the first quarter, we have $70 million outstanding on our $750 million bank revolver and $152 million cash on hand. Depreciation and amortization was $46 million, even with last year. EBITDA for the quarter was $213 million or 27.8% of sales compared with $140 million or 17.3% of sales a year ago.

Now, I will review the Company's outlook for the second quarter and full year 2009. We anticipate that earnings per share for the second quarter will be in the range of $0.54 to $0.58. We have raised our EPS outlook for the full year from a range of $1.80 to $2 to a range of $2.15 to $2.25. Pension income for the full year is expected to be $37 million pre tax or $0.18 per share. The effective tax rate will be approximately 36.5%. The low end of our range assumes resin cost remained flat with the current level. The high end of our range assumes resin cost fall somewhat in the second half of this year.

On the sale side, we expect to see a decline for the full year in the range of 10% to 12%. This outlook incorporates flat volume for the rest of the year, 8% to 9% lower pricing based on normal price reductions to reflect lower resin cost and unfavorable foreign exchange of 1% to 2%. In that net, we expect year-over-year margin improvement. We anticipate SG&A expenses will be approximately $320 million to $330 million, up from our earlier expectations of $305 million to $315 million due to higher incentive compensation accruals based on our improved outlook for financial performance.

The outlook for free cash flow for 2009 has been increased from a range of $110 million to $130 million to a range of $230 million to $250 million. This outlook reflects depreciation and amortization expense of $185 million, CapEx of $120 million, a cash tax rate of 15% and $200 million of free tax pension contributions or $130 million after tax. Our free cash flow outlook is $120 million higher than the one we gave in January reflecting higher earnings and lower usage of working capital.

Richard, I will turn the call back to you.

Richard Wambold

Now, we will take questions. I would ask all of you to kindly limit your questions to one each, please. Rotate to them quickly, thank you.

Question-and-Answer Session

Operator

(Operator's instruction) Your first question comes from the line of Tim Thein - Citigroup.

Tim Thein - Citigroup

My question Richard is on your comment within the food and food service segment. I think it was centered down in terms of the market share gains will not kick until the second quarter. What for them to kind of offset or what would be the number in terms of kind of organic growth for the rest of the business or organic declines for the remainder of the business? I am just trying to get an idea in terms of what those mean.

Richard Wambold

Okay, well I did not mean to say that we did not have any market share gains in the first quarter. We did. What I meant to say is if you look at the seasonality of our sales, obviously a lot more of the new business that we brought on is really going to shift, really begin shifting in the second quarter. So, it is continuing thing but it is going to hit stronger in the second and third quarter so obviously the impact that we have in the first one. When you say, what does it mean for organic growth, it obviously means that we have the potential of depending on exactly what the market does and things slightly negative there to somewhat positive in that business, all things are taken in. I mean, not breaking out the new business from the old business but we have a reasonable expectation of being pretty close to, that is slightly positive in food service, I guess slightly negative in consumer side of the business and that can net out flat for the year.

Tim Thein - Citigroup

Okay, Richard, I know it is tough to put numbers on this just because the market is pretty tough to define but what is your best guess in terms of what your outflows relative to the market however you define that since Prairie has been fully integrated?

Richard Wambold

Okay, I think if you look at, it is very difficult to get a sense. I think you are looking for me to give you what is the market doing in food services and what we are doing. It is really difficult for us to pin that down. If you look at some of the data that we see, you can guess that the market is down 6% or 7%. Certain channels or certain markets are down even more than that but other channels are doing pretty well and I guess if you look at us in total and say that we are flat, obviously we have been moving our mix with the Prairie acquisition in a more balanced way so that we are less sensitive to the market downturn than what we used to be and it is a bit of surprise to use frankly but we are getting more of where the business is going in a down environment which is helping us offset some of the places where it is declining more like tablecloth and some of the distributor products. We are actually seeing more in faceted in other areas like that.

Operator

Your next question comes from the line of George Staphos - Banc of America Securities/Merrill Lynch.

George Staphos - Banc of America Securities/Merrill Lynch

I guess my question is around lean, can you quantify or give some general feel for how much that and productivity help the result in the first quarter and is it all contributing to the shared gains that you expect to increasingly come in second quarter and thereafter? Thanks.

