Graphic Packaging Holding Company — Q2 2014 Form 10-Q
Business context and reporting period. The company supplies paperboard packaging and related products to food, beverage and other consumer-products markets. This unaudited filing covers the three and six months ended June 30, 2014, compared with the corresponding 2013 periods.
Financial results and condition
| Metric | Q2 2014 | Q2 2013 | First half 2014 | First half 2013 |
|---|---|---|---|---|
| Net sales | $1,116.7 million | $1,139.7 million | $2,189.4 million | $2,240.2 million |
| Operating income (loss) | $(52.9) million | $87.7 million | $26.8 million | $172.9 million |
| Net income (loss) attributable to GPHC | $(40.0) million | $21.2 million | $(4.8) million | $56.1 million |
| Diluted earnings (loss) per share | $(0.12) | $0.06 | $(0.01) | $0.16 |
| Operating cash flow | Not separately stated | Not separately stated | $153.6 million | $109.9 million |
- Margins: Calculated gross margin was 19.1% in Q2 versus 16.6% a year earlier, and 18.3% for the first half versus 16.6%. Operating margin was (4.7)% in Q2 versus 7.7%, and 1.2% for the first half versus 7.7%; the 2014 operating results include a large asset-sale loss.
- Cash flow and investment: First-half investing cash outflow was $90.0 million, including $190.7 million for Benson, offset in part by $167.4 million in net cash proceeds from asset sales and a $26.9 million government grant. Capital spending was $108.9 million, compared with $84.6 million. Cash rose to $157.0 million from $52.2 million at year-end.
- Debt and liquidity: Total debt was $2,318.3 million at June 30, up from $2,253.6 million at December 31, 2013; long-term debt was $2,245.3 million. Revolver availability was $764.9 million, net of outstanding letters of credit. The company reported covenant ratios of 3.07x total leverage against a maximum of 4.25x, and 8.80x interest coverage against a 3.00x minimum; it stated that it was in compliance.
- Other metrics: Net interest expense for the first half fell to $41.6 million from $56.9 million. About 46.3% of debt had floating rates. The company reported a $8.4 million first-half income tax benefit and approximately $917 million of U.S. federal net operating losses.
Material changes versus the prior comparable period
- Q2 sales declined 2.0%; first-half sales declined 2.3%. Higher pricing, Benson, new products and favorable exchange effects partly offset lower volumes and divestitures.
- Paperboard Packaging sales increased 1.6% in Q2 and 1.1% in the first half; segment operating income rose to $131.5 million and $231.7 million, respectively. Flexible Packaging sales fell 22.8% in Q2 and 21.6% in the first half, primarily reflecting divestitures.
- Q2 operating results included a $164.5 million loss on sale of the multi-wall bag business. First-half restructuring and other special charges totaled $178.9 million, including $170.4 million of asset-sale losses, versus $9.7 million a year earlier.
- Inflation increased first-half costs by $41.8 million, principally labor and benefits ($21.4 million) and energy ($10.1 million). Management cited approximately $32 million of incremental savings from continuous-improvement and manufacturing initiatives. Severe winter weather and power outages caused an estimated $14.5 million of lost production and higher manufacturing and freight costs.
Outlook, commentary and risks
- 2014 guidance: capital investment of $185–$205 million; depreciation and amortization of $265–$275 million; interest expense of $80–$90 million; net debt reduction of approximately $350 million, excluding acquisitions and divestitures; and pension contributions of $40–$60 million.
- The company acquired U.K.-based Benson on May 23 for $190.7 million in cash, funded with existing cash and revolver borrowings. Its preliminary allocation included $117.8 million of goodwill, which the company did not expect to be tax-deductible.
- The multi-wall bag business was sold on June 30 as part of a focus on core assets. It had generated approximately $440 million of 2013 sales, about 10% of consolidated sales. The labels business was sold in February. The company was reevaluating segment disclosures following the multi-wall bag sale.
- Management said cash from operations and available financing were expected to cover debt service, capital spending and operating needs, but noted there was no assurance. Risks include raw-material and energy inflation, constrained ability to pass through costs, competitive and volume pressure, execution of cost savings, facility disruptions, foreign-exchange exposure and substantial debt. Debt covenants and cross-default provisions may constrain flexibility; future covenant compliance depends on operating performance.
- The company expected to spend less than $10 million in aggregate during 2014–2015 on Boiler MACT compliance. It said ordinary-course lawsuits were not expected to have a material adverse effect, while acknowledging that environmental remediation costs could change as information develops. No material risk-factor changes from the 2013 Form 10-K were reported.
- Other notable items: the second-quarter secondary offering involved 43.7 million shares sold by existing shareholders at $10.45 per share; it was not a company issuance. The company also acquired the remaining 13% interest in its flexible-packaging joint venture. Management reported effective disclosure controls and no material change in internal controls.
Important facts for investors to verify
- How much of the reported operating loss and special charges reflects nonrecurring divestiture costs, and what are ongoing earnings after those effects?
- Whether the $350 million net-debt-reduction outlook remains achievable after the Benson acquisition, capital investment and working-capital needs.
- Actual sales, margins and cost savings in the continuing paperboard business, including the effects of inflation, pricing and market volumes.
- Integration progress and returns from Benson, and the final purchase-price allocation and goodwill assessment.
- Debt, interest-rate exposure, revolver availability and covenant headroom as results and cash flows develop.
- Potential environmental, litigation and tax developments, including use of U.S. net operating losses.