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Graphic Packaging Holding Company (NYSE:GPK)

Q1 2009 Earnings Call Transcript

May 7, 2009 10:00 am ET

Executives

Scott Wenhold – VP and Treasurer

David Scheible – President and CEO

Dan Blount – SVP and CFO

Analysts

Joe Stivaletti – Goldman Sachs

Sandy Burns – Sterne Agee

Bruce Klein – Credit Suisse

Jeff Hollis [ph] – Barclays Capital

Operator

Good morning. My name is Molly and I will be your conference operator today. At this time, I would like to welcome everyone to the Graphic Packaging Holding Company first quarter 2009 earnings conference call.

All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. (Operator instructions) As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, May 7th, 2009.

Thank you. I would now like to introduce Mr. Scott Wenhold, the company's Vice President and Treasurer. Mr. Wenhold, you may begin your conference.

Scott Wenhold

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

I would like to remind everyone that statements of our expectations on this call constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements including but not limited to statements relating to debt reductions, targets, declines in raw material and commodity prices is expected to reflect on the company’s results, additional synergies from the Altivity transaction, consumer purchasing trends, pension contributions, and the performance of our Multi-wall Bag business are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the company's present expectations.

These risks and uncertainties include but are not limited to the company's substantial amount of debt, inflation of and volatility in raw material and energy costs, volatility in the credit and securities markets, cutbacks in consumer spending that could affect demand for the company's products, continuing pressure for lower cost products and the company's ability to implement its business strategies, including productivity initiatives and cost reduction plans.

Undue reliance should not be placed on such forward-looking statements as such statements speak only as of the date on which they are made and the company undertakes no obligation to update such statements. Additional information regarding these and other risks is contained in the company's periodic filings with the SEC.

David, I’ll turn it over to you.

David Scheible

Thank you, Scott. Good morning, everyone. Thank you for joining us today to discuss our first quarter results. Arguably we are operating in one of the more challenging economic environments in history. Seems on a daily basis, there is elevated market volatility in the global economy entire credit markets. With that as the backdrop, however, I believe we have performed very well taking the necessary steps to successfully navigate this environment, position Graphic Packaging for long-term growth.

This morning, I am going to start by providing you with a brief overview of our quarterly results including progress on the synergies we realized from the combination with Altivity. I will conclude with a review of our key business and their performance and then I will provide some insights into our future direction. Following my comments, Dan Blount, our CFO will walk you through our financial results for the quarter in greater detail.

Similar to our practice last year, we will include comparisons to the 2008 first quarter results restated on our pro forma basis, assuming the acquisition of Altivity that occurred on January 1st, 2008 and excluding the results for the two divested mills. This will give you a more apples-to-apples comparison between the periods. Once we have concluded our remarks, we will open the call and look forward to answering any questions you may have.

Last night, we reported results for the first quarter of 2009. A quick recap shows that due to the slowing global economy and continued de-stocking of our customers, our pro forma sales decreased by about 7% year-on-year on lower volumes. The majority of this decline was in our Multi-wall Bag and Containerboard businesses as they were buffeted by the downturns in the construction and general economy. However on a more positive sign, sales to our food, our core food and beverage markets were down roughly 3% in the quarter, where GDP was down 6%, industry sales were down almost 5% from previous periods.

Trends towards consumer eating and drinking at home continued to help make our core business more recession resistance in the general economy. Following trends we’ve seen over the last few quarters, both pricing and total cost reduction including synergies were improved and led to higher margins. Pro forma adjusted EBITDA margin improved over a full point from 11.6% in the prior year quarter to 12.7% in the first quarter of 2009 and 2.9 points over fourth quarter of 2008.

Our first quarter adjusted net loss was $0.04 a share, a $0.03 per share improvement over our pro forma adjusted net loss in the prior year quarter of $0.07. Pro forma adjusted EBITDA improved as well to $130 million during the first quarter of 2009 compared to $127.6 million during the first quarter of 2008. This was our best quarter following the transaction with Altivity and you will recall it was just a year ago in March ’08, we combined the operations of Graphic Packaging and Altivity to create one of the world’s largest packaging companies.

As part of that combination, we set out to achieve at least $90 million in the annualized synergies by 2010. Although, we will discuss this in greater detail in just a moment, I’m proud to announce that we’ve already exceeded this goal by achieving annualized synergies of almost $92 million by the end of first quarter. We are excited by this accomplishment and continue to work on locking future savings as well.

Another positive during the quarter relates to cash flow. Cash flow from operations improved $77 million versus the same period last year. Our continued focus on the reduced working capital particularly our inventory management combined with the margin improvement were the key drivers.