Richard Wambold

Well, in looking at the lean program, we talked a lot about with all of our investors about what we are trying to do on the cost side and obviously we have the lean program that we are really focusing on the operating environment, we have Perfect Cube which is driving logistics cost and we have a project that we call 360 which is attacking procurement cost throughout the Company in a variety of way and all of those were actually highly interlinked in terms of driving the cost down right now.

If you were to look at our original forecast for this quarter and try to estimate how much of the better news, how much of the beat are paying from one area or another, you would see that more than half of the improvement results were coming out of the improvement results were coming out of those areas and the surprise here is not that we were going to get it. I think the surprise here is that we pulled out its motion the first quarter as we get. I would expect it to get the same ultimately the results but we did not expect to see as much of the savings in Q1 as what we did.

George Staphos - Banc of America Securities/Merrill Lynch

Right and it is far as a benefit to you in terms of share?

Richard Wambold

I do not know how to figure that out, George, I really do not. I mean obviously we are more cost competitive and we can go for more share but those kinds of decisions are not necessarily related. Obviously we are trying to drive our cost down in one area in all areas and we are trying to be competitive on the price side. We do not necessarily look at lean is allowing us to grow our business faster even though it probably is.

Operator

Your next question comes from the line of Claudia Hueston - J.P. Morgan.

Claudia Hueston - J.P. Morgan

You talked about the downturn you took in the fourth quarter. Can you just comment on how you operated this quarter and maybe just give some color on where inventories are now and then if you have any comments just on working capital going forward? It is obviously a very strong quarter for you on that type.

Richard Wambold

Yes, I am going to let Ed give you some of that.

Edward Walters

Yes, we would say that in the first quarter, we operated very well inventories. We have normal seasonal build in Q1 on inventories but we did not build inventories in the first quarter this year anywhere near the grade that we did last year and really frankly, we are finding out that we can operate at lower inventory levels. That was one of the benefits of driving inventories down to a very low level at the end of last year and that we found that we can serve our customers very well at a new lower level.

Richard Wambold

It is fairly one of the big surprises of lean. I mean, it is not supposed to be a surprise. People tell you that this is what happens but the reality is until you have actually taken the inventory out of the system, you do not prove it to yourself that you can actually have high fill rate on lower inventories and so as we went into this year and we start in looking at our working capital needs, particularly our inventory needs, we thought we were going to have to build more inventory than we ultimately did and it is one of the reasons of free cash flow is actually going to look better this year than what we anticipate it.

Operator

Your next question comes from the line of Peter Ruschmeier - Barclays Capital.

Peter Ruschmeier - Barclays Capital

Congratulations in the quarter. I want to ask a question if I could on the consumer business. I think you mentioned that Hefty may have tailed off early in the quarter but it looks like it plays some catch up in March and April. Can you share some of the least trends in terms of pricing shared dynamics that you see? I am curios if you are tracking the Nielsen data. I know it is not perfect but that shows lower share early in the quarter, better share later and then lastly related to Hefty and consumer, any guidance you can provide on the cash flow impact of promotional activity as it relates to rebates and what not going forward?

Richard Wambold

Well first to answer the last question and that is that we have a good plan to support the product and it is all incorporated in the range of outcomes that we gave you for the year. So, we have a good plan there but I will break out exactly how much because obviously it is a competitive question for us. But in terms of the trend in Hefty, the fact of the matter is from the launch period which really we think of as being late last year into beginning of this year; we really did not have our pricing right. I mean we were attempting to but prices were getting adjusted in the market place. We were trying to understand what the market was really doing and we were trying to get to get there but the reality, we did not get on the shelf side appropriately until fairly recently.

The result was that our product will sell at a premium over private level but not an infinite premium over private level and we had got it out the line. So, it was very difficult for us to really move a lot of product and therefore the market share data well is accurate and we start to look at it as we stay couple of points off or whatever, it is accurate. But it does not really necessarily describe what is really going on in the market. What we really saw was the fact that our pricing was out of lag. And so as we have adjusted that, we have began to see a waste bag business pick up the volume again. So, we think we are probably posted out right now.

Operator

Your next question comes from the line of Alton Stump - Longbow Research.

