Graphic Packaging Holding Company (NYSE: GPK) — FY 2018 Form 10-K
Reporting period: Year ended December 31, 2018; comparisons are primarily with FY 2017. The company supplies paper-based packaging and paperboard to food, beverage, foodservice and consumer-products markets. Results include the North America Consumer Packaging (NACP) combination with International Paper, completed January 1, 2018, as well as smaller 2018 acquisitions.
Financial results and condition
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net sales | $6,023.0 million | $4,403.7 million |
| Gross profit | $946.0 million; about 15.7% margin | $719.5 million; about 16.3% margin |
| Operating income | $458.2 million; about 7.6% margin | $327.9 million; about 7.4% margin |
| Net income | $294.0 million | $300.2 million |
| Net income attributable to GPHC | $221.1 million; diluted EPS $0.71 | $300.2 million; diluted EPS $0.96 |
| Cash and cash equivalents at year-end | $70.5 million | $67.4 million |
| Debt on balance sheet | $2,957.1 million | $2,274.5 million |
| Capital spending, including packaging machinery | $395.2 million | $260.1 million |
Sales rose 36.8%, primarily reflecting $1,547.9 million of sales from the NACP combination and 2017 and 2018 acquisitions, with additional contributions from pricing and foreign exchange. Core volumes were broadly stable, but beverage volumes and some open-market paperboard volumes declined. Operating income increased 39.7%; higher pricing, acquired operations, cost savings and a $37.1 million gain on the Santa Clara site sale were partly offset by inflation and an approximately $52 million Augusta, Georgia mill outage. Gross margin declined year over year.
Net income attributable to GPHC fell despite higher operating income, reflecting higher interest expense, tax expense versus a tax benefit in 2017, and $72.9 million of income attributable to noncontrolling interests created by the NACP transaction. Interest expense, net was $123.7 million, up from $89.7 million. The 2017 tax benefit included the effect of U.S. tax reform.
Cash flow from operating activities was negative $373.8 million, compared with negative $192.5 million in 2017. The company attributed the increase in cash use to higher receivables sold during the period and higher inventory. The reported operating cash flow is materially affected by the accounting presentation of receivables-sale programs: net cash receipts under those programs were $1,131.2 million in 2018, classified in investing activities. Receivables sold and derecognized totaled $3,824.5 million. Investing cash flow was positive $689.1 million and financing cash flow was negative $310.7 million.
Year-end current assets were $1,763.8 million and current liabilities $1,172.3 million. The company reported $1,236.2 million available across revolving credit facilities. Approximately 41% of debt was variable-rate; credit-agreement leverage and interest-coverage ratios were 2.74x and 8.55x, respectively, and the company reported covenant compliance. The balance-sheet cash figure is modest relative to debt and capital needs.
Material developments, outlook and risks
- NACP transaction and acquisitions: The NACP combination contributed $1,407.1 million of 2018 sales and $134.7 million of operating income. International Paper holds a 20.5% GPIP interest, with units subject to exchange or redemption under specified terms. Letica Foodservice and PFP were acquired during 2018 for approximately $95 million and $34 million, respectively.
- 2019 outlook: Management expected capital investment of approximately $320 million; depreciation and amortization of $430–$440 million, excluding approximately $10 million pension amortization; interest expense of $135–$145 million; and pension contributions of $10–$12 million. These are estimates, not guarantees. The company expected not to be a meaningful U.S. federal cash taxpayer until 2021, citing approximately $168 million of federal NOLs and other tax benefits.
- Costs and markets: Raw-material, freight, labor, chemical, energy and transportation costs, competition and substitution by plastic, corrugated and other packaging can pressure margins. The company may not be able to pass cost increases through to customers. Consumer preferences, customer contract renewals, execution of productivity programs and acquisition integration also affect results.
- Debt and liquidity: Debt service, variable interest rates, debt covenants and financing-market conditions may constrain acquisitions, investment, dividends or repurchases. Contractual obligations totaled $4.22 billion, including debt, leases, interest and purchase commitments.
- Pension and other contingencies: Pension plan assets were $1,186.5 million against projected obligations of $1,245.2 million. The company began terminating its largest U.S. pension plan; the expected benefit obligation associated with termination was approximately $800 million, with lump-sum offers and annuity purchases planned. Environmental investigations and ordinary-course litigation remain, though management did not believe the disclosed matters would have a material adverse effect. Brexit, foreign exchange, cyber incidents and operational disruptions are additional identified risks.
- Internal controls: Management and Ernst & Young identified a material weakness in controls over business-combination accounting, including review and documentation of accounting and estimates for the complex NACP combination. The auditor issued an adverse opinion on internal control over financial reporting; the financial-statement audit opinion was unqualified. Management said remediation had begun. The weakness did not result in a material misstatement of the 2018 audited financial statements, according to the filing.
- Capital returns: The company repurchased $120.0 million of shares and paid $93.1 million of cash dividends in 2018. A new $500 million repurchase program was authorized January 28, 2019.
Key investor verification points
- Assess the recurring earnings contribution of NACP and other acquisitions separately from acquisition-related costs, the Santa Clara gain, and the Augusta mill outage.
- Reconcile reported negative operating cash flow with receivables-sale and factoring programs, including their ongoing availability, costs, and continuing-involvement exposure.
- Review debt maturities, variable-rate exposure, covenant headroom and financing needs alongside planned capital spending, dividends and repurchases.
- Track remediation of the material weakness and any changes to acquisition accounting estimates or controls.
- Monitor pension termination costs, funding requirements, and the company’s ability to realize expected tax benefits and use federal NOLs.