Q3 2019 Earnings Call
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Thank you I'm joining enemies are going at this time. Good question. During this time simply Presto and that number one on your telephone keypad. If he would like to withdraw the question press the pound T. Thank you at this time I would like to turn the conference over to Melanie Skijus Vice President of Investor Relations. Please go ahead.
Good morning, and welcome to graphic packaging holding companies conference call to discuss our third quarter 2019 result speaking on the call will be liked off the company's president and CEO and Steve Scherger Executive Vice President and CFO .
Oh, along with today's call we've provided a slide presentation, which can be accessed on the investor section of our website at Www graphics peak AG dotcom.
I'd like to remind everyone that statements of our expectations plans estimates and beliefs regarding future performance and events constitute forward looking statement.
Such statements are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the company's present expectations.
Information regarding these risks and uncertainties is contained in the company's periodic filings with the Securities and Exchange Commission.
Undue reliance should not be placed on forward looking statements as such statements speak only as of the date on which they are made and the company undertakes no obligation to update such statements, except as required by law like I'll turn it over to you think you Melanie good morning, and thank you for joining us to discuss our third quarter 2019 result.
Thank you as well to those of you who attended our Investor day last month, either in person or on webcast.
Our remarks today regarding future plans and expectations will be very consistent with those we provided to you last month.
Turning to the third quarter.
We reported solid operating and financial results with volume up 2.6% net revenue of 3.3% on a year over year basis, adjusted EBITDA of $244 million was at the high end of our expectations, notably we delivered organic growth in the quarter and are on track for 100 basis points of network.
Panic volume growth for the second half of the year.
The quarter benefited from $34 million have improved pricing importantly, our pricing to commodity input costs relationship was a positive $26 million in the third quarter and $67 million for the first nine months of 2019, reflecting our pricing initiatives and modest inflation.
Steve will discuss our third quarter financial results in greater detail shortly but favorable pricing in the quarter was offset by inflation, both commodity input costs as well as labor and benefits.
In addition, and as expected our results were impacted by the previously announced and planned extensive maintenance outage at our Texarkana Sps mill.
As a result, adjusted EBITDA of $244 million decline from prior year period, but was at the high end of our expectations and we continue to expect to deliver approximately $1.03 billion and adjusted EBITDA for the full year. This reflects an increase of approximately 6% when compared to 2018.
And is higher than our projections when we began the year.
Moving now to key operational trends in the quarter.
Volume in our global Paperboard packaging business was up 2.6% in third quarter, driven by acquisitions in net organic volume growth in the quarter.
We're capturing growth opportunities as customer shift into our innovative paperboard solutions, new product wins, and foodservice, including insulated paperboard cups, and bowls, new beverage categories and beverage packaging wins to name a few physician our business for 100 basis points of net organic volume growth for the rest of year.
And 100 to 200 basis points in 2020, I will talk more about new business, we're capturing in a moment.
Our mills and converting assets ran well during the quarter work at the new Monroe converting facility continues as we approach full run rate.
We are meeting the needs of our customers as we continue to enhance and optimize our mill and converting facility footprint.
The S&P reported Q3 2019 operating rates of 98%.
For CRB and 93% for US, yes, graphic packaging see UK operating rate remains over 95%.
Backlogs remain healthy.
Remain healthy five plus weeks receive K four weeks for CRB and three weeks for Sps as you know one of our key strategic priorities is to increase or integration rates CRB in UK mill operations are highly integrated with our converting platform today and we are focused on driving integration rates higher across all three substrates over.
Were tied.
Our combined integration rate is currently 68%.
As a reminder, we defined integration as paperboard tons, we manufacture and convert at our facilities into products, we sell to our end use customers.
Shifting to performance.
Well over overall productivity levels met expectations for the third quarter net productivity was impacted by the planned extensive mill outage at Texarkana importantly, the completion of this large maintenance project, which included structural modifications to the recovery boiler was completed on time and on budget.
The work done is expected to yield long term safety efficiently C and reliability improvements and is reflective of our ongoing focus on productivity and operational efficiencies.
Our business generates significant cash flow, which provides us with flexibility to execute on our balanced approach to capital allocation.
I will wrap up my prepared remarks with the discussion of capital allocation will quickly touching on some of the initiatives. We shared with you at our Investor day in our vision 2025.
