Graphic Packaging Holding Company Q4 2009 Earnings Call Transcript

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 |  About: Graphic Packaging Holding Company (GPK)
by: SA Transcripts

Graphic Packaging Holding Company (NYSE:GPK)

Q4 2009 Earnings Call

December 31, 2009 8:30 am ET

Executives

[Brad Ingerholt] - Vice President and Treasurer

David Scheible - President and CEO

Dan Blount - Senior Vice President and CFO

Analysts

Brian – Oppenheimer & Co.

Roger Spitz – Bank of America

Joe Stivaletti – Goldman Sachs

Sandy Burns – Stern Agee

Bill Hoffmann – RBC Capital Markets

Richard Close – Jefferies

Mark Kaufman – Rafferty Capital Markets

Blaine Marder – Loeb Capital Management

Operator

(Operator Instructions) Welcome everyone to the Graphic Packaging Holding Company Fourth Quarter and Full Year 2009 Earnings Conference Call. At this time, I would like to turn the conference call over to [Brad Ingerholt], Vice President and Treasurer of Graphic Packaging.

[Brad Ingerholt]

Welcome to the Graphic Packaging Holding Company’s fourth quarter and full year 2009 earnings call. Commenting on results this morning are David Scheible, the company’s President and CEO; and Dan Blount, Senior Vice President and CFO.

I would like to remind everyone that statements of our expectations in this call constitute forward looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements including but not limited to statements relating to declines in raw material and commodity prices and the expected effect on the company’s results, capital expenditures, cash pension contributions, and pension expense, depreciation and amortization, interest expense, net debt reduction, and consumer purchasing trends, 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, cut backs 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 now.

David Scheible

First I’d like to say due to some personal reasons, I’m remote in this conference call. Dan and I will do our best to coordinate the Q&A afterwards but it may be such that we have to follow up with you separately.

I’d like to say first of all we are pleased with our fourth quarter results and performance in 2009 overall. While the environment certainly remains challenging, our strategic focus on the food and beverage sectors within the paperboard/packaging segment along with an ongoing focus on product innovation, cost reductions, supply chain management, and capital deployment, generated solid results in 2009 and I believe positions us well for the future.

In both the quarter and the full year we were able to drive meaningful improvement in our EBITDA margins and cash flow. In the fourth quarter, excluding black liquor, we generated $143.8 million in operating cash flow and our adjusted EBITDA margin increased over 250 basis points to 12.6%. Our fourth quarter income per share improved to $0.02 from a loss of $0.11 last year. For the full year, we generated $368 million in operating cash flow, increased our adjusted EBITDA margin to 13.6% and reduced net debt by approximately $363 million. Including black liquor, our operating cash flow for the full year was over $500 million and our net leverage ratio at the year end was just under five times.

Let’s talk a little bit about segments. Sales in our Folding Carton Food and Beverage business which accounts for roughly 85% of our total sales were once again solid, decreasing only 1.8% in the fourth quarter and 2.5% for the full year. Our focus on center of the aisle everyday products such as cereal, dry foods, frozen pizza, soft drinks, domestic beer, and facial tissue, and our large positions with major branded manufacturers continues to keep our Folding Carton business steady. In general, we saw fairly consistent demand trends in the fourth quarter similar to what we experienced all year.

Our customers are still tightly managing inventory as well as promotinal spending and consumers continue to shop on price and necessity. In terms of volume, we are starting to see some positive signs and this coincides with the recent reported pickup in industry wide grocery store sales. Advance retail sales in the grocery store channel increased nearly 2% in November and December compared to being flat in September and October. This was the biggest increase in this channel that has been reported all year and may be a sign that volumes are slowly moving in the right direction.

When looking at the broader paperboard/packaging industry we believe our focus allows us to outperform to total industry. Total folding carton sales across the entire industry declined roughly 4.5% in the quarter and 3.7% for the quarter as reported through Paperboard Packaging Council.

If you look at consumer products, sales to food and consumer markets improved slightly from earlier trends this year. As discussed previously, consumer purchasing preferences have shifted towards value products and consumers still appear reluctant to increase their purchases of products that are more discretionary in nature.

Looking at the value products in the fourth quarter, H.D. Nielsen reported that dry food mixes increased 1.6%, baking mixes increased 4.6%, frozen pizza units were up 12% and packaged meats and yogurt units increased 6.6% compared to the same period in 2008. The more discretionary products such as candy, pet food, and frozen baked goods were all down in the quarter. Most non-food product categories decreased from fourth quarter 2008. The one bright spot in non-food is really packaged detergent which posted a unit sales increase of 8% for the quarter and 6.6% for the full year. We believe this is another example of value conscious consumers shifting to lower cost, higher value products.

