Graphic Packaging Holding (GPK)

Q3 2011 Earnings Call

October 27, 2011 10:00 am ET


David W. Scheible - Chief Executive Officer, President and Director

Brad Ankerholz - Investor Relations

Daniel J. Blount - Chief Financial Officer and Senior Vice President


Mark Kaufman - Rafferty Capital Markets, LLC, Research Division

Ian A. Zaffino - Oppenheimer & Co. Inc., Research Division

Joseph Stivaletti - Goldman Sachs Group Inc., Research Division

Matthew R. Wooten - Robert W. Baird & Co. Incorporated, Research Division

Alex Ovshey - Goldman Sachs Group Inc., Research Division

Philip Ng - Jefferies & Company, Inc., Research Division

Unknown Analyst -

Phil M. Gresh - JP Morgan Chase & Co, Research Division



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Good morning. My name is Cody, and I will be your conference operator today. At this time, I would like to welcome everyone to the Graphic Packaging Third Quarter 2011 Earnings Call. [Operator Instructions] And I would like to turn the call over to Brad Ankerholz, Vice President and Treasurer. Sir, you may begin.

Brad Ankerholz

Thank you, Cody. And good morning to everybody. Welcome to the Graphic Packaging Holding Company's Third Quarter 2011 Earnings Call. Commenting on results this morning will be David Scheible, the company's President and CEO; and Dan Blount, our Senior Vice President and CFO. To help you follow along with today's call, we've provided a slide presentation which can be accessed by clicking on the Q3 earnings webcast link on the Investor Relations section of our website at I would like to remind everyone morning that statements of our expectations in this call constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Such statements, including but not limited to, statements relating to the recovery of raw material, inflation costs, consumer demand and pricing trends, capital expenditures, cash pension contributions and pension expense, depreciation and amortization, interest expense, debt and leverage reduction, performance improvements, and cost reduction initiatives, including the closure of facilities, are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the company's present expectations. These risks and uncertainties include, but are not limited to, the company's substantial amount of debt, inflation of and volatility in raw material and energy costs, cutbacks in consumer spending that could affect the demand of 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.