Alton Stump - Longbow Research

Just a quick question on the pricing front in view of what you just said to that prior question, obviously it looks like things are going quite better on that front in a falling resin cost environment. How stable do you think price they can be over the rest of the year if we do see let us say a fall off in the cost of resin for a couple of quarters? Do you think there might be more margin gain opportunities there?

Richard Wambold

Well, I think the way to look at it is this, I mean if you look at the back end, if you look at our forecast right now, you can see the pricing is adjusting. I mean otherwise, we will be giving you the forecast that we just gave you for the full year. It is up but we are going to give back a lot or half. Actually, we are giving back a fair enough of the resin cost already. We are contractually obligated to a large portion of our business and we do in the other portions of our business to remain competitive where we would not be able to move as much volume as we are.

So consequently, those prices are naturally adjusting and coming down. So what is going to go on with margin as we look at the remainder of the year, my guess is they are going to stay healthy. They are not going to be at the kind of the rate that we had in the first quarter but you actually what do I think will happen in gross margins between 31% and 33% probably likely numbers, I think we will stay on the healthy side of that curve throughout the remainder of the year and that is using the resin forecast kind that we have given you. The decline as you said and that gives us the upside obviously we will be towards the operating to that margin range.

Operator

Your next question comes from the line of Mark Wilde - Deutsche Bank.

Mark Wilde - Deutsche Bank

On Tuesday, big supplier of packaging into the food and food service business reported that their volumes had picked up pretty sharply in the first half of April. I am just curious about whether you have seen this. I think you have suggested that you have in the Hefty business, but across the rest of your portfolio?

Richard Wambold

Yes, I cannot make the April comment per se. I think the way we view it, it was not that big sharp uptick in April. I think what really saw is a trend that really started in March. It has been better in March and even a little bit better than that in April.

Mark Wilde - Deutsche Bank

Okay, that is helpful.

Richard Wambold

It could be, every packaging spot is different in how they are seeing things but I think what we all probably come to grips with is it was dismal in January and February. So, anything after that looks great. But it had ticked up.

Operator

Your next question comes from the line of Chris Manuel - KeyBanc Capital Markets.

Chris Manuel - KeyBanc Capital Markets

Congratulations on an outstanding start of the year. I want to come back to George's question and come out in a little different direction. Given such strong performance here in the first quarter and then taking into account your guidance for the second quarter, if we were to take the midpoint of that second quarter range and sort of the midpoint of what has been the balance of the year would be, it would suggest that the back half of the year is essentially flat, maybe up a penny or two but close to flat versus last year on flat volumes. Is there anything about either should we think of that as somewhat conservative or should we think about some of the productivity initiative that you saw such good traction on this quarter as being more front end loaded that will not have the same fall through later in the year? Can you help maybe bridge that gap?

Edward Walters

I think when you are saying flat, I think you are referring to earnings flat, right?

Chris Manuel - KeyBanc Capital Markets

Yes.

Edward Walters

And I think, you are more or less correct. You are off the mark, I mean that is about right, about a couple of cents.

Richard Wambold

It is a little better. It is better than it was last year. Keep in mind also the fourth quarter of last year with resin declined. So, you have a pretty good comp in the fourth quarter to start with but I think that is probably reasonable. Now, when we gave you our original forecast, we gave you a forecast that included its pretty good productivity improvement or pretty good, let us call it cost that includes all the programs to begin with in those numbers and I think the surprise to us is not that we got them. I think the surprise to us is that we have done as well as early as we have and so therefore they were not really incorporated in the performance that we expected in the first quarter.

So, will they get better? They could. I am not going to project them at this point that they will be better. There is room for them to be better but just because you can problem it earlier does not necessarily mean that there is more of it. Of course because they get a price reduction on a procurement project and you get it on February 1^st but if you get more of it for the full year because you got it out on February 1^st but it does not increase the reduction that you got. So, I would say your estimate is about right and why will we give you that? I guess we are still looking at a year that is very difficult for anybody to predict.

Chris Manuel - KeyBanc Capital Markets

And it is early in the year, I appreciate it. [38.21] at the expense of whether you felt it at this juncture as though there were not any necessarily one-time nature in what you got and it does not sound like something that you just got some stock early?