Food and plate inflation, which increased steadily through 2007 and 2008 began to moderate in 2009 and was actually deflationary in the fourth quarter. According to the US Department of Labor CPI Data in the key food at home category, prices declined 2.7% in the fourth quarter 2009 compared to a decline of only 7.7% in the third quarter 2009 and it increased to 7.1% in the fourth quarter 2008. Traditionally, lower food prices lead to increases in consumer demand which in turn is positive for packaging demand. We are cautiously optimistic on the food and consumer product side of our business. Time will tell.

If I look at beverage, this business continues to be an area of strength and also improved again in the fourth quarter from recent trends. This business was up mid to high single digits in the fourth quarter and mid single digits for the full year. Domestic beer, carbonated soft drink, and international are all contributing to the increases.

The US beer market decelerated in the fourth quarter as brewers focused on price at the expense of volume. The trend towards sub-premium brands and larger format packages continued with growth in larger multi-pack can packs reflecting the continued effect of the weak economy. There also continued to be a significant new product activity in the beer packaging as brewery customers seek to innovate in response to loss of market share to wine and liquor.

For the first time in a while we did see wine and spirit sales trending up in the fourth quarter which could be the consumer’s reaction to the recent price increases in beer. With beer being a volume based business we’ll see how long this trend continues. For the full year, US beer volumes decreased about 2.4% with domestic beer down about 1% to 2% and imports down in the mid single digit range. As we commented previously, with consumers trading down there continues to be a shift towards lower priced domestic and canned beer over higher priced imports and bottled beer.

In the carbonated soft drink market it improved in the fourth quarter and estimated was up almost 2% in the quarter. For the full year this market was flat. In our quarter, our shipments of core branded canned packaged exceeded prior years results for the first time in 2009. Similarly, premium brand products such as IBC and Snapple made gains as well and outperformed prior year shipments for the first time in 2009. Also, sports drinks were up in the fourth quarter after declining over the first three quarters of 2009. Overall we are pleased with the fourth quarter performance in the soft drink category and are cautiously optimistic that the positive tends could continue.

Our multiwall, bag, and specialty business continued to be negatively impacted by the general economic conditions. With a significant amount of our sales volume in these businesses linked to industrial and construction product end use markets during the fourth quarter we continued to see lower sales volume. Our multiwall, bag and specialty businesses were also impacted by lower selling prices resulting primarily from lower paper and resin pricing. As a result of weak demand during 2009 we focused on cash generation, right sizing our assets and fixed cost structure.

The business continues to generate very positive cash flow; although market indicators, housing starts, and existing home resale and private residential fixed income investment have been inconsistent we are optimistic that we will see some volume recovery in 2010. Current trends show some signs of improvement.

If you look at new products, one thing I would say is that innovation remains a key growth area for Graphic and our customers continue to depend on us to provide differential packaging to support their marketplace growth and cost reduction goals. However, the challenging economy has dampened overall new product launches in 2009.

A recent review conducted by a leading product database firm estimated that new product launches in food and beverage categories were down almost 30% in 2009 compared to the same period in 2008. As a leading innovator of new packaging products for the food and beverage industry, this has clearly impact our business.

Despite the headwinds in the market, however, innovation remains a critical component to our business and industry. Packaging has long been sighted as the single biggest variable to differentiating a product and driving sales. Increasingly, however, packaging is also becoming a critical component in the supply chain and ecosystem.

Through packaging manufacturers are seeking creative ways to not only differentiate their product but to bring it to market and recycle in a more efficient environmentally friendly manner. Given the recycle ability advantages of paper versus other substrates, Graphic Packaging is well positioned to benefit from this trend.

I partnership with our global customers we are creating new and innovative ways to bring products to market such as the new easy paperboard pad that is engineered to work with shrink wrap solutions for bottled water. This pad allows the retailer to simply drop the pre-packaged pallet on the floor thereby minimizing freight, handling, and labor costs.

Another recent innovation that benefits suppliers, consumers, and the environment is the paperboard high cone ring replacement called Cap-IT. Because of the printability and recyclability of this product it provides 33% more facing for greater billboard impact on the shelf and requires 41% less energy consumptions to manufacture. This product was a recent paperboard package eco award winner and is being tested today by several beverage customers.

Our new product sales were slightly over $50 million in the quarter and over $200 million for the full year. Plastic replacement technologies resulted in 62% of the new product sales in 2009 improving our customers packaging sustainability metrics. For the year, we saw significant year over year growth for some of our key innovation platforms such as microwave and cost reduction packaging.

Microwave packaging continues to be driven by growing demand for single serve items that can be prepared quickly and easily. Our patented line of susceptor cartons and smart pouches allows for better crisping, steaming and customization of products. In the quarter, Nestle introduced a new line of Lean Cuisine breakfast panini sandwiches that utilizes specialized susceptor disks that provides visible grow marks and superior product crisping.

