Graphic Packaging Holding Company — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. The company makes paperboard packaging, including cartons, cups, lids and foodservice containers. Financial amounts are in millions of dollars except per-share data.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $1,552.8 | $1,510.9 | $3,058.7 | $2,988.3 |
| Income from operations | $144.4 | $110.3 | $278.4 | $184.3 |
| Operating margin | 9.3% | 7.3% | 9.1% | 6.2% |
| Net income attributable to GPHC | $63.8 | $49.4 | $121.7 | $79.3 |
| Diluted EPS | $0.22 | $0.16 | $0.41 | $0.25 |
| Net interest expense | $35.5 | $30.3 | $70.5 | $59.1 |
Q2 sales rose 2.8%; higher prices, 2018 acquisitions and mill open-market sales were partly offset by unfavorable currency and lower converting volumes. Operating income increased 30.9%, reflecting pricing, cost savings, capital-project benefits and synergies, partly offset by inflation, foreign exchange, Monroe facility start-up costs and higher incentive costs. For the first half, sales rose 2.4% and operating income 51.1%; reported income benefited from lower acquisition and integration expenses compared with 2018.
Cash flow: First-half operating cash flow was $59.8, versus $300.2 used in 2018. The improvement reflected receivables-program changes and improved operations, partly offset by higher inventory. Investing cash flow was a $10.0 outflow, versus $299.7 inflow; cash flows in both periods were materially affected by beneficial interests in receivables. Capital investment was $158.3, compared with $173.4. Financing cash flow was a $56.4 outflow. Cash ended the period at $64.7, down from $70.5 at year-end.
Liquidity and debt: Current assets were $1,860.8 and current liabilities $1,094.0 at June 30. Reported short- and long-term debt totaled $3,056.4; the filing separately states aggregate principal debt of $3,070.6. Revolving facilities had $1,430.2 available. The company issued $300.0 of 4.75% senior notes due 2027 and used net proceeds to repay revolver borrowings. About 38% of debt was floating-rate. The company was compliant with debt covenants: leverage ratio 2.75 versus a maximum 4.25, and interest coverage 8.07 versus a minimum 3.00.
Quarterly dividends were $0.075 per share. During the first half, the company repurchased 6.46 million shares at an average $12.04 under its prior program; approximately $512 remained available across the repurchase programs at June 30.
Material changes and segment results
- All three reportable segments improved operating income year over year in Q2 and the first half. Q2 operating income was $12.5 for Paperboard Mills, $125.3 for Americas Paperboard Packaging and $15.5 for Europe Paperboard Packaging.
- Pricing supported results, but inflation was a significant offset. First-half cost inflation totaled $53.7, led by wood ($27.5) and labor and benefits ($19.4), with external board and other costs also higher.
- Converting volumes were weaker in dry and frozen foods, cereal and away-from-home products, including cups; beverage volumes were stronger in some categories. Europe sales were affected by adverse currency movements.
- The company adopted lease accounting standard ASC 842 on January 1, 2019. It materially increased reported assets and liabilities, with no material effect on results or cash flows. Operating lease liabilities were $204.3 at June 30.
Outlook, risks and other notable items
- 2019 capital investment guidance is approximately $325, including $275 for process-capability improvements, $40 for capital spares and $10 for packaging machinery.
- Management expects 2019 depreciation and amortization of $440–$460, excluding approximately $10 of pension amortization; interest expense of $135–$145; and pension contributions of $10–$12.
- The company had approximately $168 of U.S. federal net operating losses at December 31, 2018 and does not expect to be a meaningful U.S. federal cash taxpayer until 2021, based on those losses and other tax benefits.
- On July 23, 2019, the company announced an agreement to acquire substantially all assets of Artistic Carton Company, subject to customary closing conditions, with closing expected in Q3 2019. The business includes a CRB mill and two converting facilities.
- A three-year program to dismantle and dispose of idle and abandoned assets began in 2019; expected charges are approximately $40. Q2 special charges were $9.9, including $9.4 of shutdown and other special charges.
- Key risks include volatile raw-material and energy costs, limited ability to pass through cost increases, competition and product substitution, changing consumer demand, execution of cost-reduction and acquisition plans, foreign-exchange exposure, and the company’s debt and covenant restrictions. Environmental investigations and ordinary-course lawsuits are disclosed; management does not expect the matters described to have a material adverse effect.
- Management reported that disclosure controls were effective at June 30. A material weakness involving business-combination accounting controls, identified at year-end 2018, was reported as remediated in Q1 2019.
Important facts for investors to verify
- Whether pricing and productivity gains can continue to offset inflation, particularly wood, labor and external-board costs.
- Whether converting volumes recover and whether lower sales in selected consumer and foodservice categories persist.
- Cash conversion and working-capital trends, including the company’s reliance on receivables-sale and securitization arrangements.
- Debt levels, floating-rate exposure, covenant headroom and liquidity after capital spending, dividends and share repurchases.
- Completion and financial impact of the Artistic Carton acquisition, and execution of the idle-asset dismantling program.
- Assumptions supporting the timing of U.S. federal cash taxes and the stated 2019 spending and expense outlook.