Productivity based margin improvement a pivot towards organic volume growth coupled with targeted acquisitions are keys to our 2025 vision.
A discussion of some of the new wins and product development initiatives will provide insight into the organic volume component of our vision and why we see 100 to 200 basis points of net organic volume growth in 2020.
As we released late last week AB Inbev will be one of the first to commercialize our new Q clip paperboard packaging solution for beverage cans beginning in the first quarter of 2020 last quarter, we shared with you to a customer interest in the queue clip food and beverage solution remain very high.
Hi.
And we were building new packaging machinery for several large customers. We are excited that AB inbev has announced that its brands in the UK market will be the first to leverage keel clip. We believe our innovative solution offers both sustainability advantage in merchandising benefits over other packaging alternatives and we expect demand for Q clip.
To accelerate.
Another encouraging development for our businesses the move within the food service market to paper based packaging solutions to replace other alternatives.
Customers are choosing graphic packaging for their conversion from foam and plastic cups and containers into insulated paperboard cups and containers.
The previously announced artistic Carton acquisition, which was completed in the third quarter is an example of targeted acquisitions. We will continue to pursue with the acquisition. We added two converting plants located in offer in Indiana, and Elgin, Illinois in one CRB mill in White Pigeon, Michigan to transact.
And drives compelling optimization and growth opportunities for our paperboard mill and converting platforms in North America, including expansion and diversification into new end markets artistic serves several market verticals, we weren't participating and before this was a great acquisition and supports our priority to drive integration rates.
Higher.
Finally, the $600 million transformative CRB platform investment in Kalamazoo, Michigan announced during the quarter will drive meaningful cost reduction and consolidation as we move from operating five CRB mills to three the capital we are investing in this project over the next two years will yield significant quality and cost benefits for years.
To come and positions us for long term leadership in the coated recycled paperboard market. We continue to expect a new machine to be operational in early 2022.
With a strong balance sheet and cash flow model.
We maintain the financial flexibility to continue to deploy a balanced capital approach to capital allocation. This was demonstrated in the third quarter of 2019, where we generated $187 million and cash flow paid approximately $51 million for artistic tartan acquisition invested $72 million and capital.
Projects and returned $79 million of capital to stakeholders with that I'll turn the call over to Steve for more detailed discussion or our financials, Steve Thanks, Mike and good morning.
We reported third quarter earnings of 18 cents per diluted share down compared to 30 cents in the third quarter of 2018.
Third quarter 2019, net income was negatively impacted by an at $5.3 million special charge.
Third quarter 2018, net income was positively impacted by that $25.2 million of special charges and credits.
Details can be found on the reconciliation of non-GAAP financial measures table attached to the earnings release.
When adjusting for these charges and credits adjusted net income for the third quarter was $57.4 million or 20 cents per diluted share.
This compares to third quarter 2018, adjusted net income of $69.1 million or 22 cents per diluted share.
Focusing on third quarter net sales.
Revenue increased 3.3% driven primarily by $34 million higher pricing.
And $28 million of volume mix related to acquisitions and organic volume growth.
These benefits were partially offset by $12 million of unfavorable foreign exchange.
Turning to third quarter adjusted EBITDA, the $12 million decreased $244 million was driven by $20 million of operating items, primarily the previously announced and planned extensive maintenance outage at the Texarkana mill.
$8 million, the commodity input cost inflation, primarily would.
$12 million of other inflation, primarily labor and benefits.
$3 million of unfavorable foreign exchange and $3 million of volume mix.
Importantly, these items are partially offset by a favorable $34 million in pricing during the quarter.
Pricing will remain favorable in the fourth quarter fourth quarter and as noted at our Investor Day, we expect pricing of approximately $20 million for the year.
In Q3, we repurchased $50 million of shares advise we estimate that really below intrinsic value of graphic packaging.
Over the last 12 months, we repurchased $248 million shares successfully reducing share count by meaningful 6%.
Since February 2015, and we began the repurchase program, we repurchased $538 million of shares resulting in an 11% net reduction from shares outstanding a program inception.
We ended the third quarter with roughly $1.5 billion of global liquidity and $2.9 billion of net debt.
Total net debt decreased $52 million during the quarter.