Regional Foods launched a similar microwave tray for their single serve pizzas. We also launched a new smart pouch product line with Aldi. More cost effective packaging is also a function of several growing trends in the industry with consumers looking for better value, manufacturers are looking for better shipping and display efficiencies and everyone is looking for better sustainability. We’re seeing a lot of substitution from corrugated and specialized carton products that benefit the consumer, the manufacturer, and the environment.

Key wins in this quarter involved a new bag in box liquid laundry detergent package and a new z-flute package for kitty litter. On the international front, we launched several new wrap designs in China with a range of beer and alcoholic beverages which included brands like Bacardi, [inaudible]. This market remains small but is growing in the multi-pack segment.

Let’s talk a little bit about raw material inflation. We continue to benefit from favorable year over year declines in natural gas, chemicals, and wood prices in the fourth quarter. On a quarter to quarter sequential basis we have seen moderate price increases in natural gas and fiber and more significant movement in OCC. OCC prices have increased around $60 a ton in the last several months and close to $100 a ton over the same period last year. We have announced a $40 per ton increase in CRB effective January 11th to offset some of the increases.

Despite the cold and wet weather we have not seen material increases in virgin wood prices but supplies remain tight in West Monroe. We will be watching both wood and OCC prices closely over the next few months. While the overall inflation environment is becoming less favorable other than really potentially OCC in general we do not expect huge swings in 2010.

The mills had another strong performance of board production through a series of continuous improvement initiatives. We reduced grade to grade cycle times and increased our trim utilization. In fact, our CRB mill operating rates are well into the high 90’s and we took no market related down time in the quarter. Our Kalamazoo mill actually moved its annual maintenance from October to December as CRB demand remained very strong during the quarter.

Turning to continuous improvement, with input costs moving we continued to focus on synergies and continuous improvement cost reductions to drive margins. Total cost reduction synergies were around $51 million for the quarter and $184 million for the year. Cost reduction through synergies was a key element of the Altivity combination and really allowed to expand our margins in a difficult revenue environment. In 2009 we accelerated our original plant consolidation plan, completing this 18 months ahead of schedule. Going forward we will not be reporting synergy savings separately as all future cost reduction becomes part of our continuous improvement efforts from lean and six sigma.

I do want to recognize for the last time the strong achievements of our integration teams. We announced in 2009, 12 plant closures, we integrated over 75,000 tons of externally purchased board into the Graphic Packaging mill system, we reduced grade changes and improved trim efficiencies at the mills, removing $70 million of inventory permanently from our system in 2009. We significantly shorted the supply chain and eliminated warehouses and reduced SG&A expenses across the entire enterprise.

I’m extremely proud of the integration teams and the support they got from the operations. As I look into 2010 we will be transitioning those dedicated resources to our continuous improvement teams. Our efforts and continuous improvement were equally impressive in 2009 as we achieved the 6th consecutive year of substantial cost reduction improvement to our performance capabilities across the entire organization.

This year we completed the roll out of lean to 15 additional operating locations. These, along with other locations trained approximately 1,900 people in a variety of lean methods and platforms, we completed over 400 Kaizen events and almost 1,550 people participated in improving a variety of processes and areas across our company. These improvements resulted in approximately $64 million of cost savings in 2009 above our synergy work. We have made significant progress in transforming our organization utilizing continuous improvement principles across our manufacturing and supply chain processes.

I often get the question about our ability to continue to reduce costs year after year. My answer is the same. With over $400 million of inventory still in our system and a cost of goods sold base in excess of $3.5 billion we have plenty of opportunity to further reduce expenses. However, we must invest in the right processes to do so. During 2009 we strengthened our methods for managing the execution of our cost reduction through the implementation of policy deployment, this global process has provided us with the tools and systems to identify, measure and drive a more focused and effective level of execution.

Through this process we are linking annual improvement priorities and key performance indicators from the corporate level initiatives down through the entire organization. We are excited about the process and ability to gain a clear line of sight throughout the entire organization, engaging everybody to achieve our goals and objectives.

Let me talk a little bit briefly about 2010 then I’ll turn it over to Dan. Looking ahead we are cautiously optimistic. While GDP has begun to stabilize, unemployment rates remain pretty high and consumer spending patterns may not return to what they were a few years ago any time soon. However, our core food and beverage markets are stable and volume is beginning to modestly improve.

As the economy continues to slowly recover, consumers will remain value conscious, cooking more at home and buying more necessity items. At the same time, active lifestyles today are driving higher demands for convenience, more multi-pack, individual servings, and microwavable products. Finally, sustainability continues to be a major theme with consumers in the packaging industry. These trends should continue to be positive for Graphic Packaging over the longer term.

