Business context and reporting period
Graphic Packaging Holding Company filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2018. It produces paperboard, cartons, cups, lids, food containers and related packaging for consumer, food and beverage markets.
Results include the North America Consumer Packaging (NACP) business acquired from International Paper on January 1, 2018, as well as 2017 acquisitions. Comparisons with 2017 therefore reflect a substantially expanded business and are not wholly like-for-like.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $1,509.3 million | $1,094.7 million | $2,985.3 million | $2,156.2 million |
| Income from operations | $110.3 million | $83.8 million | $184.3 million | $155.4 million |
| Net income attributable to GPHC | $49.4 million | $42.0 million | $79.3 million | $79.0 million |
| Diluted earnings per share | $0.16 | $0.14 | $0.25 | $0.25 |
- Q2 sales rose 37.9%; management attributed $398.5 million of the increase to NACP and 2017 acquisitions, with additional contribution from favorable currency and higher prices. Six-month sales rose 38.5%, including $793.7 million from those acquisitions.
- Operating income increased 31.6% in Q2 and 18.6% for the six-month period. Operating margin was approximately 7.3% in Q2 versus 7.7% a year earlier, and 6.2% for six months versus 7.2%.
- Management cited acquisition contributions, price increases and productivity savings, partly offset by inflation and integration and stock-compensation costs. Six-month inflation added $35.1 million of costs, led by freight, labor and benefits, chemicals and external board.
- Net interest expense increased to $30.3 million in Q2 from $22.5 million and to $59.1 million for six months from $43.8 million, mainly reflecting higher average debt and interest rates. About 42% of debt bore floating rates at June 30.
- Q2 consolidated net income was $66.0 million, of which $16.6 million was attributable to noncontrolling interests. Six-month consolidated net income was $108.7 million, including $29.4 million attributable to noncontrolling interests.
Cash flow, debt and liquidity
- For the first six months, operating cash flow was negative $300.2 million, compared with negative $103.9 million in the restated prior-year period. Management cited increased receivables sold and higher inventory. The 2017 cash-flow comparison was affected by a new accounting classification that moved $269.0 million of receivable-sale proceeds from operating to investing activities.
- Investing cash flow was positive $299.7 million, including $473.1 million of net receipts from receivable securitization and sale programs. Capital investment was $173.4 million. Financing cash flow was negative $15.2 million; cash ended the period at $50.9 million, down from $67.4 million at year-end.
- Debt principal was $2,987.8 million at June 30; balance-sheet debt, including current and long-term portions, was approximately $2,975.8 million. Total available revolving credit capacity was $1,141.4 million. The company reported compliance with its debt covenants: leverage ratio 2.82 versus a maximum of 4.25, and interest coverage 10.33 versus a minimum of 3.00.
- Current assets were $1,816.4 million and current liabilities $1,026.3 million. The company said cash from operations and investing, together with available credit and other financing, should meet expected obligations, but provided no assurance.
- Receivables programs are a significant liquidity factor: the company sold and derecognized $1,669.6 million of receivables in the six months, and $621 million of receivables sold remained subject to continuing involvement at June 30.
Material changes, outlook and risks
- The NACP combination was valued at approximately $1.9 billion, including $660 million of assumed debt. Acquisition accounting remained preliminary. International Paper held a 20.5% interest in GPIP; portions of its units are exchangeable for GPHC shares or cash, and the company recorded $287.1 million of redeemable noncontrolling interest.
- Q2 core converting volumes were described as stable, with new-product introductions offset by lower beverage volumes, particularly beer, and some consumer-product weakness. Lower open-market paperboard volumes reflected greater internal use following the Santa Clara mill closure.
- For 2018, management expected capital investment of approximately $380 million, depreciation and amortization of $430–$450 million excluding about $6 million of pension amortization, interest expense of $125–$135 million, pension contributions of $5–$10 million, and postretirement health payments of approximately $3 million. No specific revenue or earnings guidance was provided.
- The company expected not to be a meaningful U.S. federal cash taxpayer until 2021, based on approximately $327 million of federal net operating losses at December 31, 2017 and other tax benefits. It recorded a roughly $4 million tax benefit related to indirect NACP effects in the first half.
- Key risks include raw-material, energy, freight and labor cost inflation; limits on passing costs through to customers; competition and packaging substitution; consumer demand and customer-contract repricing; acquisition integration; foreign-exchange exposure; floating-rate debt and covenant restrictions. Environmental investigations and ordinary-course lawsuits were disclosed; management did not expect current legal matters to have a material adverse effect. No material change to previously disclosed risk factors was reported.
Important facts for investors to verify
- How much of sales and operating-income growth is attributable to acquired operations versus underlying volume, pricing and productivity, and whether acquired results are comparable to prior periods.
- The sustainability and working-capital implications of negative operating cash flow and the company’s substantial use of receivable sales and securitization.
- Debt-service capacity and sensitivity to interest rates, given higher debt following NACP and the floating-rate portion of borrowings.
- Whether cost inflation can be recovered through pricing and whether management’s 2018 capital, interest and pension estimates remain achievable.
- Final acquisition valuations, integration charges, and the potential cash or share dilution implications of International Paper’s exchangeable units and tax receivable agreement.