Richard Wambold

I think that is probably on the cost side. I think that is probably right and I think you have to look really when you, our business is a sunny business swinging. Everybody likes to measure businesses first quarter versus first quarter and that is how we do it but when you have a business that has a twice in cost structure that rise throughout the year together, sometimes sequential views of the year are maybe a better way to look at it. So, sometimes looking at the fourth quarter versus the first quarter is we have sequentially we get is another piece of important data to look at and I think because resin began to drop in the fourth quarter, you can see that while we put that in our pocket to some extent then and did not get a lot of it back, we gave some of it back which you can see the difference really between the first and fourth, a lot of that is that cost coming in but also could be coming in.

Chris Manuel - KeyBanc Capital Markets

That is helpful. The only follow up question I have in relation to this was with the big swing in resin movement that we have seen, what would you consider normalized margins to be in your food service and in your consumer business? It is different once you pick the different levels and clearly the levels that we saw here in the first quarter were not permanent levels either but what would you consider now to be a normal range for both of those businesses?

Richard Wambold

I think we have always said the same thing. I will stay with it now. I think the reality is this business is going to move and it is somewhere between the high 20s on a gross margin basis to the low 30s and it is going to pivot around what is going on in the resin market at any given point in time and we have always tried to point people to 30% to 31% as the gross margin as kind of a good average number to look at over the long haul. It will never be exactly that number on a steady basis but that is a good average number for us.

Operator

Your next question comes from the line of Al Kabili - Macquarie Capital.

Al Kabili - Macquarie Capital

Question on the pricing trends, I think you commented you expect a down a high single digit. Can you just talk about what you saw in the first quarter pricing that you mentioned that it was starting to come down probably anywhere near that down high single digit already in the first quarter or where are we right now?

Edward Walters

Well, the pricing in the first quarter was down 1% year-over-year. So, the pricing coming down I think you will see it hit pretty significantly here in the second quarter.

Al Kabili - Macquarie Capital

Okay and then what is driving so much of that? I mean I understand contractually 30% of the business is contractually obligated but on the remainder and particularly in the consumer, I mean there is no contractual obligation. Is there any chance to hold on to some of that price better than that just given the volumes were not too bad in the first quarter and you got a kind of margin expansion?

Richard Wambold

Well, actually when you look at those numbers, we actually are holding on to some of the pricing. I mean we are not going back to what we were last year. We are in fact managing spread to some degree better but at the end of the day, this is a competitive business and whether or not we have a contract or whether or not we have a free market, we are finding competitors out there. They are prepared to supply the product and if we want to supply the product, we are going to have to be competitive on the price and therefore over a period of time, the whole market sort of move. It is not a matter of us moving our price. It is a matter of the market pricing moving down through what is probably millions and millions of transactions that are going out there. It is like it just begins to slide and so we can say guys were going to give better than the other guys and I think we are probably might be a little bit better but the reality is that the market will in fact control pricing ultimately based on the demand for the products.

So, I would expect what Ed said to be exactly true. I would expect to see a fair amount of the adjustments come out in pricing happen so that they impact the second quarter.

Al Kabili - Macquarie Capital

Okay, got it but just to clarify those have not happened yet to your knowledge.

Richard Wambold

They are happening everyday.

Operator

(Operator's instruction) Your next question comes from the line of Richard Skidmore - Goldman Sachs.

Richard Skidmore - Goldman Sachs

Richard, can you just talk about how you think about use of free cash flow as you go forward given the revised guidance outlook for free cash flow?

Richard Wambold

Obviously, it is going to be focused on one to two things right now. But likely it is going to be focused on debt reduction or potentially focused on the pension fund. We have not made any decisions about that yet. We like to generate the free cash flow before we spend it. So, consequently as we go through the remainder of this year, we are pretty positive about the prospects we are generating a lot of cash. It gives us a good chance to make some good progress on our balance sheet or against the potential influence of our pension one or another. But that will be our two primary uses of cash now.

Richard Skidmore - Goldman Sachs

Okay, thank you and if I might just follow up on a previous question with regards to the productivity gains that you made in the first quarter, do you expect that over time that helped to have a higher sustainable margin or do you ultimately see that be competed away in the form of lower prices?

