Graphic Packaging Holding Company — Q3 2012 Form 10-Q
Business context and period: The company supplies paperboard, cartons, packaging machinery and flexible packaging to food, beverage and other consumer-products markets. This unaudited report covers the quarter and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods unless noted.
Financial performance and position
- Q3 revenue: $1,104.7 million, up 2.9%. Operating income was $91.4 million versus an operating loss of $17.7 million; net income attributable to Graphic Packaging was $40.1 million versus a $47.5 million loss. Diluted EPS was $0.10 versus $(0.12).
- Nine-month revenue: $3,283.8 million, up 4.1%. Operating income was $259.1 million, up from $127.2 million; net income attributable to the company was $99.7 million versus $11.3 million. Diluted EPS was $0.25 versus $0.03.
- Margins: Operating margin was approximately 8.3% in Q3 (versus negative 1.6%) and 7.9% for nine months (versus 4.0%). These are calculated from reported operating income and sales.
- Segments: Q3 paperboard packaging sales were $929.0 million and operating income $115.3 million; flexible packaging sales were $175.7 million and operating loss $9.4 million. Nine-month segment operating income was $325.4 million for paperboard and a loss of $18.3 million for flexible packaging.
- Cash flow and investment: Nine-month operating cash flow was $288.3 million, up from $198.9 million. Investing cash outflow was $114.2 million, including $128.4 million of capital spending; financing cash outflow was $410.7 million. Cash fell to $36.5 million from $271.8 million at year-end 2011.
- Debt and liquidity: Total debt was $1,977.2 million at September 30, 2012, compared with $2,365.8 million at December 31, 2011; cash-adjusted debt was $1,940.7 million. The company reported $675.4 million available under revolving facilities, after letters of credit. Current assets were $1,086.7 million and current liabilities $688.2 million.
- Interest and tax: Nine-month net interest expense was $85.6 million, down from $110.7 million. Nine-month income tax expense was $68.6 million; management said use of tax net operating losses meant higher tax expense did not affect cash flow. The company reported approximately $1.0 billion of U.S. federal NOLs.
Material changes versus 2011
- Revenue growth reflected higher volume, new consumer-products business and the DNK flexible-packaging combination; currency movements and softer markets partly offset gains.
- Operating results improved substantially, partly because Q3 and nine-month 2011 results included a $96.3 million non-cash goodwill impairment charge. Cost savings, volume and mix also helped; flexible packaging remained loss-making.
- Management reported $53 million of incremental year-over-year cost savings in the first nine months. It also cited $46 million of inflationary cost increases, partly offset by lower secondary-fiber and energy costs.
- On March 16, 2012, the company refinanced debt with a new $2.0 billion credit agreement, including a $1.0 billion revolver and $1.0 billion term loan due in 2017. It recorded an $8.9 million debt-extinguishment loss and incurred approximately $22 million of refinancing fees and expenses.
Outlook, commentary and risks
- For 2012, management expected $70–$80 million in year-over-year operating cost savings; capital investment of $190–$210 million; depreciation and amortization of $260–$280 million; interest expense of $110–$120 million; net debt reduction of approximately $220–$240 million; and pension contributions of $45–$60 million.
- At September 30, the company reported compliance with debt covenants: leverage ratio of 2.86x against a maximum of 4.75x for 2012, and interest coverage of 5.98x against a minimum of 3.00x. Management believed operating cash flow and available financing would meet expected needs, while noting there was no assurance.
- Key risks include raw-material, energy and labor cost volatility; limited ability to pass cost increases through; market softness and competition; execution of cost-reduction and integration plans; high debt and restrictive covenants; and exposure to interest rates and foreign currencies. Approximately 42% of debt was floating-rate.
- Environmental investigations and remediation may create future costs that cannot currently be estimated with certainty. The company said accrued and reasonably possible losses were not material; ordinary-course lawsuits were not expected to have a material adverse effect. No material risk-factor changes from the 2011 Form 10-K were reported.
- The DNK acquisition valuation was still being finalized, with completion expected in Q4 2012. The partner’s interest in the joint venture is subject to put rights that could require the company to acquire it at fair value.
Important facts for investors to verify
- Whether the 2012 savings and net-debt-reduction outlook was achieved, and how much resulted from recurring operational improvements.
- Subsequent debt balances, refinancing terms, floating-rate exposure, revolver availability and covenant headroom.
- Whether flexible packaging improved beyond its reported operating loss, and the continuing effects of market softness, integration costs and inflation.
- Final DNK purchase-price allocation and any exercise or valuation consequences of the partner’s put rights.
- Use and availability of the reported NOLs, future tax cash payments, pension funding requirements, and developments in environmental or legal contingencies.