In the third quarter, we invested $72 million and capital expenditures repurchased $50 million or shares.
$23 million in dividends and made a $6 million distribution to our GP IP partner.
Third quarter pro forma net leverage ratio was 2.9 times.
We remain committed to our long term net leverage target two and half to three times and expect we will end the year with leverage of approximately 2.6 times.
There is no change to the 2019 adjusted EBITDA guidance of approximately $1.03 billion, we provided at our Investor day, representing 6% growth over 2018.
We expect 2019 cash flow will be approximately $525 million.
We also established initial 2020 EBITDA range at our Investor day of $1.04 billion to $1.1 billion.
We remain of our guidance for 2019, our initial guidance for 2020 is included in the presentation on our website.
Thanks for your time this morning, I'll now turn the call back to Mike Hi, Thanks, Steve as outlined during our Investor Day last month, our vision 2025, redefines leadership in our industry, we intend to continue to invest in our business to drive innovation growth and productivity improvements, while delivering value to our stakeholders.
I'll now turn the call back to the operator for today.
At this time I would like to remind everyone that if you would like to ask your question superstar and the number one on your telephone keypad. As a reminder, please ask one question and one follow up we'll pause for just a moment.
The first question will come from George Staphos with Bank of America. Please go ahead.
Hi, Thanks, everyone appreciate the detail.
Two questions for me to start.
Mike can you talk at all in terms of what you might be seeing in terms of potential growth opportunities and the CRB market in light of ultimately the the Casey.
Pam three coming up and a couple of years, it's obvious why you'd be seeing more opportunities and some of the other grades but curious to see what.
CRB is looking like in terms of perhaps new products and are you seeing any related share shift away from paper have you lost anything in paper to plastic can last a couple of months them at a follow on.
Yes, Thanks, George for that as we talked about our Investor day, one of the things. We're really excited about our investment in net new paper machine in Kalamazoo is going to be the actual quality that we're able to produce it'll have a smooth the surface.
So that'll provide opportunities for different types of emerging digital printing, which right now on CRB, we're really not capable of providing the other thing that it's going to have is a much wider range profile ranged from Mcallister standpoint will comfortably be able to go down and run 14 point as an example, where right now we struggle with that and so.
So that's going to give us some opportunities to work on some new.
Products for our customers for sure in regards to any shift.
Material shifts out of.
Paperboard and into plastic in the last few months I mean, none really come to mind that I can think of we track Thats a pretty closely as you know George and.
Im not able to comment anything specific.
There that I'm aware of Okay. I appreciate that my second question I'll turn it over.
When I look at the EBITDA bridge, the volume mix was with a minus 3 million rounding up it's not a big deal obviously and we're pleased to see the organic growth, but what was driving the price mix excuse me the volume mix being negative given what looks to be a little bit better volume momentum for the company going forward. Thank you.
Hey, George its Steve, Yes, just with regards to that modest negative obviously, we've got positive.
Net organic volume growth that's flowing through we also have some positives relative to our acquisition.
What's offsetting that modestly or two things one we do continue to see a little bit of negative mix rolling through the business, mostly focused around some of the Roes in the guys center of the store some of the more traditional applications and we're working through that as we round out here. The end of the year and also were Onboarding a lot of new business a lot of what.
We're talking about as exciting in new and we're ramping up relative to our margin profiles in the return so little bit of negativity is we round out the end of this year, we expect that to turn modestly positive driven by the net organic volume growth as we round into 2020.
Thank you Steve.
You bet in Q.
The next question is from Mark will do with bank of Montreal. Please go ahead.
Good morning, Mike Good morning, Steve.
Mark Mark.
I wondered either Mike or Steve if you can talk a little bit about kind of conditions over in Europe and.
Any changes you might be seeing in terms of behavior in front of Brexit.
Yes, that's a great question, then as you know the Brexit.
It's almost like a daily thing right now in terms of where it stands relative to parliament and how thats all playing out. So like you were watching pretty carefully we have seen the pound strengthened a little bit thats a good thing for us.
Obviously on it on a translation basis, but in terms of overall demand our demands held up well in that market and again the majority of what we we manufacturer in the UK is consumed in the UK were not exporting out of the UK and into mainland Europe for Central Europe . So.
You know were little insulated in terms of what that profile looks like.