2009 benefited from higher prices and lower inflation, 2010 will likely see a modest reversal in these trends. Contract pricing will move slightly lower and input costs will be slightly higher. To continue to grow our margins we will improve our operating efficiencies and reduce our expenses. We remain confident in our ability to do just that and believe we are well positioned to gain share and grow our margins this year.

With that I’ll turn it over to Dan for a review of the financials.

Dan Blount

During the fourth quarter we successfully completed our integration initiatives and continued to strengthen our balance sheet through substantial debt reduction. In total, integration produced $150 million of annual run rate operating performance benefit and dramatically improved working capital efficiency. The improvements in our cost structure, balance sheet, and operating model, also provide us with a solid foundation to build on, heading into 2010.

Looking at 2009 financial highlights, which were achieved in a very tough operating environment, we see full year EBITDA improved 11% year over year to $556 million. Fourth quarter EBITDA improved 18% year over year to $124 million. Net leverage ratio improved to 4.8 times from 6 times at the end of 2008. With those highlights in mind, let’s discuss fourth quarter and full year financials in more detail.

First we will discuss revenue and EBITDA performance, and then move to cash flow debt leverage ratio and liquidity. As a reminder, when I refer to EBITDA or other financial performance metrics in my discussion today I am referring to pro-forma adjusted numbers. These adjustments, which include charges related to the combination with Altivity and benefits from the alternative fuel tax credit, provide meaningful year over year comparisons of our financial performance. A reconciliation table detailing the pro-forma non-GAAP numbers is posted on our website.

Revenue and EBTIDA, as a result of our success in reducing costs through integration and continuous improvement initiatives, EBITDA margins substantially increased in 2009. For the fourth quarter, EBITDA margins improved 260 basis points to 12.6%. For the full year, EBITDA margins improved 220 basis points to 13.6%. The majority of the margin improvement was in our paperboard/packaging segment which delivered a 17% EBITDA margin in 2009. The multiwall bag and specialty segments EBITDA margin was relatively constant throughout 2009 at 9%.

In total, EBITDA improved $54 million in 2009 to $556 million. For the fourth quarter, EBITDA improved $19 million year over year to $124 million. Fourth quarter EBITDA improvement was made up as follows: a $33 million net positive impact from performance improvements resulting from integration and continuous improvement initiatives, and a $4 million positive impact from lower input costs. Partially offsetting these were $11 million negative impact from lower selling prices net of foreign currency exchange, and $7 million of negative impact from volume and mix.

The fourth quarter reductions were principally in multiwall bag and specialty packaging businesses as well as open market paperboard sales. Carton pricing was slightly favorable year over year. As David stated, we expect contracts for food and beverage packaging through lower pricing slightly in 2010 as they adjust to reflect the lower raw material input costs experienced in 2009.

The fourth quarter benefit from lower input costs was driven by lower prices for chemicals and energy, partially offset by higher prices for secondary fiber and higher costs for employee benefits. The year over year energy cost decline was primarily driven by lower prices for natural gas. In the fourth quarter of 2009 our cost was almost $3.20 per MMBTU less than the prior year quarter. Our natural gas usage per quarter averages approximately $3 million MMBTUs. For the full year 2009 our natural gas price averaged around $8.00 per MMBTU.

In terms of 2010, we have hedged 75% of our first quarter needs at $5.33. This compares to the first quarter 2009 rate of $10.90. For the remaining quarters of 2010 we have hedged approximately 68% of our natural gas needs at an average rate of $5.60.

In terms of sales in the fourth quarter, we experienced the same trends that we have seen all year. Total net sales decreased 7% in the fourth quarter and 7% for the full year. The $69 million fourth quarter decline in sales breaks down as follows: $62 million from lower volume and mix, and $7 million from price reductions net of foreign currency changes.

Sales in our two primary businesses continued to tell two different stories, given the major differences in their product offerings and end markets. Sales in our paperboard/packaging segment which is predominantly carton sales to food and beverage markets, showed a slight trend improvement with a modest 3% decline in the fourth quarter as compared to 4% for the full year. Sales in our multiwall bag and specialty packaging segments continued to experience steep volume declines with 21% in the quarter and full year.

During 2009 cost reduction resulting from integration initiatives increased each subsequent quarter and totaled $119 million for the full year. 2010 will benefit further from integration savings as we enter 2010 with an annual run rate of $150 million of cash flow. Stronger earnings, reduced working capital levels, and lower CapEx contributed to an outstanding year of cash flow generation. Excluding the impact of the fuel tax credit, cash flow from operations increased by $184 million to $368 million. Cash flow available for debt reduction which is cash after CapEx, interest, and all other outflows, was $229 million. The fuel tax credit contributed an additional $135 million.