Daniel J. Blount

Thanks, Brad. Good morning, everyone. We're pleased with our third quarter results and our ability to continue to grow sales and earnings in what remains a very challenging operating environment. We grew sales 3% and adjusted net income 40% in the third quarter, in spite of the soft demand and significantly higher input costs. Higher pricing, stronger operating performance and cost reduction more than offset modestly lower volumes and higher input costs. Third quarter pricing increased by $29 million, and we generated $17 million net benefit from ongoing cost reduction and supply chain optimization efforts. We are still tracking to approximately $70 million of cost reductions for this year, and remain comfortable with our ability to further reduce total costs through our continuous performance improvement initiatives. A large portion of our cost savings is being driven by significant ongoing investments we are making in the business. Through the first 3 quarters of this year, we have spent over $108 million in capital, much of which was focused to streamline the business and reduce our long-term cost structure. Last quarter, I talked about the over $30 million investment in our Perry, Georgia carton facility. To further stand this state-of-the-art plant, which is now capable of converting over 275,000 tons of paperboard annually, I'm pleased to report that the new press came online in the third quarter and we have successfully transitioned volume from other higher cost facilities into the expanded Perry plant. The integration of the Sierra Pacific acquisition, our new West Coast facility, is progressing well. And we're pleased with this performance. The new facility further optimized our manufacturing footprint by providing a strategic location in northern California to service our West Coast customers and it leverages our Santa Clara, California recycled board mill. This acquisition has reduced our cycle times, lowered our transportation costs and better align volumes within geographies. With the added flexibility of this new West Coast facility, along with the delay in the recovery of our end markets, we made the decision to close our La Porte, Indiana web plant and consolidate the remaining volume into our northern California and our other lower-cost midwestern facilities. These are never easy decisions but they were necessary to balance our manufacturing footprint with the changing demands of our customer base. We have strategically closed and consolidated the equipment and production capacity of 19 facilities since our acquisition of Altivity in 2008. These consolidations streamline our footprint and operations without diminishing our overall production capacity. Another capital project that we continue to be excited about is the building of a bio-mass boiler in our Macon, Georgia mill. The bio-mass system will make the mill self-sufficient from an electrical power and steam generation standpoint, thereby dramatically reducing energy cost and dependency on fossil fuel-based alternatives. I'm very happy to report that during the quarter, we received our environmental permit for this bio-mass project. This was the final government hurdle, and we are now officially cleared to begin the construction and installation process. Our plan is to have the boiler fully operational by mid-2013. Two other areas we continue to strategically invest to drive both demand and performance improvement include product innovation and enterprise resource planning systems. On the product innovation side, we commercialized over $80 million of new products versus same quarter 2010. We remain focused on developing new and unique packaging that helps our customers differentiate their products, lower their distribution costs and improve their sustainability metrics throughout the entire supply chain. A newly developed solid CUK fiber carton was recently chosen to replace a traditional Litho-laminated structure by a major customer within the fast-growing beverage pouch sector. This launch represents a continuation of our participation in this market as we currently service Coca-Cola for its Minute Maid drink pouches, storable foods for their Swizzlers brand at Wal-mart and Target's Archer Farms line as well. We'll start supplying this package late in the fourth quarter and should be at a full run rate by the middle of 2012. In total, this conversion represents over 75,000 new tons of CUK annually. To support this business, we are making a significant converting investment in our West Monroe carton plant and we are also providing packaging machinery to support the transition. We believe the superior performance characteristics of a solid fiber carton and the enhanced environmental aspects make for an attractive substitute for traditional corrugated Litho-laminated materials in this sector. We're excited about the long-term growth opportunities across the board. Our strength in barrier packaging portfolio continues to grow, with our customer adoption of new and patented structures to create lower costs and use less fiber and increase consumer convenience. Our fresh, first food service line aimed primarily at replacing plastic containers continues to gain traction in the market, adding a number new customers in the quarter, including Racetrack [ph] and Bob Evans and is being tested by a major food service provider. New products are not just about selling board, of course, and in our microwave business we had 4 successful commercial launches during the quarter. Some of these were focused on expanding our reach in the microwave market into new applications beyond our traditional susceptor or microwave applications. For example, ConAgra restaged their line of Marie Callender lasagna in press paperboard trace. And again in July, the Schwan Food Company launched a new Asian takeout style carton that is PET-laminated made by Graphic Packaging. Our international efforts in microwave resulted in our first commercial susceptor product in China for the frozen pizza category. And we introduced a microwave susceptor sleeve through our joint venture in Japan for the frozen fish market. Focusing internally, our investment at SAP and other enterprise-wide systems have allowed us to lead out our back office functions improving lines of sight across our asset base and automating the functions on the shop floor. Improved systems have led to better matching of orders with our production facilities thereby allowing us to optimize our footprint and consolidate our purchasing. New enterprise systems allow for centralization of production planning capabilities and streamline many of the overhead functions. This has led to consolidation of administrative activities and reduced related back-office work for requirements. As a result, on October 12 of this quarter, we announced a reduction in the force which reflects these structural changes in our cost structure. When combined with the La Porte, Indiana closure, this is expected to generate annual savings in the range of $20 million to $25 million ongoing. Let's talk a little bit about the sectors. Paperboard production volume in our mills delivered another strong quarter due to improvement in initiatives, in energy, operating efficiencies and fixed costs. Tons per day remained relatively flat compared to the third quarter last year, but they improved by 94 tons per day versus our rate of production and the first 6 months of this year. Backlogs remain consistent and we expect to build some board inventory to scale up -- to support the scale up of the new product work in 2012. Our continuous improvement efforts at the mill generated nearly $5 million in cost savings in the third quarter alone, which included almost $1 million in reduced energy usage. If you look at the folding carton business, our U.S. business decreased in volume 1.4% in the third quarter. This compares favorably to the overall industry, which according to Paperboard Packaging decreased around 3.4% in the same period. In market demand for many of our core consumer products remained relatively weak as a result of continued softness in the economy, low consumer confidence and sticky, high unemployment. Consumption across a wide variety of even staples continues to be impacted by a high level of cost consumer savings and substitutions. ACNielsen estimated that in a key category, cereal and frozen pizza, their volumes were down approximately 5% in the quarter. As economic conditions remain challenging, our consumer products business will continue to focus on innovation and customer service to capture the fast-growing opportunities in the marketplace. If I look at beverage, industry volume trends across the can market decreased on a year-over-year basis in the third quarter but showed some sequential improvement over the second quarter. According to the Can Manufacturers Institute, total beverage can shipments decreased 3.6% in the third quarter, compared to a 5% decrease in the second quarter. Both canned soft drink canned beer volumes remain down in the quarter, with soft drink declining 4% and beer declining 2.6%. We have seen trends flattening for take home and our customers indicate they believe we're at the bottom of the curve as we head into 2012. Look, I hope that that's the trend, but we are being more cautious with our own internal projections at this time. Categories that did perform well during the quarter included our facial tissue, dairy, confection and retail carry out. All were up year-on-year. Looking at Flexible Packaging, we've seen really little change in this segment as the weak construction and industrial manufacturing sectors continue to prolong any type of real recovery. Flexible Packaging sales increased 4% on a year-over-year basis. It was driven primarily by higher pricing from recovery of paper and resin inflation and stronger demand for shingle wraps from the spring hurricane and storm damage replacement. If I look at pricing and inflation, we continue to see significant increases in both pricing and cost inflation in third quarter. Pricing increased $29 million in the quarter, and therefore $89 million over the 9-month period year-to-date this year. Pricing increases continue to be driven by pricing reset mechanisms in our contracts that adjust price up and down based on changes in inflationary cost on approximate 9-month with back lag. We expect pricing to remain positive in the fourth quarter and carryover into 2012. Total cost inflation for 2010 in the quarter was approximately $39 million, driven primarily by externally purchased board, secondary OCC and chemicals. OCC pricing has begun to pull back from recent highs as a result of softening export market, non-fiber based inflation was primarily driven by TiO2 and freight increases in the quarter. Looking forward, difficult to do honestly but our view of the fundamental trends driving our business has not changed. Pricing should remain positive, inflation costs have begun to abate and we continue to invest in performance improvement and cost savings initiatives to expand our margins. Commodity inflation is proven to be a major headwind for 2011 but I believe it could soften as we move into 2012 based on difficult global economies. I think time will tell, we'll know more as we move forward. Debt reduction continues to be our primary focus and we will run our business to optimize cash flows and improve our credit profile. It's been nearly 4 years since the current recession first began. I don't think any of us believe that we would be bouncing along the bottom, but that's exactly where we are. The prolonged weak economy and continued high unemployment rate, have taken their toll on American consumer and they are likely to remain very frugal with their spending, even for basic necessity items like food and beverage. This is a new reality and companies that are going to prosper in this operating environment need to be focused on bringing better, faster, smarter cheaper solutions to the marketplace. That's exactly what we have been doing at Graphic Packaging. This has allowed us to deliver innovative cost-saving solutions to our customers and grow our earnings and cash generation at the same time. I'll now turn the call over to Dan for a more detailed discussion of our financial results. Dan?

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