We’ve increased our debt reduction targets for 2009 to a range of $170 million to $200 million. We are keenly where our critical list metric is in the credit challenged marketplace. We have several strategies in place to achieve this target and we believe our business is headed in the right direction. We’re taking the necessary steps to navigate through this unprecedented market to improve our year-on-year results.

Just talk a little bit about raw materials. Higher input costs continued to negatively impact results. But we are seeing the rate of inflation moderate from prior year quarters. As we experienced about $30 million of inflationary costs in the first quarter, this compares to a 2008 quarterly run rate of almost $60 million.

In particular, we are seeing year-over-year favorability in our secondary fiber as OCC pricing remains at relatively low historical levels. We’re being careful not to count on this benefit going forward. However, as we did see a small uptick in pricing during the first quarter, as international demand for OCC has picked up particularly in China.

Although those to incrementally higher than a year ago, the rate of increases have slowed dramatically for chemicals, inks, and coatings, freight and other petro related inputs as a barrel of crude oil is roughly half of what it was a year ago today.

Prices were relatively stable during the first quarter, contributed $24 million versus the same period 2008. CUK board remains essentially unchanged from fourth quarter of 2008, while CRB price moved down slightly in the quarter. This reflects the difference in operating rates of these two substrates. Our current supply contracts typically have time lags both as costs moved up and down. So as you would expect, prices did move up slightly during this quarter, driven by last year’s unprecedented increase to input cost. We do expect downward pressure on most products will remain in this soft economy.

If you look at our mills, both our SUS and CRB mills had a very solid operating performance in Q1. I’m particularly encouraged by the improvement on our West Monroe facility. We exceeded all key operating effectiveness and total cost metrics versus the same period last year.

Fortunately, it was not necessary to take market related downtime in these grades. But you will recall that we did permanently shutdown our number-two paper machine in West Monroe late last year, which allowed us to balance production to demand particularly for SUS. However, it was necessary to take 19 days of market related downtime on our corrugated medium machine in West Monroe and five days on our URB mill in Pekin, Illinois.

The financial impact for the quarter was roughly $3 million of EBITDA. Medium and URB volumes are expected to remain under continued pressure, but we’ve put initiatives in place to leverage more internal volume in these grades going forward. We would prefer not to have to take markets downtime on our machines, but we will continue to match supply to demand to all grades. Building unsold inventory in this economy is a poor cash flow decision.

If I look at our synergies, our ongoing continuous to improve initiatives to integrate and optimize our production facilities ensure that our customers are reliably supported from a solid network of efficient low-cost manufacturing facility, while generating positive EBITDA. We’ve continued to focus on these goals over the past 12 months and we’re better positioned today to strengthen our earnings performance and continue our debt reduction, even under the current challenging operating environments.

During the first quarter, we implemented a standardized metric and counter pressure system in all seven of our production mills, which is now being used to evaluate, manage, sustain and share improvements across the entire mill system. This continuous improvement tool will helped to perform mill performance during the first quarter.

Additionally, the Macon, Georgia facility and our Middletown, Ohio mill rolled out lean sigma initiative during the first quarter and we’ll anticipate extending this continuous improvement method to our other mills throughout the rest of 2009. Our focus on these processes to drive down our cost will ensure we maintain our lowest cost producer position in this space.

As I mentioned, the combined – the combination of our Altivity has resulted in annualized synergies of over $90 million, while our continuous improvement initiatives have generated additional total savings of over $80 million since the combination in March of 2008.

During the quarter, synergies contributed $23 million of cost benefit. Looking forward, we expect to continue to realize incremental savings above the $90 threshold while we are taking out an additional $50 million from cost from our continuous improvement programs in 2009 as well. As a result of the additional cost savings opportunities resulting from the combination of Altivity and our experience and track record taking out our settlement costs, I believe we are better positioned than our competitors for continued margin improvement.

Some of the actions we took in the first quarter to help us continue to achieve those results included announcing the discontinuation of production at our Tuscaloosa, Alabama folding carton facility by the end of second quarter of 2009, as well as the permanent shutdown of our folding carton plant in Morris, Illinois and Muncie, Indiana during the third quarter of 2009.

In addition to these facilities, we announced the permanent layoff of approximately 60 employees at our Elk Grove Village, Illinois converting facility and the expected closure of our Multi-wall Bag facility located in Cantonment, Florida by the end of the third quarter ’09 as well.

These actions are not a result of the slowing economy, rather an extension of our synergy integration plans and are designed to increase our manufacturing efficiencies and streamline operations, helping the company to operate the lowest cost structure in the industry. This streamline cost structure and improved manufacturing efficiency will put us in a position to generate higher long-term margins and better cash flow when the market eventually rebounds.

