Graphic Packaging Holding Company — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Unaudited results; amounts are in millions of dollars except per-share data. The company makes paper-based packaging, including folding cartons and paperboard for food, beverage and consumer products.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $1,094.7 | $1,103.2 | $2,156.2 | $2,137.2 |
| Income from operations | $87.6 | $105.6 | $163.1 | $212.8 |
| Net income | $42.0 | $77.8 | $79.0 | $135.3 |
| Diluted EPS | $0.14 | $0.24 | $0.25 | $0.42 |
| Operating margin | 8.0% | 9.6% | 7.6% | 10.0% |
Q2 sales fell 0.8%; six-month sales rose 0.9%. Q2 operating income declined 17.0%, and six-month operating income declined 23.4%. The six-month sales increase reflected $62.5 million from 2016 acquisitions and new products, partly offset by lower prices and unfavorable currency. In Q2, volume and mix added $13.0 million to sales, but lower pricing reduced sales by $10.2 million and currency by $11.3 million.
Management attributed the six-month operating-income decline principally to $54.4 million of higher costs, lower selling prices, unfavorable exchange rates and planned paper-machine upgrade downtime. Higher costs included secondary fiber ($25.5 million), labor and benefits ($11.3 million), chemicals ($6.8 million), energy ($6.0 million) and freight ($4.3 million). Cost-reduction initiatives partly offset these pressures. Net interest expense rose to $43.8 million from $35.1 million for the half year, mainly due to higher average debt and interest rates.
Q2 income taxes were $23.6 million versus $10.1 million a year earlier; six-month taxes were $41.2 million versus $43.3 million. The 2016 comparison benefited from a $22.4 million discrete tax benefit related to an IRS agreement and previously expired net operating losses. The 2017 six-month period included an approximately $2 million share-based-payment tax benefit.
Cash flow, balance sheet and capital allocation
- Cash flow: Six-month operating cash flow was $165.1 million, down from $247.0 million. Investing cash use was $146.8 million, versus $517.7 million, which included $328.9 million of 2016 acquisitions. Financing used $66.6 million, compared with $253.5 million provided in the prior-year period.
- Capital spending: $144.5 million in the first half, compared with $186.0 million in 2016.
- Cash and liquidity: Cash was $12.5 million at June 30, versus $59.1 million at year-end 2016. Current assets were $1,152.0 million and current liabilities $769.3 million. Revolving and other credit facilities had $1,182.3 million available.
- Debt: The company reported $2,227.4 million of outstanding debt obligations in MD&A; balance-sheet short- and long-term debt totaled $2,213.2 million on a carrying-value basis. Debt was primarily senior notes, term loans and revolving facilities. About 34% of total debt was floating-rate. The company was compliant with debt covenants; leverage ratio was 3.11 against a maximum below 4.25, and interest coverage was 8.82 against a minimum of 3.00.
- Capital returns: Six-month dividends paid were $46.9 million, and $59.6 million of common stock was repurchased. The quarterly dividend was raised to $0.075 per share. Approximately $213 million remained under the 2017 repurchase authorization at June 30.
Segments and material developments
For the six months, Americas Paperboard Packaging sales increased to $1,605.5 million from $1,595.4 million, but operating income fell to $179.9 million from $213.4 million. Europe Paperboard Packaging sales fell to $278.4 million from $293.2 million and operating income to $16.0 million from $18.4 million. Paperboard Mills reported an operating loss of $22.6 million, versus income of $0.5 million. The mill result reflected inflation and downtime, including an approximately $14 million second-quarter maintenance outage and approximately $18 million of first-quarter upgrade downtime at West Monroe, Louisiana.
Effective January 2017, the company reorganized operating segments and recast prior periods. On July 10, 2017, after quarter-end, it acquired substantially all assets of Carton Craft Corporation and affiliate Lithocraft, Inc.; the filing does not provide a purchase price.
Outlook, risks and contingencies
Management’s 2017 outlook was capital investment of approximately $250 million; depreciation and amortization of $300–$320 million; interest expense of $80–$90 million; and $370–$390 million of cash flow available for net debt reduction, dividends and share repurchases, excluding acquisitions and capital-market activity. Pension contributions were expected to be $30–$40 million. Management expected to retain approximately $280–$330 million of U.S. federal NOLs at year-end and did not expect to be a meaningful U.S. federal cash taxpayer until 2019.
Key risks include raw-material and energy inflation that may not be recoverable through pricing, competition and packaging substitution, consumer-demand changes, foreign-exchange movements, execution of productivity initiatives, and debt service and covenant restrictions. Environmental investigations and remediation may create future costs; the company said accrued and reasonably possible losses were not material, though some potential costs could not be quantified. Ordinary-course lawsuits were not expected by management to have a material adverse effect. No material changes to previously disclosed risk factors were reported. The company hedged approximately 50% of expected natural-gas usage for the remainder of 2017 and 23% for 2018. Disclosure controls were reported effective as of June 30, 2017.
Most important facts for investors to verify
- Whether pricing, productivity savings and cost pass-through can offset continuing inflation, particularly secondary-fiber, labor and chemical costs.
- How paper-machine downtime and the West Monroe maintenance outage affect subsequent mill performance and cash generation.
- Debt levels, floating-rate exposure, covenant headroom and the company’s ability to meet its cash-flow and interest-expense outlook.
- The sustainability of cash flow and capital returns given low period-end cash and reliance on available credit facilities and receivables programs.
- Progress integrating prior acquisitions and the financial impact of the July 2017 Carton Craft/Lithocraft acquisition.
- Use of NOLs and any developments in tax, environmental or legal matters that could alter the stated outlook or contingencies.