GRAPHIC PACKAGING HOLDING CO quarterly report, Q3 FY2019

Graphic Packaging Holding Company — Q3 2019 Form 10-Q

Reporting period: Three and nine months ended September 30, 2019. The company supplies paperboard packaging and operates Paperboard Mills, Americas Paperboard Packaging, and Europe Paperboard Packaging segments. Amounts below are in millions of dollars except per-share data.

Financial performance

Metric	Q3 2019	Q3 2018	Nine months 2019	Nine months 2018
Net sales	$1,581.6	$1,531.8	$4,640.3	$4,520.1
Income from operations	$122.7	$166.4	$401.1	$350.7
Net income attributable to GPHC	$52.1	$94.3	$173.8	$173.6
Diluted EPS	$0.18	$0.30	$0.59	$0.56
Interest expense, net	$35.9	$31.0	$106.4	$90.1

• Sales rose 3.3% in Q3 and 2.7% year to date. Q3 operating margin was approximately 7.8%, down from 10.9%; nine-month operating margin was approximately 8.6%, up from 7.8%.
• Q3 operating income fell 26.3%, mainly reflecting the prior-year $37.1 million Santa Clara mill-site sale gain, inflation, start-up costs, maintenance outage costs, incentive costs, and unfavorable currency. Higher prices and productivity savings partially offset these items.
• Nine-month operating income increased 14.4%, supported by higher prices, productivity, capital-project benefits, synergies, and lower acquisition/integration expenses; inflation, currency, and the prior-year sale gain were offsets. Nine-month cost inflation was $73.3 million, led by wood and labor/benefits.
• Cash from operating activities was $300.7, compared with cash used of $300.0 in the prior-year period. The filing attributes the improvement primarily to changes in receivables sale/securitization programs and improved operations, partly offset by higher inventory. Capital spending was $229.9 versus $270.0.

Financial position and liquidity

• At September 30, 2019, cash was $48.7; current assets were $1,771.0 and current liabilities $1,091.8. Total assets were $7,194.1.
• Debt principal outstanding was $3,002.8; balance-sheet debt, including current and long-term portions, was approximately $2,989.4 before deferred issuance costs. The company issued $300 million of 4.75% senior notes due 2027 and used proceeds to repay revolving borrowings. Net interest expense increased year over year.
• Revolving credit facilities had $1,479.1 available. The company reported compliance with debt covenants: leverage ratio 2.70 against a maximum below 4.25, and interest coverage ratio 7.78 against a minimum of 3.00. Credit ratings were BB+ from S&P and Ba1 from Moody’s, both with stable outlooks.
• Cash declined $21.8 during the nine months to $48.7. Financing cash use was $200.8, including $128.8 of share repurchases and $87.0 of dividends and distributions. The company repurchased 10.2 million shares at an average $12.55; approximately $462 million remained under the $500 million 2019 program.

Material changes, outlook, and risks

• Artistic Carton was acquired on August 1 for approximately $51 million, funded with cash and revolving borrowings. Its preliminary allocation included $4.5 million goodwill and $6.5 million identifiable intangibles.
• On September 24, the company announced an approximately $600 million new CRB mill in Kalamazoo, Michigan. To remain capacity neutral, it expects to shut the K3 paper machine and close two smaller CRB mills in 2022. Estimated charges include $50–$60 million of accelerated depreciation and $15–$20 million for post-employment benefits, retention, and incentives. A three-year idle-asset disposal program is also expected to incur approximately $40 million of charges.
• 2019 outlook: capital investment approximately $350 million; depreciation and amortization approximately $455 million, excluding approximately $10 million pension amortization; interest expense approximately $140 million; pension contributions approximately $10 million. Management expected cash, operating generation, and available financing to meet obligations, while noting this depends on operating performance and market conditions.
• The company did not expect to be a meaningful U.S. federal cash taxpayer until 2022, based on tax attributes and planned capital-project benefits. The U.S. pension-plan termination is expected to generate currently unquantified non-cash settlement charges: lump-sum payments in Q4 2019 and an anticipated annuity purchase in Q1 2020. The related plan benefit obligation was approximately $800 million.
• Key business risks include raw-material and energy-cost volatility, limited ability to pass through cost increases, packaging substitution and competition, customer contract renewals, consumer demand, foreign exchange, leverage and covenant restrictions, and execution of cost-saving and strategic projects. Environmental investigations and ordinary-course litigation are disclosed; management did not expect the described matters to have a material adverse effect. No material risk-factor changes were reported.
• Management said disclosure controls were effective and the previously identified material weakness in business-combination accounting controls was remediated in Q1 2019.

Investor verification points

1. Assess whether pricing, volume, and productivity can offset persistent wood, labor, and other cost inflation, particularly given weaker Q3 operating income.
2. Review the economics, funding, schedule, and eventual closure costs of the $600 million CRB mill plan, alongside other capital needs and the company’s leverage.
3. Track debt service, floating-rate exposure, covenant headroom, and liquidity; about 37% of total debt was subject to floating rates at quarter-end.
4. Verify future cash-flow quality and working-capital trends, including the effect of receivables-sale programs and inventory growth.
5. Monitor pension-plan settlement charges and the timing and assumptions behind expected U.S. tax payments.