Let’s talk about our businesses a little bit, starting with food and consumer. First in food and consumer sectors during the first quarter, packaging sales to domestic food and consumer products markets were impacted by continued de-stocking and aggressive cash management at our key customers. Sales continued to show similar trends to Q4 with consumers focusing on value purchases as opposed to premium brands. More specifically, sales of these markets during the quarter were down approximately 3%.

Looking at consumer prices in general, according to US Department of Labor, CPI, inflation in the food and home category averaged about 4.9% in the first quarter. This is in star contrast to overall inflation and average to negative 1.7% for the quarter. The ACNielsen retail packaged sales data reinforces our view that the economic environment has affected both type and amount of package goods purchased.

Aggregate annual units growth in the major packaged food categories that we track did increase about 2.2% in 2009 and this is compared to 1.4% growth in the same period for 2008. The categories that did particularly well in the quarter were dry dinner mixes, which increased 7.3%, frozen pizza 3.3%, and refrigerated products at 2.7%.

Although our consumers are still buying products, the data suggest they are being more value conscious and avoiding or delaying purchase of non-discretionary items. Products such as candy, frozen baked goods showed steep unit decline from a year ago, posting sales losses of 18.7% and 7% respectively.

We actively track those trends to ensure we remain nimble and can adjust our manufacturing and sales efforts accordingly. The data supports our views as the consumers are increasingly seeking more basic high-value food and packaged goods offerings and our business has realized a benefit in this area as a result providing us some insulation from the down economy.

Additionally, the sales decline was driven by de-stocking across the entire supply chain. Not just that our customers and their customers, but in consumer pantries as well. People everyone are watching cash and adjusting their purchase pattern. They’re keeping one frozen pizza versus three or fewer types of cereal on hand and they’re buying less overall large quantities of time.

Poor consumption is not down, but inventory is being adjusted within the entire foods supply chain. This inventory purchase has slowed from Q1 level, but I know it’s hard for our customer to predict how volume will flow for the entire quarter and for the entire year and difficult for us as well.

If I look at beverage, the story is very similar. While growth in overall domestic beer market continues slow, it demonstrates some recession resistance as take home volumes were actually up 0.5% over the same period last year. Imports continued to decline, were down 2.1%, while domestic premium segment was down almost 1.1%.

The domestic sub premium segment on the other had grown 2.5%. Supporting these trends, the consumers are trading down from (inaudible) can which is consistent with the move to less premium offerings. In total, net beer sales beat the prior year quarter by more than 6% as driven by improved pricing, mix and new product launches.

Sales in corrugated soft drinks and premium beverages such as teas continued to be sluggish largely due to the reduced retail promotional activity and the negative impact to the economy on premium beverage sales. Offsetting these declines are co-packers strategy aimed at increasing multi-packing for energy drinks and non-corrugated beverage continues to outperform our expectations as these segments – as this segment of the business outpace the overall soft drink market.

Within soft drink, first quarter sales increased roughly 3%. During the first quarter, we launched several new brands such as energy drinks for Target stores within our co-packer network, essentially tripling our quarterly sales volume compared to last year. We signed a long-term exclusive agreement with the Minute Maid Company to supply our patented deep blue packaging substrate replacing the corrugated construction for their juice pouch business and that will begin scaling up middle of this year.

Looking at Multi-wall Bag, it’s a little different story. This makes up roughly 12% of our sales and we experienced considerable weakness in our industrial and building products end-used markets as demand in those two areas fell remarkably. As a result, tons shipped in the first quarter were down almost 18%. Despite the drop in sales, cash flow year-on-year was positive due to the quick counter measures taken in this business. Including our combination of improved working capital and inventory management as well as extended converting downtime, again we are balancing demand and supply.

As we look ahead, our plan remains to be focused on minimizing sales shortfalls in this business, optimizing our manufacturing footprint and maximizing our cash flow opportunities through capital spending and working capital reductions. We are encouraged by some of the recent trends in this business we are seeing with our customers who have noted and expectation to see stabilized volumes by early summer.

Regardless, we’re preparing and operating business in such a way that it will allow us to flex cost in response to changing volumes either up or down. We will watch these developments closely and look to capitalize on market opportunities early in the process. In summary, by right sizing the cost structure and optimizing this business foot print, now we expect our Multi-wall Bag business to emerge from this lack luster period stronger than before.

Before turning the call over to Dan, I would like to mention that despite a difficult sales environment, we continue to make significant investment in new product development and have seen positive results during the quarter. In fact in Q1, new product sales were up 20% versus Q1 last year. Clearly in this environment, the windows are narrower for what our customers are willing to do, but they’re in fact investing in new products if they create the right value proposition.