The working capital improvement was driven by reducing inventory levels by about $70 million. By closing 10 plants and further optimizing the supply chain, we improved inventory turns by more than one full turn and permanently reduced the amount of inventory needed to run the business. We are pleased with our 2009 progress but we are not satisfied and we expect to further improve inventory turns in 2010.

Capital spending for full year 2009 was $130 million as compared to $183 million in 2008. With a wrap up of integration we have completed the major investments to upgrade production assets and implement SAP information technology. In 2010 we expect to further leverage capital investments made during integration and as a result, 2010 capital spending is expected to be in line with 2009.

Debt leverage ratio and liquidity, during 2009 our strong cash performance had reduced net debt by $363 million and improved our net leverage ratio to 4.8 times from 6 times at the end of 2008. We are clearly focused on our de-leveraging strategy and expect strong cash generation in 2010 to further reduce leverage in the range of 4.3 times. Our longer term target is to reduce our net leverage ratio to between 3 and 3.5 times.

We continue to operate with a low cost flexible debt structure and with the successful financing of our 2011 senior notes in 2009 we have no significant debt maturities until 2013. Our only financial maintenance covenant under our credit agreement is a consolidated senior secured leverage ratio. At year end this ratio stood at 2.94 times which is well below our maximum allowable ratio of 4.75 times. Additionally, at year end we had no borrowings under our $400 million revolving credit facility and $150 million of cash and cash equivalents. Total liquidity net of letter of credit commitments was $513 million.

In the fourth quarter, we reduced outstanding senior secured term debt by making voluntary pre-payments totaling $239 million. Going forward we plan to continue using our strong cash generation to reduce outstanding debt. To increase the effectiveness of future debt reduction actions we successfully amended our senior secured credit agreement in the fourth quarter to create a sizeable basket that allows us to purchase our 9.5% senior subordinated notes which come due in 2013. With this added flexibility we can further accelerate the reduction of cash interest costs by including the higher cost debt with our pre-payments.

Before moving to guidance, let me mention the $11.5 million impairment charge taken against our Ontario, Canada specialty packaging business in the fourth quarter. This business has been hard hit by the economic downturn as it focuses on the construction and heavy industrial end markets. Uncertainty as to the extent and timing of a recovery led to the impairment testing. No other businesses in the specialty segment were deemed to be impaired.

Finally for guidance, I’ll just lay out a few financial targets for 2010. Capital expenditures are expected to be between $130 and $150 million, cash pension contributions will be in the $45 to $70 million range, pension expense will be approximately $32 million, depreciation and amortization around $310 to $330 million, interest expense is expected to be between $180 and $200 million, and finally we expect net debt reduction to be in the $180 to $200 million range.

With that, I’ll turn the call back to David for his closing comments.

David Scheible

In closing, let me just say thanks to the many employees who’ve worked tirelessly to integrate Altivity into our company over the past year and a half and executed real change across the organization. While it hasn’t been easy in this environment, and there’s a lot of work to be done, I believe we’ve done a nice job of positioning Graphic Packaging as the leading producer of innovative packaging solutions for the global and consolidated consumer goods market.

Our strategic direction is unchanged, we’re going to focus on our core mix of business and integrated model. We’re going to invest in new product development to grow the top line and we’ll work to accelerate our financial performance through solid CI and cash management processes. The strategy served us well in 2009, enabled us to reduce debt, improve our financial ratios and market position and it will position us well for continued steady returns in the year ahead.

Now I’d like to open the call up to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brian – Oppenheimer & Co.

Brian – Oppenheimer & Co.

Around the costs, obviously OCC is up but you also purchased about a million tons of wood fiber exclusive of OCC. Can you shed some light on what’s going on with those costs?

David Scheible

As you know, wood fiber is a very, very regional business. While we’ve certainly had some moisture in Georgia and Louisiana basket we have not seen an appreciable change in the pricing of wood. Some availability from time to time has occurred in West Monroe this time of year we see that but as we look forward on our inflationary costs while we watch wood I don’t believe that’s what’s putting the upward pressure on inflation in our business. We certainly haven’t seen it yet.

Brian – Oppenheimer & Co.

As far as the OCC increases, is that going to be able to be recouped as we go throughout the year in the form of higher selling prices?

David Scheible

Of course there’s been announced, as I mentioned, there’s been announced a price increases and certainly in the CRB market with the tightness of the supply and the cost we certainly see our prices moving up on CRB board. I think they will be recovered. Those of us that fall in the past recognize that since we don’t really sell a lot of open market board, for us to recover prices it really becomes a roll through our contracts which some of them reset quarter, some of them reset differently. Ultimately we almost get it all back but I can’t tell you period to period where that change is. We certainly will see pricing moving up in 2010 as a result of CRB capacity and costs.

Brian – Oppenheimer & Co.

