GRAPHIC PACKAGING HOLDING CO quarterly report, Q3 FY2018

Graphic Packaging Holding Company — Q3 2018 Form 10-Q

Reporting period: Three and nine months ended September 30, 2018. Amounts are in U.S. dollars; financial figures are in millions unless stated otherwise. Comparisons are with the corresponding 2017 periods. Results include the North America Consumer Packaging (NACP) business from January 1, 2018, so year-over-year growth reflects the combination and other acquisitions.

Financial performance

Metric	Q3 2018	Q3 2017	Nine months 2018	Nine months 2017
Net sales	$1,530.0	$1,137.6	$4,515.3	$3,293.8
Income from operations	$166.4	$91.4	$350.7	$246.8
Net income attributable to GPHC	$94.3	$47.3	$173.6	$126.3
Diluted earnings per share	$0.30	$0.15	$0.56	$0.40
Interest expense, net	$31.0	$22.6	$90.1	$66.4

• Q3 sales increased 34.5%; operating income rose 82.1%. Nine-month sales increased 37.1%; operating income rose 42.1%. Management attributed growth mainly to NACP and other acquisitions, higher selling prices, and cost savings.
• Operating income included a $37.1 gain on the sale of the closed Santa Clara mill site in Q3. Excluding that gain, Q3 operating income was $129.3 million; this is a simple subtraction, not a company-reported adjusted measure.
• Q3 sales growth included $378.2 million from NACP and the 2017 and PFP acquisitions; nine-month growth included $1,172.0 million from NACP and the 2017 and PFP acquisitions. Core converting volumes were generally stable, with weaker beverage volumes, particularly beer. Higher inflation partly offset pricing and productivity benefits.
• Nine-month cost inflation was $53.1 million, led by freight, labor and benefits, chemicals, and external paperboard, partly offset by lower secondary fiber costs.
• Segment operating income in Q3: Paperboard Mills $10.0 million (versus a $13.4 million loss), Americas Paperboard Packaging $128.0 million (versus $101.3 million), and Europe Paperboard Packaging $12.8 million (versus $10.2 million). The Santa Clara gain is included in Corporate and Other.

Cash flow, debt and liquidity

• Nine-month operating cash flow was negative $300.0 million, compared with negative $118.3 million in 2017. The filing cites higher receivables sold and inventory; changes in operating assets and liabilities used $872.8 million of cash.
• Investing cash flow was positive $360.3 million, including $902.8 million of beneficial interests on sold receivables and $49.4 million of net asset-sale proceeds; capital spending was $270.0 million and net cash paid for acquisitions was $89.0 million. Financing cash flow was negative $87.2 million. Cash ended the period at $39.7 million.
• Cash-flow comparisons are affected by the retrospective adoption of a standard that reclassified consideration from receivables sales from operating to investing activities; 2017 operating cash flow was reduced by $424.8 million by that reclassification.
• At September 30, long-term debt on the balance sheet was $2,880.7 million, and short-term debt/current maturities were $51.9 million. The company separately reported $2,943.9 million of aggregate debt principal. Approximately 42% of total debt was floating-rate.
• Revolving facilities had $1,178.2 million available. The company reported compliance with debt covenants: leverage ratio 2.84 versus a maximum below 4.25, and interest coverage ratio 9.65 versus a minimum of 3.00. Credit ratings were BB+ (S&P) and Ba1 (Moody’s), both with stable outlooks.
• Current assets were $1,952.0 million and current liabilities $1,169.3 million. The company stated that operating and investing cash flows, available facilities, and other financing sources were expected to cover obligations, capital expenditures, and working capital, while noting this was not assured.

Material developments, outlook and risks

• The January 1 NACP combination had total consideration of approximately $1.984 billion, including $660 million of assumed debt, based on adjusted preliminary purchase accounting. IP received a 20.5% GPIP interest; a portion is redeemable and may ultimately be exchanged for GPHC shares or cash. The company also entered a tax receivable agreement providing IP 50% of projected tax benefits associated with certain exchanges.
• During 2018 the company acquired PFP and Letica Foodservice, and sold the Santa Clara mill site. It paid approximately $34 million for PFP and $95 million for Letica Foodservice.
• 2018 outlook: capital investment approximately $390 million; depreciation and amortization $430–$450 million, excluding about $6 million of pension amortization; interest expense $120–$130 million; pension contributions $5–$10 million.
• Management cited raw-material and energy-cost volatility, limits on passing cost increases to customers, competition and product substitution, consumer demand and buying preferences, acquisition integration, foreign exchange, and debt and covenant constraints as risks. Environmental investigations and ordinary-course litigation are disclosed; the company said it did not expect the legal matters to have a material adverse effect. No material change to previously disclosed risk factors was reported.
• The company had approximately $327 million of U.S. federal net operating losses at year-end 2017 and did not expect to be a meaningful U.S. federal cash taxpayer until 2021. Tax benefits recorded in 2018 included provisional Tax Act adjustments; the estimate remained subject to review.

Important facts for investors to verify

1. How much reported profit growth reflects acquired operations and the $37.1 million Santa Clara gain versus recurring pricing, volume, and productivity improvements.
2. Whether working-capital needs and reliance on receivables-sale programs continue to pressure operating cash flow; receivables sold and derecognized totaled $2,507.2 million during the first nine months.
3. Progress on NACP integration, acquisition accounting, synergies, and the effects of IP’s noncontrolling interest, potential exchanges, and tax receivable agreement.
4. Debt service and interest-rate exposure, including the floating-rate share of debt, covenant headroom, and liquidity available under revolving facilities.
5. Delivery against 2018 capital-investment and expense outlook, and the ability to pass through continued freight, labor, chemical, and paperboard cost inflation.