This quarter for instance, we continued to drive beer packaging sales with the launch of several new products. In the quarter, we introduced the Blue Moon brand of six pack basket carrier and saw a continued expansion of our 18 and 20 pack bottle packaging in our Litho-Flute high strength package. Significant progress was made during the quarter to integrate all Litho-Flute into Graphic Packaging’s paperboard supply stream.

In Europe, new packaging machines were shipped to Heineken, Cott and CCE. Our focus on non-carbonated beverages such as premium juices and teas as well as energy drinks, the United States has continued to deliver new products through our co-packing network. During the first quarter, we gained four and 12-pack Z business with new titles with Fizz Ed and Apple & Eve, as well as reinforced our leading position in the energy segment with organics DT business including Red Diamond Tea which is packaged in our 12 pack with a vertical vendor dispensing feature and light [ph] wash UV on the outer carton gained attention behind refrigerated section doors.

In food and consumer products, we continued to see growth from primary microwave and strength packaging applications. Kraft has launched the latest microwave food concept with its introduction of the Flatbread Melt. The frozen product is sold under the California Pizza Kitchen and DiGiorno labels. Once again Graphic Packaging’s focus in susceptor technology has shown its versatility and resilience with this recent for into the consumer home pizza market.

In the strength packaging, we experienced significant expansion of our Z-flute structure at (inaudible) and Kraft with multiple items moving into its patented structure. Kellogg's also moved forward and picked Z-flute for their Kashi cereal carton for a major Canadian launch in the warehouse club market.

I would also like to highlight our recent win at 66 Annual Paperboard Packaging Council’s National Packaging Competition where a jury of industry experts selected our cap-it package as the winner of the Inaugural Eco Award. Our eco-friendly paperboard multipack was chosen as the paperboard package with the most positive impact on product differentiation and merchandizing and sustainability.

We believe we can reposition paperboard as a competitive alternate to plastics and shrink film generating a variety of growth opportunities over the long-term for both the industry as well as Graphic Packaging ourselves. Our cap-it paperboard multi-package demonstrates the designing sustainability all along the supply chain can deliver more value compared to conventional plastic choices.

Let me briefly look forward and remind ourselves, our strategy in this difficult environment is essentially unchanged. Internally, I continue to remind our organization of three key elements of our about strategy. First, we will continue to focus on strengthening our core business. We’ve created a network of low-cost mills and converting facilities that are second to none to our space. No one makes folding cartons more cost effectively than Graphic Packaging today. We would like to say we will compete where we have a right to win and in food and beverage packaging with the acquisition of Altivity, we clearly have developed that position in all these key sectors and channels.

Two, we will grow even in this environment through our new product development investments and strong competitive positioning in end-used segments that will outperform the general economy. And three, we will accelerate our financial performance by paying close attention to volume trends, matching production to demand, while keeping cash flow squarely and focused.

We look to improve our contractual pricing, implement continues to improve the strategies across all of our manufacturing facilities and we remain committed to delivering improved EBITDA margins, increasing our EBITDA in better cash flow to drive significant debt reduction during this year.

With that, I will turn it over to Dan.

Dan Blount

Thank you, David. Good morning, everyone. David discussed the economic challenges and provided a brief overview of our quarterly results. I am going to walk you through a more detailed review of our first quarter results.

As we move through the numbers, what will become clear is that our volumes held up well. But more importantly, on the strength of the synergies realized from the Altivity transaction, our cost structure improved. We delivered greater EBITDA on lower sales and we accelerated cash generation.

To simplify today’s discussion, unless I specify otherwise, when I refer to net sales and EBITDA, I will be referring to the pro forma adjusted numbers, which provides an apples-to-apples comparison of operating performance to the prior year. A reconciliation table detailing the pro forma adjustments is included as an attachment to last night’s earnings release.

Turning to results, first of all, I will cover the change in net sales then bridge EBITDA to the prior year and end with a review of cash flow. First quarter net sales at $1.19 billion were $77 million or 7% lower than the prior year. The change in net sales is broken down as follows. Pricing improved by $24 million or 2.2%. We realized pricing as a result of contractual, inflationary recovery and year-over-year increases in open market board pricings.

Volumes, lower volumes resulted in reduced sales by approximately $92 million. The majority of this decline almost 60% was attributable to softer demand in construction, industrial plastics and corrugated markets. The largest volume declines were in our Multi-wall Bag segment and in Containerboard open market sales.

Sales in our core food and beverage markets held up well as volumes were off only 3%. As we expected, our concentration in food and beverage demonstrated strong recession resistance. The remaining sales change resulted from foreign currency exchange due to strengthening of the dollar.