Any increase in CRB and paperboard we can basically expect that to translate into packaging prices.

David Scheible

It ultimately blows through our P&L in different methods, there’s all sorts of contractual movements in the process but historically its been the case that in inflationary costs, pricing tends to mirror and you get recovery on those costs, that’s exactly right, continuous improvement takes out permanent costs and that’s how the margins expand.

Operator

Your next question comes from Roger Spitz – Bank of America

Roger Spitz – Bank of America

Within food and beverage are you more exposed to the branded or the private label relative to the overall industry?

David Scheible

By virtue of the fact that the branded is by far and away the largest sector in that space we are clearly more exposed to branded. Our share is about the same in the two spaces but branded is of course materially larger than private label.

Roger Spitz – Bank of America

When you said that detergent volumes were up due to drive by consumers the value categories, were you referring to a consumer shift to powdered detergent cardboard boxes versus liquid detergent plastic bottles or were you referring to the liquid bag in the box detergent you mentioned?

David Scheible

For us it’s been more, bag in a box is pretty small element, what we really have seen is the consumers using more dry versus liquid. That’s where it showed up in carton volume.

Roger Spitz – Bank of America

On the split of fiber supply between recycled fiber and virgin, does that basically run with your product text mills essentially 55% virgin, 45% recycled?

David Scheible

Close enough. Fiber translates directly to the board for the most part.

Operator

Your next question comes from Joe Stivaletti – Goldman Sachs

Joe Stivaletti – Goldman Sachs

Can you tell us where you are with your usage of OCC per year right now?

David Scheible

We use about 900,000 tons a year or so of OCC in our system.

Joe Stivaletti – Goldman Sachs

Obviously you’re saying your contract prices are trending down a little bit to reflect last year’s deflation. Now you’re obviously seeing inflation on OCC.

David Scheible

So they start to move back up. Middle of the year they start to adjust. I think the hard thing this year is to get a handle on how those pricing trends intersect. You’ve got the 2008 rolling through which by design of the contracts, has some reduction and then you start to see price increases that occurred in the fourth quarter for some of those board types and so on and so forth.

Or actually you see a little bit of GDP a deflator going up and then you start to see as we move through the year a counterbalancing of pricing going up. I think on net basis as I said I think pricing will be down year over year but it will start to trend up in the second half of the year and so as you go through 2011 you’re on the other side of the equation. That’s the way the industry is structured.

Joe Stivaletti – Goldman Sachs

Your contracts, you said you had different types of resets and some were quarterly and what not. I wondered if you could give us a little bit of a feel for how many of those, what sort of portion roughly resets on a quarterly versus annual basis.

David Scheible

I could, I’m not, and the reality is I don’t get into individual customer contracts. Our customer’s contracts are large enough that if I start breaking those things out it becomes a problem for me. What I will do, just like we’ve always done general pricing trends, I think pricing will be generally down for the year but trending up in the second half that’s about as much as I would say about those individual contract flows.

Joe Stivaletti – Goldman Sachs

You obviously have had huge success with all the cost improvements and synergies and six sigma and all that. I wondered if you had embedded in your 2010 outlook what type of benefits you would be expecting from those initiatives this year?

David Scheible

As Dan said, if you look at the flow through rate of CI and synergy combined we have traditionally run from those businesses on a combined basis so well in excess of, on a combined basis, $70 or $80 million. Clearly with the synergy stuff on top of that we would be seeing or expecting total cost reduction of over $100 million this year is the way we would sort of look forward and say that’s where we’re headed. Based on the flow through and based on what we accomplished in the fourth quarter. I think our fourth quarter rate just in continuous improvement of synergies is like $18 million. If you sort of think about the accelerated rate of that those are the right kinds of trends.

Operator

Your next question comes from Sandy Burns – Stern Agee

Sandy Burns – Stern Agee

In terms of the contract renewals as you entered into 2010 you talked a little bit about the pricing adjustment. Anything you could share with us in terms of any material changes on the volume side, picked up any new customers or bigger pieces of your customers board needs or anything that you lost in the competitive environment?

David Scheible

I really like to tread lightly in this process, what I would say is that share trends are pretty consistent in our business. We’ve had some where we’ve picked up; we’ve lost a little bit here and there, some we’ve just decided not to do business because it really was not in the space that we wanted to do. I would say trends are overall positive but they’re not the big driver by any way of our volume trends.

What I would say more about volumes more optimistic at this point is that we have, as I mentioned, started to see some improvement in the core underlying and the consumer products and of course the multiwall bag business as well. That’s probably the more pertinent trend for our volume than share processes.

With the share we picked up I will tell you has been more in conversion of solid fiber from corrugated and we have seen in our z-flute and some high weight sufts replacing SBS, replacing corrugated in some cases even CRB we have seen those kinds of trends. That’s really a pie grower more than anything else. Those are the trends that we tend to focus on internally, growing the whole solid fiber core pie.