Richard Wambold

It depends on which one makes us more money. I mean, it is a simple as that. At the end of the day, we try to make good decisions around what is going to drive earnings and returns in the Company and for me to say it is going to always show us higher margins. Sometimes it does because we think it is the smarter way to move to hold the margin. Sometimes, we can be more price competitive and get a very good piece of business that will drive more earnings in the portfolio and particularly, if we are doing that with existing assets, it is going to drive returns out. So, we make this kind of tradeoff everyday.

Operator

You have a follow up question from the line of George Staphos - Banc of America Securities/Merrill Lynch.

George Staphos - Banc of America Securities/Merrill Lynch

Richard, I want to come back to the question of productivity and logistics. I guess realizing that some of the shared gains that you have captured will begin to show up visibly in second quarter and third quarter. Are you finding that some of the new ways to running a business with some of the processes you had developed around logistics have allowed you to sign up even more in the way of the types of customers and food service who could have been a partnering arrangement, actually it is not the correct phrasing, but how find that attractive?

Richard Wambold

I know where you are going, George. The answer is clearly a more frequent discussion point and it is clearly a benefit that we have that we can go out and sell. Can I claim that that is will close us a deal at this point in time that logistics, occasionally it plays a role on it. At this point in time, we have not had more what I would call partnerships, what I would call a full blown partnership close although the discussion is more frequent in that direction. I think it is going to take us time to do that but it is a very, very useful tool to us and it should help us long term when you form that kind of a partnership, it lets both parties drive cost out of their system and it is very, very attractive to both the customer end because they are costs are down at the same time.

So, it is something that we have to prove to people that we can do on a routine basis that I think we are going to see more of a going forward.

George Staphos - Banc of America Securities/Merrill Lynch

If I could ask a follow on..?

Richard Wambold

Alright, yes.

George Staphos - Banc of America Securities/Merrill Lynch

I appreciate it. Do you think that in an environment where credit maybe is finally fine that the value added around that type of relationship maybe is not as great as when credit is very, very tight and your customers potentially are focusing a lot more on their own working capital efficiency where you think it really is not to make much of a difference either way?

Richard Wambold

I have not heard that come up yet but I am going to use it in my next meeting.

George Staphos - Banc of America Securities/Merrill Lynch

And you will share the notes with all of us.

Richard Wambold

Yes, it is a great sales point. It is a great sales point. I should have thought of that at myself.

Operator

Your next question comes from the line of Tim Burns - Cranial Capital.

Tim Burns - Cranial Capital

Richard, I am sharing your cold at. Good morning, Christine. Resin runs through a lot of P&Ls and it is negative at points, it is positive at points. We are enjoying it right now as you should. I guess when you look at the core of your business, I mean our permanent cost reductions like you are doing through lean and new and more profitable products in the portfolio, I mean are those kinds of the core drivers beyond resin?

Richard Wambold

Absolutely. I mean this year, we are tackling cost I think extremely well in the Company and it is something that we have to do long term. It has become more competitive and as we said a moment ago, does that mean more margin or more growth? It is a tradeoff. It depends on what we are looking at. But obviously, we have a big procurement project going on this year which is becoming very, very successful. We call it project 360 where we are going out and meeting with all of our vendors and bringing our cost down. Our lean project, it is clearly now showing up in two ways. One of them is lower production cost, higher productivity but clearly, our ability to run this business on lower levels of inventories and have better fill rates is now established. I mean, it is just a fact and how far we can go with that? I do not know but we still have a good distance to go with it.

So, obviously those kinds of things are going to play a bigger role in terms of driving the profitability let us call it that the profitability of this business going forward.

Tim Burns - Cranial Capital

Got you. I always ask you this but where are people eating today?

Richard Wambold

I am going to eat in the cafeteria downstairs.

Tim Burns - Cranial Capital

That is because it is subsidized but that is beyond the point. I got a last question for you. Point 342, new products, is there a realistic number that you can bring to the shelf each year and do you have to fund it or do you choose to fund it by reducing CapEx, the ANR expense?