Now let’s discuss EBITDA. Overall first quarter EBITDA at $129.9 million is $27 million higher than last quarter and $2.3 million higher than Q1 2008. This represents a significant margin increase as we improved to 12.7% from 9.8% last quarter and 11.6% in Q1 2008. Bridging the change in EBITDA from Q1 2008, we see that it was favorably impacted by pricing and cost reduction.

Improved pricing resulted in benefit of $24 million. Cost reduction initiatives, which includes integration synergies and continuous improvement delivered $37 million of benefit, $23 million of the $37 million is from integration synergies. As David stated, we are now at a $92 million annual run rate for synergies.

Over the remainder of 2009, synergy benefits will principally be driven from well-established projects and purchasing and previously announced plant closures. We consider the execution risk to be low and have a high level of confidence in the better phase [ph] delivery.

Looking forward, we have a portfolio of synergy opportunities yet to pursue. As a result, we expect the synergy run rate to grow further in 2009. Partially offsetting the EBITDA benefits were volume declines, market related downtime and inflation. Volume declines negatively impacted EBITDA by $16 million. As we stated previously, the volume declines were principally in our Multi-wall Bag and Containerboard businesses.

In response to the demand declines, we took market related downtime on our corrugated medium and URV paper machines to control inventory levels. These machines principally cell [ph] board in the open market and their integration into converting them small. Although positive for cash, this action resulted in an EBITDA charge of approximately $3 million. As a side note, demand for production of our SUS and CRB machines with our 80% plus integrated into our converting plants was stable and the machines ran well.

Input cost inflation during the quarter was $31 million. Although we are currently experiencing some deflation with key raw material inputs, our cost of goods sold in the first quarter reflects the higher costs associated with inventory on hand at December 31, 2008. As you have seen from past earnings releases, changes in inflation lagged two months to three months before they were reflected in our P&L. Without this lag, input costs would have been lower by approximately $12 million. This benefit of lower cost product in the inventory should benefit second quarter financial results.

Now to summarize first quarter performance, despite an ongoing difficult operating environment, our sales held up well. Our sales of core food and beverage markets were relatively recession resistant. The key achievement in the quarter however was the improvement in our cost structure as synergy efforts and other cost cutting initiatives delivered permanent cost takeouts. EBITDA margin improved to 12.7% and this margin improvement is yet to reflect the full impacts of lower input costs.

Now I will end my discussion with comments about cash flow and liquidity. Let’s start with cash flow. As we saw in yesterday’s press release, net cash from operations increased by $77 million versus the prior year. This increase represents a GAAP comparison which does not adjust to include a full quarter of prior year Altivity results. Taking into account a full quarter of Altivity results, I estimate that cash flow available for debt reduction improved $40 million over the prior year. This cash flow improvement principally results from working capital reductions achieved through the supply chain and flat rationalization synergies.

One of the largest improvements into its cycle time in our mills, which on average improved 30%. With 80% plus vertical integration of mill output into our converting operations, we have further aligned production schedules and are now able to run our operations with much smaller on-hand board inventories. The permanent shutdown of our paper machine number-two in 2008 also contributed to the cycle time improvement. Overall working capital needed to operate the business has been reduced by approximately $50 million since the Altivity transactions.

For the full year 2009, we expect debt reductions to be in the $170 million to $200 million range as we continue to lower working capital levels, carefully manage CapEx and deliver improved EBITDA margins.

In terms of our CapEx, we have reduced our spending projections to the $150 million range. CapEx in 2008 was approximately $200 million. In light of volume changes in the industry and to a greater extent increased efficiencies in our plants, we can get the output we need without further capacity investments. In 2009, our CapEx will be focused on maintaining assets and high return cost reduction projects, principally related to synergy initiatives.

Now with regard to expected cash pension contributions, we maintain our estimates of $65 million for 2009. Turning to liquidity, on March 31st, we had strong liquidity of approximately $343 million. This liquidity level $61 million better than last year. We remain comfortably in compliance with our debt covenant as our senior secured leverage ratio of 3.98 to 1 is well within our required 5 times. Additionally, we have no significant debt maturity until August, 2011.

In conclusion, I just want to reiterate David’s comments that we are clearly focused in 2009 on improving cash margins and driving significant debt reductions. We will build on our solid Q1 performance by continuing to drive our cost structure lower, aggressively manage working capital, and strengthening our leadership position in our core businesses.

Now with that operator, we will open the line for the question-and-answer session.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Joe Stivaletti with Goldman Sachs.

Joe Stivaletti – Goldman Sachs

Good morning, thanks for all the detail. I just wanted to follow up on your – some of your comments on the input costs. I know that was a very big challenge in ’08 and I understand the lag and the benefits of these lower costs showing up in EBITDA. Could you maybe help us a little bit though in terms of Q1 to Q2 type of bridge on input costs or what kind of reduction we might see in the input costs running through your income statements from Q1 to Q2?

