Business context and reporting period
Graphic Packaging Holding Company filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The company produces paperboard packaging, including folding cartons, for food, beverage and other consumer-product markets. Its reportable segments are Paperboard Mills, Americas Paperboard Packaging and Europe Paperboard Packaging.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $1,103.7 million | $1,070.0 million | $3,240.9 million | $3,135.3 million |
| Income from operations | $105.1 million | $110.0 million | $317.9 million | $325.5 million |
| Net income | $57.8 million | $60.2 million | $193.1 million | $172.9 million |
| Diluted EPS | $0.18 | $0.18 | $0.60 | $0.52 |
| Operating margin | 9.5% | 10.3% | 9.8% | 10.4% |
| Operating cash flow | Not separately reported for the quarter | $394.3 million | $351.0 million |
Q3 sales rose 3.1%, while operating income fell 4.5% and net income fell 4.0%. For the first nine months, sales rose 3.4%, operating income declined 2.3%, and net income increased 11.7%. Gross margin was approximately 17.3% in Q3 versus 18.9% a year earlier, and 18.6% for the nine months versus 18.8%.
- Revenue drivers: Acquisitions and higher beverage volumes supported sales. Lower pricing, unfavorable foreign exchange, certain weaker consumer-product categories, and facility shutdowns offset growth. Acquisitions contributed $85.3 million of Q3 sales and $201.8 million of nine-month sales.
- Profitability: Management attributed operating-income pressure to lower pricing, inflation, purchase-accounting depreciation and amortization, currency effects, operational issues onboarding new or transferred business, and West Monroe mill upgrade downtime. Cost-reduction initiatives and lower incentive compensation partly offset these pressures.
- Cash flow and investment: Nine-month operating cash flow was $394.3 million. Investing cash outflow was $594.4 million, including $258.4 million of capital investment and $331.9 million for acquisitions, net of cash acquired. Financing cash inflow was $190.1 million. Cash declined by $9.2 million to $45.7 million.
- Debt and liquidity: At September 30, balance-sheet short-term debt and current maturities were $64.1 million and long-term debt was $2,190.9 million. The debt note reports total debt of $2,233.1 million; MD&A separately cites $2,271.8 million of outstanding debt obligations, so investors should reconcile the differing measures. Revolving-facility availability was reported at $1,119.8 million. The company was compliant with debt covenants; its leverage ratio was 2.74 against a maximum below 4.25, and interest coverage was 12.08 against a minimum of 3.00.
- Capital returns: The company repurchased 8.45 million shares for approximately $107.6 million, including share-based withholding repurchases, and paid $48.5 million in dividends during the nine months. After quarter-end, the board declared a $0.075 quarterly dividend and stated an intention to increase the 2017 annual dividend to $0.30 per share, subject to board approval.
Material changes and unusual items
During 2016 the company acquired Colorpak, Metro Packaging & Imaging, Walter G. Anderson and G-Box for approximately $332 million, net of cash acquired, and assumed approximately $31 million of debt. It also issued $300 million of 4.125% senior notes due 2024. Total debt increased from $1,878.4 million at year-end 2015 to $2,233.1 million in the debt note at September 30, 2016.
The nine-month tax expense was $71.3 million, down from $102.3 million in 2015. An IRS agreement enabled the company to use previously expired NOL carryforwards; a $22.4 million discrete tax benefit was recorded in Q2. The company estimated $284 million to $334 million of U.S. federal NOLs would remain at year-end 2016 and did not expect to be a meaningful U.S. federal cash taxpayer until 2019. Business-combination and other special charges were $23.2 million for the nine months, versus $14.1 million a year earlier.
Segment results were mixed: Americas Paperboard Packaging sales increased, but Q3 operating income eased to $101.5 million from $103.2 million. Paperboard Mills reported a Q3 operating loss of $3.5 million, compared with income of $11.5 million a year earlier. Europe Paperboard Packaging operating income improved to $6.9 million from $4.4 million in Q3.
Outlook, risks and contingencies
For 2016, management expected capital investment of $280 million to $290 million; depreciation and amortization of $290 million to $310 million, excluding purchase-accounting effects for 2016 acquisitions; interest expense of $70 million to $80 million; and $350 million to $360 million of cash flow available for net debt reduction, dividends and share repurchases, excluding acquisitions and capital-market activity. Expected pension contributions were $40 million to $60 million. The filing gives no specific revenue or earnings guidance.
Management said operating cash, revolving-credit availability and other financing sources should be adequate for debt service, capital spending and working capital, but cautioned that results depend on demand, selling prices, raw-material and energy costs, credit markets and successful execution of strategies. Risks include cost inflation and volatility, competition and product substitution, consumer preference changes, acquisition integration, foreign exchange, leverage and covenant restrictions. The company hedged approximately 71% of expected natural-gas usage for the remainder of 2016 and 29% for 2017. Environmental investigations and remediation may create future costs that cannot all be estimated; the company said recorded reserves and reasonably possible losses beyond reserves were not material. Ordinary-course lawsuits were not expected to have a material adverse effect. No material risk-factor changes from the 2015 Form 10-K were reported.
Important facts for investors to verify
- Reconcile the debt totals reported in the debt note, balance sheet and MD&A, and assess acquisition-related leverage and refinancing needs.
- Track whether acquisition integration and onboarding issues improve, and whether acquired businesses deliver the sales and cost benefits anticipated.
- Monitor pricing, input-cost inflation, volumes in weaker consumer-product categories, foreign-exchange exposure and mill performance.
- Compare full-year cash generation, capital investment, interest expense and pension contributions with management’s stated ranges.
- Review the realization and timing of tax benefits, NOL utilization and the outlook for U.S. federal cash taxes, as well as the proposed dividend increase.