Richard Wambold

Oh, no, the last part, no. We do not think of it as, we never compete with capitalist. It is something different but we have a pool of money that we use for launching products and we try to launch the launch that we think will be even more successful out of that pool and occasionally, we will have a product that requires more. We have not had one for few years but occasionally, we do. But really if you are really looking what the driver of new product development is, it usually is, it is a function of the amount of engineering resource we have and frankly to some degree, the customers were working what their demands are for new products. Some of these are individually done for individual customers and some of them are done for the nice market.

So, every year we look at it. It takes two or three or four years sometimes to get a product under the shelf so it is not an over night decision. So, once you have invested in and you are ready to go, you usually launch in that year.

Tim Burns - Cranial Capital

Got you, go ahead.

Richard Wambold

This will be four.

Tim Burns - Cranial Capital

This will be four?

Richard Wambold

We will have to put you back in line, Tim.

Tim Burns - Cranial Capital

No, this is not four, is not it?

Richard Wambold

Yes. I was just going to have two but you have done three. If you do not mind, get back in line and we will pick up your question before we end.

Tim Burns - Cranial Capital

Sure.

Operator

You have a follow up question from the line of Mark Wilde - Deutsche Bank.

Mark Wilde - Deutsche Bank

Richard, you have been talking about some of these food service partnering relationships for at some time as well as the fact that they would ramp up here as we move to the second quarter. I am just curios over the last three or four months, have you seen those relationships give you even more traction than you would expect it?

Richard Wambold

Okay, so let us get back and let me try to repeat what I did say to your close. What I have said is we have signed one partnership. That is with Cisco, we announced that and we said it would, the volume from it would ramp up as we went through in the first quarter and first half of this year, which it is doing. We are eager to develop other partnerships with other customers. We are working on a couple of those today but we have at this point in time, we have no others that I would call full pledge partnership signs. We have one other where we are doing a lot of the work that would go into a partnership, not all of it but we do not have the exclusivity with that customer and I think at the end of the day, you need to have an exclusive product arrangement in order to provide all the benefits.

So, the one that we have is in fact ramping up. It is ramping up nicely and we are working on trying to develop some others this year.

Mark Wilde - Deutsche Bank

Okay, fair enough.

Operator

You have a follow up question from the line of Peter Ruschmeier - Barclays Capital.

Peter Ruschmeier - Barclays Capital

Just a follow up on your Perfect Cube and 360 program, I just want to try to better understand this because this is I believe primarily related to transportation types of savings, logistical savings and I was curios if you could in any way help to quantify how big of an opportunity this is in terms of how much you are spending on transportation. I would think it is a big number and then how much was realized already in the quarter and I presume it is a function of both market prices but also what you are doing specifically. So, any clarification on how to think about those issues will be helpful.

Richard Wambold

Well, there are different programs actually so let me untie them for you. Perfect Cube is a logistics program. It is all about redesigning our product line so that we can put it in due boxes. I do not mean we are driving any new product but redesigning the skews with the way we actually boxed the product and so on such that we can increase the utilization inside the truck so that we can get full shipments. That is going along, we think we will probably be somewhere in the neighborhood of maybe as much as 80% of our volume. We will have a capability of being shipped in Perfect Cube by the end of this year. We have estimated that that is worth about $10 million to our P&L with, this is a program that is rolling out during the year and you have to go to individual customers and get them to accept it. That is a number that has legs on it for adding more value in 2010 and beyond.

But at this point, the only number we have given out as we would anticipate that we review were $10 million in 2009. Project 360 really does not necessarily have anything to do with any particular functional area. It may have some benefit in logistics but it is a general program up for procurement. So, it is focused on every single thing we buy from MRO parts and the maintenance items that we use in our plants to office supplies to airplane tickets to the containers and cover bags that we use when we ship our products to everything that this Company pays for it and it is a fairly, not fairly, it is actually a very strategic program, has a number of permanent teams that have been formed cross functional that allow us to go out, understand what we buy, consolidate what we buy and bid it out to suppliers in such a way that we can reduce our overall cost.

I think we suggest that that is worth this year about $30 million to our bottom line and it is going along nicely and I would say part of the reason that we are doing better is in the first quarters that we have actually been able to do more of that earlier than what we anticipate.

Peter Ruschmeier - Barclays Capital

Okay, and how much if any of those numbers reflects lower market places for transport in terms of diesel fuel surcharges and lower freight rates?