Sandy Burns – Stern Agee

In terms of the natural gas usage and pricing, you gave a helpful comparison of this year’s average hedge price versus last year’s average price. Could you give us, for the remaining three quarters of 2009 what your average natural gas price cost was?

Dan Blount

You’re talking about 2009?

Sandy Burns – Stern Agee

Compared to that $5.60 that you mentioned where you hedge that for the remaining three quarters of 2010? What would be a comparable number to that $5.60?

Dan Blount

The full year 2009 was around $8.00. The first quarter was about $10.90 so if you look at it it’s probably around that $7.50 for the remaining three quarters approximately.

Operator

Your next question comes from Bill Hoffmann – RBC Capital Markets

Bill Hoffmann – RBC Capital Markets

I wonder if you could talk a little bit about, until these cost initiatives whether you think, it sounds to me like you’ll probably more than make up for what you might experience in the margin squeeze from the lower contract pricing. The second question is, taking a step back; out of all the restructuring activities you guys have done over the last couple of years with 10 plant closures last year etc. where do you see your asset positioning from converting operations both domestically as well as some of the positioning for picking up some international growth?

David Scheible

The reality is that what I simply said in the call is that relative to the integration we have the footprint that we want. Those of us, you have followed us for a long period of time; know that every single year we assess every one of the converting assets in our entire business. I’m not suggesting that we will not ever or not look at a higher cost one of our converting assets coming out but it would really be more in line with how do we look at that asset versus long term future. I’ve got plenty of capacity in the United States for growth within my converting business so the key is operating only the most efficient capacity.

Where I see expansion for us and where we do need some capacity is in the international markets. I’ll talk a little bit about our Mexico business. Because some of our large customers have started to consolidate into Mexico, businesses that they have done in Central, South America and the Caribbean our plant in Mexico in Queretaro has been a facility that’s grown remarkably. We are going to move new assets into that facility because essentially it’s just about at capacity and yet we have plenty of growth. In fact, we outsource in Mexico converting that we do that honestly we could probably do more cost effectively internally. That is something we’re looking at for sure there.

In Western Europe I consolidated my three plants in Europe but I did expand my French and Spanish facilities internal to their walls. I have an opportunity to grow in Western Europe but that’s primarily focused on beverage. Despite the fact the US market is tough, that pales in comparison to the challenges that face the European market. Even the beverage market in Europe had an extremely difficult quarter and year compared to what we saw here. I’ve got plenty of capacity, I’m going to continue to focus to reduce my footprint in light of the fact that we get more efficient in some of the plants.

Bill Hoffmann – RBC Capital Markets

What percentage are international sales at this point and what kind of growth rate do you think you can get?

David Scheible

I think our international sales right now are probably about...

Dan Blount

Just slightly less than 10%.

David Scheible

I would say on that base they’ll probably grow faster than the US. Especially if you consider Mexico international sales then we will definitely grow faster than the US.

Bill Hoffmann – RBC Capital Markets

From the cost synergies versus balancing that against the decline in contract pricing.

David Scheible

You know that question is of course exactly on point, we’ve done that for years and years and years which is we’ve taken costs out faster and that’s why our margins have moved up and that’s exactly what we expect. I think the arbitrage for us has always been we expect contract pricing to keep us whole with inflationary moves through the business and then we expect the cost improvement initiatives to offset any labor inflation and improve our margins. That model served us in 2008 and 2009 and we expect the same thing in 2010.

Operator

Your next question comes from Richard Close – Jefferies

Richard Close – Jefferies

Would you mind talking a little bit about the working capital in your business? I know you said that you’re planning on further reducing your inventory turns. How much benefit do you really think you can continue to get from that with input costs moving up?

David Scheible

I will tell you we took $70 million of inventory out; we still have over $400 million worth of inventory. Our turns, were they 8.5 last year is that about right?

Dan Blount

That’s pretty close.

David Scheible

If you look in the space and you put a world class moniker on that there are people in the packaging space that are turning 10. There’s no reason we cannot get there. While our goals internally this year are a little bit more modest than $70 million I look at our working capital and suggest it really is not unreasonable for us to look at ongoing reduction in inventory in 2010 and we expect to see it. We have community warehouses, we shut down a number last year but we still have a number of them that needed to get out, we had to wait for some of those contracts to expire, we’ll continuing consolidate back, Altivity brought 120 warehouses into the mix.

We still have well more than we need and we still have some of the plants that are shutting down. Every time we shut a plant down we pick up $6 or $7 million worth of inventory that comes back into the system. We still have some to blow through the system. You can put that together and sort of target that there’s still pretty sizeable working capital reductions in 2010 and 2011 at least from our planning standpoint.

