Graphic Packaging Holding Company — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. The company provides paper-based packaging, paperboard and related machinery to food, beverage and other consumer-products markets.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $1,137.6 million | $1,103.7 million | $3,293.8 million | $3,240.9 million |
| Income from operations | $95.4 million | $105.1 million | $258.5 million | $317.9 million |
| Net income | $47.3 million | $57.8 million | $126.3 million | $193.1 million |
| Diluted EPS | $0.15 | $0.18 | $0.40 | $0.60 |
| Operating cash flow | Not separately provided for the quarter | $306.5 million | $394.3 million |
- Q3 sales rose 3.1%, supported by the Carton Craft acquisition, higher converting volumes and favorable currency; lower pricing partly offset growth. Nine-month sales rose 1.6%.
- Operating income fell 9.2% in Q3 and 18.7% over nine months. Reported operating margin was approximately 8.4% in Q3 (9.5% prior year) and 7.9% for nine months (9.8% prior year).
- Management attributed operating pressure chiefly to inflation and lower selling prices. Nine-month cost inflation was $78.8 million, led by secondary fiber ($37.6 million), labor and benefits ($17.0 million), chemicals ($10.8 million) and freight ($9.1 million). Cost-reduction initiatives partly offset the increases.
- Interest expense increased to $22.6 million in Q3 from $20.0 million, and to $66.4 million for nine months from $55.1 million, primarily due to higher average interest rates. The 2016 nine-month comparison also included a $22.4 million tax benefit from an IRS agreement, contributing to the decline in 2017 net income.
Financial position, debt and liquidity
- At September 30, cash was $17.2 million, current assets $1,222.6 million and current liabilities $817.4 million. Cash was down from $59.1 million at December 31, 2016.
- Debt obligations were reported by management at $2,288.1 million. The company had $1,121.3 million available under revolving credit facilities. Approximately 36% of total debt carried floating rates.
- The company was in compliance with debt covenants. Its leverage ratio was 3.18 against a maximum of 4.25; its interest coverage ratio was 8.64 against a minimum of 3.00. Credit ratings were BB+ from S&P and Ba1 from Moody’s, both with stable outlooks.
- Nine-month operating cash flow was $306.5 million; investing cash use was $319.1 million, including $185.8 million of capital spending and the $120.9 million Carton Craft purchase. Financing cash use was $31.6 million, including $70.2 million in dividends and $62.1 million in share repurchases. Cash declined by $41.9 million during the period.
Material changes, outlook and notable items
- On July 10, 2017, the company acquired Carton Craft for $120.9 million. On October 4, it completed the acquisition of Spanish carton producer Norgraft Packaging.
- The company announced it would close its Santa Clara, California, coated recycled paperboard mill by year-end 2017. It recorded $7.1 million in accelerated depreciation related to the closure during the quarter and nine-month period.
- On October 24, after quarter-end, the company announced a combination with International Paper’s North America Consumer Packaging business. Graphic Packaging is to own 79.5% of the partnership and be its sole operator; combined-business revenue was described as approximately $6 billion.
- 2017 outlook: capital investment of approximately $250 million; depreciation and amortization of $300–$320 million; interest expense of $85–$90 million; and approximately $360 million of cash flow available for net debt reduction, dividends and repurchases, excluding M&A and capital-market activity. Expected pension contributions were approximately $35 million.
- The company expected to have $375–$425 million of U.S. federal net operating losses remaining at year-end and did not expect to be a meaningful U.S. federal cash taxpayer until 2020.
- Key risks include raw-material and energy-cost volatility, limited ability to pass cost increases through to customers, competition and product substitution, consumer-demand shifts, execution of cost-saving and acquisition strategies, debt and covenant constraints, foreign exchange, and environmental or litigation matters. The company said no material change had occurred in previously disclosed risk factors; it did not believe current legal matters or accrued environmental contingencies would be material.
Important facts for investors to verify
- Whether pricing, secondary-fiber inflation and other cost pressures ease, and whether productivity savings can restore margins.
- Carton Craft and Norgraft integration and the terms, financing, approvals and expected effects of the announced International Paper partnership.
- Liquidity and leverage trends, including the use of revolving credit, cash generation, and compliance with debt covenants.
- The Santa Clara mill closure’s final costs and operational effects, and progress toward the stated 2017 capital, cash-flow and interest-expense outlook.
- Whether the expected NOL balance and timing of federal cash taxes remain achievable.