Richard Wambold

Well, obviously lower freight rates are big deal. We have bid that out and have been successful in terms of lowering freight rates. Obviously, diesel fuel costs are down and that would factor into our savings as well.

Peter Ruschmeier - Barclays Capital

And so just lastly, is there that that is probably front end loaded that most of that step change benefit is probably with you and then you might get some incremental benefits going forward but I would think you have already had a big benefit from those lower rates.

Richard Wambold

I think that is a safe assumption.

Operator

You have a follow up question from the line of Tim Thein - Citigroup.

Tim Thein - Citigroup

Just a follow up on the consumer business, Richard, I am curios if you have seen any pressure in terms of shelf space and any I guess more pressure in maybe what you have seen in the past and as an extension of that, with the upcoming low out of the great value brand by one of your major customers, have you seen any or do you anticipate any issues of that in terms of greater presence within the private label channels in which you compete?

Richard Wambold

I think that the waste bag business, Tim, to be honest with you is going to be more competitive business not necessarily because of shelf space. Just thinking general, it is going to be more competitive business in this kind of macroeconomic environment. I mean as people learn or not willing to, they are going to private labels in a lot of different areas and to me, when I look at that that means that our competition for the time being is private label and we need to make sure that we are promoting our product the right way and that we are priced correctly against that competitor and we have made those adjustments. We feel comfortable with those adjustments. We think we will do well.

I should also point out, it is all incorporated in the forecast that we have given you and another thing I should point out is that Pactiv I think has done a really good job in terms of diversifying its growth and as it does so and drawn over the last several years, the waste bag business which at one point was a dominant part of our business is now less than 10% of our total Company business and in fact, when you look at the profitability of that, it is really in line with other consumer products that we sell on the shelf in terms of our profitability.

So, it is not quite the kingpin that it used to be but it is an important business to us. We like it. We like it at the current price. We like it at its current profitability and we will continue to invest in it and grow it and if we have to compete with private label to do so, we will.

Operator

You have a follow up question from the line of George Staphos - Banc of America Securities/Merrill Lynch.

George Staphos - Banc of America Securities/Merrill Lynch

Richard, last question, if I look back at some of our longer term models on you, the aps intensity and I am just looking at revenue dollars well relative to the amount of invested capital in the business, I have gone from under a dollar back in 1999 timeframe to almost double that now, obviously pricing resin come into play here but clearly the trend has been positive. Do you think and could you quantify to some rough measure what some of these new productivity initiatives, what thing could mean for they has been sensing the business looking out the next two to three years?

Richard Wambold

George, I will try because this is, I am more of a blocker and tackler when you asked to give into the vision side, sometimes it is a little difficult for me but if you really look at lean and what the vision is for lean here, it is nice to be talking about the fact that the cost per unit comes down. What is really interesting about lean though is that the capacity utilization as you are doing is if you are only making your product that you are selling which is the goal is ultimately that this becomes a call based system which we have done a lot towards converting it to.

When you are only making new product that you are actually selling that means you actually end up having a capacity to make a lot more product on the existing machines. So, in a sense it creates free capital for you and we have seen that. I mean you can see that in the numbers and that is really ultimately what measure this. One could say where are you in terms of overall capacity utilization in the Company right now? And we are probably somewhere in the low 80 and let us just for purposes of thinking about it, so you are at 80 and you could run it at 90.

Assuming for a moment that you can find the market for each of the products that you could produce on all of that 10% extra capacity, by definition you could add 10% of sales. That is really the way you think of it. You could add 10% of sales to the Company on the existing asset base at only the cost of the raw materials, maybe a little bit of extra labor but basically that is it. When you really start to look at lean over the long haul, that is what you are trying to get at and so, I do not know what the contribution margin on the business would be but it is quite high and so therefore, you take $350 million or so and look at the contribution margin, that is the kind of benefit you would really like to get. Can we get all the way there? Probably not but we can get a lot of that over the next several years.

Operator

There are no further questions at this time. I would like to turn this now back over to management for closing comments.

Richard Wambold

Again, I would like to thank everybody for participating in the call. We really do appreciate your interest in the Company and we are looking forward to completing 2009 at a pretty significant good numbers on the board. Thanks a lot. We will to you again in July.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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