And we'll be watching obviously here this week to see if in fact, there is a vote and you an exit here at the end of October and certainly hasn't had any impact on the momentum around sustainability driven conversions in like that momentum and certainly just continued yes, and just to put a finer point.
On that I mean, you saw that.
Hey, being up actually announced that they were going to use our Q clip in the UK to get out of icon rings. So we see progress.
And opportunities for ourselves there.
Okay, and then just as a follow on and kind of related to that sustainability issuing I see that theres a proposal over in Scotland sort of taxing single serve comps I wondered if you could talk about sort of how you see that playing on and again, Mike just to kind of recap for US where you ran in terms of your progress in improving.
Recyclability on the paper comps.
Yes, thanks for that Mark So, yes, we saw that.
And we see those from time to time, there's been some in certain counties and cities here as you know here in the us as well.
And what we found new at least up to this point has been our comp is the paper Cup is is appreciated by the end use consumer and demand for that has grown at the expense of phone.
It is a single use up at the end of the day, but a lot of that stuff is sold to drive throughs in its takeout out of the store.
And so we're going to watch that carefully to see how that all plays out.
As you alluded to and you are correct. Our focus is really on how do we get to a solution that doesn't require PE coatings on the inside of our cups, we actually have a commercial.
Solution today that P.L.A. that we outlined the play coating that we took all of you through at the Investor Day, and we continue to work very hard to ramp that up and we expect to have.
A win on that here in early in 2020.
We've got a couple of customers that have expressed.
Interest in that we're working to bring those to commercial reality.
So thats really how were thinking that through and that puts us in a situation than where from a sustainability standpoint from an east cheese standpoint, we've got even better story to tell than we do today.
The next question is from Mark Connelly with Stephens, Inc. Please go ahead.
Thanks, just two things how should we think of 2019 maintenance should we think it this is an unusually high year.
Given the big outage or is next youre going to going to be similar I. Appreciate you may not have estimates just trying to put in perspective, and then second question. Just following up on this price leakage issue you mentioned last quarter that you've got to new price review group, but can you tell us how we should be thinking about progress you might make is it going to come in.
More changes to contracts or just tightening up the way you're negotiating.
Are you looking to make meaningful progress or or discrete progress just curious.
Yes, Thanks, Marc I'll take the maintenance I'll, let Steve talk a little bit about what we're doing with in regards to pricing.
In regards to maintenance in 2020, as we mentioned in it I think it was our second quarter call we have.
A recovery boiler project that we're going to do in West Monroe, We'll do that in April of next year. It will be similar to what you just saw on Texarkana.
So we would expect that to be on a year over year basis, not a pickup if you will.
It won't be more but it won't be a pickup per se once we're done with that particular project.
Based on what we know and the inspections, we've done on all our recovery boilers. As you recall, we did a big project and against last year. We do Texarkana. This year next year, we've got West Monroe that we believe that will be good for about the next decade in terms of major maintenance that needs to be down in our recovery boiler. So that would actually in fact, the more of a pickup in 2021 is how I.
Have you think about that.
And with that I'll, let you comment a little bit on the pricing Steve you touched on it Mark we feel very good about the investment that we've made in additional pricing resources focused on locking down and eliminating leakage tighter contract language and the like and success, but a big part of why you've seen our.
Positive pricing momentum this year and what that gives us is that some of the confidence we have that at this point, we have continuation of some positive pricing momentum heading into 2020.
As we continue to execute on our contracts renew contracts and keep the terms and conditions.
Good and tight will provide more guidance on next year's pricing.
In January but the investment has yielded very real and identifiable results. We track that at a as you would expect that customer product level.
To ensure that we in fact are holding on to the pricing that we've been executing in the market and the only other thing I'd add to the pricing that we've talked about as we made a very strong commercial push to reduce our lags down to six months, which is a big change from where we were a year ago. This time, so thats been the other thing we've done in regards to pricing right pickup okay. Thank you.
Thanks Mark.
The next question is from Anthony Pettinari with Citi. Please go ahead.
Good morning.
Morning.
You've highlighted a number of growth opportunities in the slides and at the analyst day I'm just wondering beyond the capex programs that you've outlined our their investments on the SGN a side maybe in people and processes you have to to make to pursue these opportunities and just culturally can you talk about how you kind of go from being a company.