David Scheible

Yes, Joe, I don’t know whether I want to give Q2 forward-looks on the input. If you look at our business and you sort of net out what Dan talked about what was hung up on the balance sheet, and you’re talking now just input raw material cost not labor. Labor production, labor let’s say on – for us it’s around $5 million a quarter or so inflation.

And so our cash inflation costs went up in the quarter roughly $14 million or so in quarter-on-quarter increase. We still have some hedges – and our primary drivers, Joe, were energy and we still have some hedges in there. I think the second quarter hedges are going to average what Dan a little over $9.5, $9.25?

Dan Blount

No, between $9 and $10.

David Scheible

So we’ll still have some energy hedges in there. Now that will improve versus Q2 of last year, because of course our natural gas costs were higher. OCC will be pretty flat which was our other big driver. So I think what we would expect that is that the raw material input cost will be relatively flat quarter-on-quarter on the macro. I just don’t have enough chemical and ink detail to go through that. That will be net of our synergy plans, okay? So I am saying just sort of the based inputs.

Joe Stivaletti – Goldman Sachs

Right. But given that you don’t have some of the ’08 embedded costs in inventory, you should see a benefit from Q1 to Q2.

David Scheible

Well that’s correct. As Dan said, we cycle our inventories. You can look roughly 60 – every 60 days. So that $12 million that was hung up on the balance sheet, you would expect to cycle through in the second quarter, I think. So you would expect that to cycle through so you have more of a real number if you will for that year sort of thing.

Joe Stivaletti – Goldman Sachs

Thanks. So Dan you mentioned one of your components of your debt reduction for the year, your target was working capital reduction. What part of that is working capital reduction for the year?

Dan Blount

In terms of the $200 million.

Joe Stivaletti – Goldman Sachs

Right. I am just wondering how much working capital reduction – what is your target for 2009?

David Scheible

Well, this year, I think we said that – Dan just said we were – did about $50 million worth of inventory. Most of that working capital was inventory reductions

Dan Blount

And that was Q1 2008 versus Q1 2009.

David Scheible

Right.

Dan Blount

So if you look at it, Joe, and I think you’ll understand it that we – we try to be fairly conservative with our estimates that we put out there in terms of cash. So that $50 million number that we put there, I think that that’s a pretty good estimate of what’s included in that $200 million number for cash generation.

Joe Stivaletti – Goldman Sachs

Okay. And then the last question I had was, I didn’t see anything in your release unless I missed it on this big topic of the fuel tax refunds and what not. But I was just wondering where that stands as it relates to Graphic Packaging, if any benefits there are included in your $170 million to $200 million of debt reduction?

David Scheible

Well absolutely. I will tell you that there are no estimates what so ever in our – in the numbers that Dan and I talked related to the black liquor price that you’re talking about. We have made our – we certainly would qualify. We burned about I think 800,000 gallons of black liquor a day and we have made our application to the IRS. They’ve been here. They’ve been to our plants and our submission is in process. But really until we get that certificate in hand, Joe, it makes no sense to sort of put any numbers or estimates out there. And so none of the numbers that Dan and I have talked about cash flow or any of the margin improvements have any – would that be factored in.

Joe Stivaletti – Goldman Sachs

Okay. Is it just that – is there any particular reason why it’s taking a little bit longer with your company to get the certification and get some of those things firmed up or I mean it shouldn’t be necessarily viewed as a sign as there is going to be any kind of reason that there is some like a problem qualifying?

David Scheible

No, not at all. No I would expect – we would expect pretty shortly to have news on that issue or on that process. But no, we’ve given – we had no indication whatsoever, we clearly qualify. Our Macon, Georgia facility and our West Monroe facility generate black liquor and we would expect to get those credits. I mean we’re aware of them. We’ve made our applications, we’ve been doing it for sometime and we would expect to – we had no reason to believe otherwise. We just didn’t think it was prudent until in the hand to be providing forward-looks or estimates to that process. But we fully expect to it materially – we fully expect to obtain those credits.

Joe Stivaletti – Goldman Sachs

Okay, thank you.

Operator

Your next question comes from the line of Sandy Burns with Sterne Agee.

Sandy Burns – Sterne Agee

Hi good morning.

David Scheible

Good morning, Sandy.

Sandy Burns – Sterne Agee

Just big picture, when you look at market dynamics between the three paperboard grades, SPS, CUK and CRB, kind of given where we are in the economy, where you’re seeing activity? I mean there’s always a certain amount of customers who can switch between the three grades. I mean, is it getting more competitive than it typically would in this sort of environment or how would you characterize those dynamics overall?