Richard Close – Jefferies

Can you guys tell us what amount you have available in that debt repurchase basket for the senior subs at this point?

Dan Blount

We’re about $100 million and we can raise it up to $200 million.

Operator

Your next question comes from Mark Kaufman – Rafferty Capital Markets

Mark Kaufman – Rafferty Capital Markets

I know you’ve been talking about it, your ability to further reduce costs and integrate the Altivity business. I was wondering if you could put a percentage on how far along you think you are with the Altivity merger? I guess what I’m also asking do you anticipate additional charges related to the Altivity. I think you called out earlier that you’re not going to be segregating the comments about the savings but I imagine you’ll still have to put in there somewhere any additional restructuring charges.

Dan Blount

We have completed the integration activities and as David stated we’re not going to call it out any further. In terms of wrapping up some of the projects and process through the first half of the year there’s a couple additional plant closings that have been announced, you’ll noticed we stated we had closed 10 in 2009 and 12 had been announced. We have those remaining two. There’s going to be some charges that we will break out and call it non-recurring on the face of our P&L that’s related to those activities. They’re going to be far less than what we incurred in 2009.

Mark Kaufman – Rafferty Capital Markets

In 2009 what would you say your internal utilization of the paperboard was? If you could make any forecast with the reduced amount of plants going forward what you anticipate your utilization rate in 2010 would be?

David Scheible

Our integration, let me see if understand, the integration rate for Graphic is about 85% in that range. We are a net purchaser of CRB which means that we convert more into cartons than we actually have the capacity to make so we certainly buy on the open market. In our SUS business we sell some sufts on the outside remains an opportunity for ongoing integration.

Our plan overall is to be a net purchasers of all the board that we buy, we just think that makes the most amount of sense for Graphic and that’s where we’re headed certainly in 2010. We will buy the board substrates that we convert from our competitors in the space. We have relationships today, we do that and we would expect actually those relationships to expand as we go forward.

Operator

Your next question comes from Blaine Marder – Loeb Capital Management

Blaine Marder – Loeb Capital Management

You guys have had a maniacal focus on debt reduction and are ahead of schedule yet you kept your guidance for the net debt to EBITDA at 4.3 for 2010. I wonder why the conservatism there given you’re talking about $180 to $200 million of net debt reduction.

Dan Blount

Based upon what we expect for EBITDA and the $180 to $200 million that’s the way the ratio calculated.

Blaine Marder – Loeb Capital Management

You had that target before you reported this quarter and you’re substantially ahead of your 5 times leverage target for 2009.

Dan Blount

That’s true but internally we had the 4.3 what we did is we accelerated some of the debt reduction into 2009 that’s what happened so the total debt over that full period of time is equalizing.

Blaine Marder – Loeb Capital Management

How long until you think you can reach your ultimate target with a stable sort of steadily improving economy?

Dan Blount

I think you can do the math. Every $180 to $200 million is worth about a half a turn. You’re probably looking at not too far distant in the future after 2010.

David Scheible

Our targets, we want to certainly be in the three’s and heading lower. If you pay it forward sometimes if things go as we expect sometime in 2011 we will certainly have achieved what we consider to be a solid balance sheet and capital structure. That’s where we’re headed. I think our Board would love the term maniacal.

I will remind you that even in there we have spent $180 million in CapEx in 2008 and almost $140 million in 2009. I think Dan gave guidance for CapEx roughly the same in 2010. We’re continuing to invest back in the business. Its just that as those two businesses combined there was a lot of cash tied up that just was not creating a lot of value for the shareholders. We have clearly been working on that aspect. Once you start the flywheel on cash reduction it’s really incredible when a business this size with the fixed cost investment you can get there.

If volume comes back a little bit we’ll talk later but right now with sort of the unstable market, I can’t tell whether our government is working for us or against us at this point in time but I think we’re sort of hedging into that understand what inflation and interest rates are going to do and we’re saying that we feel pretty comfortable with those forward projections and anything can happen in this economy right?

Blaine Marder – Loeb Capital Management

How you handle the repurchase of the 9.5’s they’re not exactly that cheap these days. I assume you wait to call them, wait until August until the step down?

Dan Blount

We’re constantly monitoring the pricing on those bonds. I think there was a period of time just recently where they came close to the call price. We’re going to look at the economics and when we’re comfortable with it and the market will accept our bid we’ll go in the market and purchase them. If we don’t like the economics we always have the option to wait until August when we can call the bonds at an attractive rate.

Operator

At this time there are no further questions. Mr. Scheible, are there any closing remarks?

David Scheible

I would say thank you all for participating in this call. We’ll talk to you next quarter.

Operator

Thank you for joining the Graphic Packaging fourth quarter and full year 2009 earnings conference call. You may now disconnect.

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