David Scheible

Well I would say that we have not seen an increased number of switching activities, right? There is going to be downward pressure in any of these board substrate grades in this kind of economy, where input costs are going down. But I would not – I am not seeing. The only conversions we really have seen is the ones that I talked about which is we have seen – we’ve been able to shift paperboard applications to Z-Flute laminated structures out of corrugate because there was a true sort of value proposition there how fast they run the customers plant and towards the sustainability weight factor. But as far as the really switching between grades, we had not seeing any inordinate amount of that by any way, shape or form.

I think the demand differences is really, SPS and backlogs are tighter. CUK is also fairly tight, this is the beverage season and that’s what where a lot of that board is used, so you would expect it. And CRB tends to be more buffeted because there is some fair amount of CRB that is not included in beverage applications and toys and games and set-top boxes and shoe boxes, all those kinds of things are going to be buffeted so you would see a softness.

However you’ve also seen materially greater downtime in the CRB business. Everybody has taken some downtime in the fourth quarter; we expect to take additional downtime whenever it’s necessary in that grade as well. And I think for the most part we are managing not to want to build inventory in any of those grades.

Sandy Burns – Sterne Agee

Okay, great. That’s helpful. And just secondly in terms of the synergy benefits you were able to achieve your targets much quicker than you anticipated. Maybe it’s hard to quantify, but can you maybe give us some sense of how much more you think you can do going forward? Maybe there is a possibly like another $90 through the next – through 2010 or is it going to incrementally just be a little above where you originally budgeted those savings?

David Scheible

Yes, we haven’t really given any – the reason we don’t give future guidance on the synergy is because I think the way we look at this thing and – is that you get it in the first 18 months and then it really becomes part of your continuous improvement operations.

At some point, it’s no longer a synergy, it’s just – you need to drive it out with lean sigma and six sigma. So we sort of challenged to get it done in the first 18 months because we have done this three times, right? We have double sized the company. Every time we sort of found out what you get is 75% to 80% in the first year and that’s exactly what we’ve seen here, in this case, a little accelerated, but we’re getting better at this because of the practice for sure and I have got grade to prove it.

What I would tell you is that anything above and beyond, I think will just be the new targets for what we will see in continuous improvement. I mean our continuous improvement targets this year I think Dan said in the quarter we were $14 million or something like that Dan. So if you annualize that up, that’s actually a little bit higher than the guidance we have given you in the past. I would tell you that that’s where that will manifest itself. So we will continue to see $50 million to $60 million with the cost takeout on a go-forward basis beyond the synergy stuff.

Sandy Burns – Sterne Agee

Okay. And just last question, pension contributions, the $65 million how much of that is already being expensed on the income statement, so it will just be an excess cash contribution?

Dan Blount

For the year, we are expecting expense of about $40 million. So there is about 25 additional – $25 million additional on top of the expense.

Sandy Burns – Sterne Agee

Okay, great. Thank you.

David Scheible

Sure.

Operator

Your next question comes from the line of Bruce Klein with Credit Suisse.

Bruce Klein – Credit Suisse

Hi, good morning.

David Scheible

Good morning, Bruce.

Bruce Klein – Credit Suisse

I am sorry, I was – maybe I missed something. But the free cash flow estimate of $170 million to $200 million that sort of clean number, no black liquor and the working capital component of it, did you tell us that?

Dan Blount

No we said approximately $50 million.

Bruce Klein – Credit Suisse

Five O.

Dan Blount

Five Zero, yes.

Bruce Klein – Credit Suisse

Okay. And the rest there is nothing else abnormal or unusual other than $120 million to $150 million.

David Scheible

Well our operating people would say it’s going to beat your sweat equity. But no, it is not going to be anything above just running more efficiently in the operation. And you look at the EBITDA margin improvement that’s really something that’s coming from, right? We’ll continue to expect our margins to get better.

Bruce Klein – Credit Suisse

Okay. And if you were – I recognize you haven’t accrued for tax cuts as you haven’t had mills get certified. But is there an expectation to use the proceeds, if essentially you do receive? And is there any requirements by the banks or otherwise where you have to spend the money?

David Scheible

We have no requirements, but we would be looking to use those funds for debt reduction.

Bruce Klein – Credit Suisse

All right. Thanks guys.

David Scheible

As we would – as we would for all free cash flow at this point in time. We’re not – we’re not unaware of the $2.9 billion in debt. So that is going to be our focus for all free cash flow.

Bruce Klein – Credit Suisse

Got you. Thank you.

Operator

(Operator instructions) Your next question comes from the line of Jeff Hollis [ph] with Barclays Capital.

Jeff Hollis – Barclays Capital

Hi, good morning.

David Scheible

Good morning.

Jeff Hollis – Barclays Capital

Just on pricing. I know you have talked before about offsetting I think 70% of inflation with pricing. Do you see a downward adjustments now with OCC and other input costs coming down based on some of your quarterly adjusters as you look at the full year?

David Scheible

I don’t think you’re going to see a lot of adjustments on carton prices this year. I mean 2010 is where you will manifest most of those changes, right? I mean if you really look at – if you look at pricing this quarter, we had $24 million worth of pricing and $14 million worth of cash inflation in input cost, right? So probably in this case, we actually saw pricing improve the margins.

But as you go through the year, I think you are going to see additional pressure on pricing especially in the open market board business. But carton prices remained relatively flat. We don’t have that many contracts that actually have quarterly adjustments, in fact very few. Most of them are plastics [ph] and many of them are annual.

Jeff Hollis – Barclays Capital

Okay. And then on inflation, do you see yourselves getting positive year-over-year on inflation over the next few quarters or is that–?

David Scheible

That’s a great question. I mean, our primary drivers are energy, chemicals and fiber. And so what we would say is we’re hedged about 72% so we sort of know what our energy is going to be for the rest of the year. And relative to the year-on-year, it will be positive on a comparative basis because the energy was pretty expensive for us in the middle of last year.

On a fiber basis, I think it’s slightly down year-over-year, but OCC kicked back up and so there was a divergent of opinions on when China will start to buy again and that that will have some impact. I think chemical prices are prudently are going to be flat to maybe slightly down simply because it’s the petrochemical complex that drives chemicals. And when I see chemicals, I mean latex coating chemicals and to some extent ink.

So what I would say is I would think there is more downward pressure on input costs and upward pressure for the remaining part of the year for what we can see right now. But the problem is trying to figure out what you think the economy is going to do in the second half of the year and I don’t know if that I am the right guy to ask for that.

Jeff Hollis – Barclays Capital

Okay. And just paperboard packaging volumes, I realize you’re very high on food and beverage, but they were down 11%. I don’t think corrugated or Containerboard was much more than 10%. Are there other applications in there that were way down? I am just trying to understand.

David Scheible

Yes, so if you start to think about it, it was actually about half – about 5% to 6% was just pure downtime. We shutdown paper machine number-two if you’ll remember in West Monroe and last year we ran that machine during the first quarter. We took 19 days of downtime on paper machine number-one, that’s our corrugated medium machine and other two days – I am sorry, another five days in Pekin. And so we had about 35,000 to 40,000 tons just came out of just pure machinery we didn’t operate last year.

And so then that leaves rest of it really from market dislocation. And the majority of that honestly is – it was not in the grades that we necessarily make. I think we mentioned last year that we decided to get out of the tobacco market. And despite the fact those were tons – when we talk about sold tons, it isn’t just tons that we make, we buy. On average, Graphic Packaging buys, I don’t know almost 200,000 tons of board on the outside in an annual period.

So those external purchases for that we’re SPS for food services. And for tobacco, were really soft in this quarter. One, we exited tobacco and the second is that food services a pretty soft quarter. People eating out don’t use it. So those tons were down, but that’s why the EBITDA and the cash flow were not particularly affected significantly, because they were not integrated tons for the most part. So our integrated tons drop is really pretty consistent with what we saw, that Dan reported in those sorts of 3% or 4% sort of numbers.

Jeff Hollis – Barclays Capital

Okay, that makes sense.

David Scheible

Yes.

Jeff Hollis – Barclays Capital

And then just lastly, what about the impact that’s on your CUK board shipments from shipped from bottles to cans. Is that hurt you a little bit because of some ends not packaged, if you can just update us on that?

David Scheible

No, cans are all packaged. I think the incremental – and so this is a detail that you probably don’t even care about but we do. And that is that bottles use incrementally more because if you think about a bottle wrappers to the can wrap you slightly more board in a bottle wrap. But cans are cans. And when they’re packed, they’re multi-packed as well.

So, the incremental change is not significant to Graphic Packaging, but the guys that run that business think it’s the end of the earth. So yes what we do – what you’re seeing although is increased canned volume. So people are eating at home, so what’s happening is that that cans that were sold in a restaurant that is not packed in ours is now coming home to be packaged. So the net change is positive which is why we saw actually beer up in the quarter. It’s a mixed change if you will.

Jeff Hollis – Barclays Capital

Thank you.

Operator

There are no more questions at this time. That concludes the call.

David Scheible

Okay.

Scott Wenhold

Thank you very much.

Dan Blount

Thank you very much.

Operator

Thank you for participating in today’s conference call. You may now disconnect.

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Source: Graphic Packaging Holding Company Q1 2009 Earnings Call Transcript

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