That has maybe been more focus on cost management and kind of a flat declining market to an organization that can kind of capture some of these new opportunities.
Yes, thanks for that Anthony I mean, we are making investments to do in fact exactly what you just talked about I think your characterization is spot on.
To that end, we're actually building out our talent acquisition and management group is it as I talked about in the Investor Day, We've got new VP of HR She's building out our team we've actually we're putting dedicated resources into that that organization that's focused on specifically that.
We actually are actively recruiting for some to lead our new product development organization.
And we're going but bigger in that role in terms of how we're thinking about it and putting resources to work.
To help us drive the innovation and new product development pipeline, because there is a cultural shift that has to occur here I'd graphic where are very good operators and very good at controlling costs and.
And we need to continue to do that in many parts of our business, but there are certain parts of our business, where we think we can leverage for growth that you're going to see us allocate some of that.
Net savings that we've driven.
On the SGN a line push it around.
In two areas that are going to help us.
Drive and accelerate this growth so thats how were how we're talking about it in the board room, that's how we're managing the company.
And what you can expect to see US you'll continue to do as we head into 2020.
Okay, that's very helpful.
And then I just had a different question on the cost side, specifically fiber costs I should think about the coming years Theres a number of recycled containerboard machines coming online maybe driving some demand proceeds see there's some argument for the $25. Upon maybe some recyclers to stop collecting just how do you think about kind of upside.
For downside risks to this current LCC price $25, it's been pretty stable over the last few months is this sort of a new normal or just how do you think about the recycled fiber outlook going forward.
I would answer at start date answer off this way that every time I tried to predict what LCC will do I've been wrong and so.
No thats, probably not the best place for me to spend my time, but.
You can see a plausible argument for many of the things that you just talked about there.
The lower for longer certainly something that we've seen written about we know that there's probably a fairly good likelihood that China continues to tighten down the amount of material that so.
Imported into their country, which this year on the United States was over 11 million tons. So thats stuff arguably needs to find to own. There are the cash collection costs that you talked about but there is new capacity coming online that will consume some of that particularly on the.
The containerboard side the equation, so where we're adopting a we're watching that mark those markets very carefully as you can expect we buy a million tons, a little over a million tons of recycled fiber to run our business.
And we'll continue to.
Look to be aggressive in that regard and manage our costs. So.
In terms of a point of view specifically for 2020, we expect is probably going to be some modest inflation, that's what we're assuming.
In regards to fiber and we'll see how that plays out and be able to give you a finer point on that when we talk again in January and as you know Anthony for US given it is a commodity and does move it's really critical for us to just have the pricing mechanisms in place that allow for recovery.
Over a reasonable period of time, which is where we put most of our emphasis relative price recovery supply demand thats it for us, but we can influence and control.
Okay. That's helpful I'll turn it over.
The next question is from Chip Dillon with vertical research. Please go ahead.
Hi, Good morning, Mike and Steve.
Our chip.
First question is I've heard that Theres been a very low operating rate in recent weeks and bleed sport in the United States and you did mentioned your backlogs on the slides were the lowest among the three substrates I didn't know if there's anything unusual about this is just happened to be the timing of downtime and maybe that your competitors machine closure.
Or is there is there more going on there.
I think you summarize it actually pretty well you've got to remember we were down the majority of the month the September and Texarkana. So that has a big influence on a monthly operating rate the month. The September as an example, as you mentioned one of our competitors is shutting down a mill. So I would imagine that that played into that a little bit in from what we understand others. In this space we are doing.
Some third quarter maintenance as well so that probably all factors into what that looks like I think if you really want to total picture of how substrate is performing you've got to look at the backlog at the operating rates.
And production year over year, which if you take a look at production year over year Sps is down I think 40000 tons.
Here year to date, which is a little less than 1%.
Probably Kelly gives you a good harbinger on how it's actually.
Operating.
Gotcha and then just my follow up is it.
You know in your guidance for lab for next year, which is effectively unchanged from whatever from from the numbers you provided in September .
You do have this wide range of free cash flow or cash flow as you call it $75 million.
Wider than for example, the.
Yes, it is consistent with EBITDA guidance, but is there anything there other than just the EBITDA range EBITDA range that would cause a $75 million difference.
Are you looking at working capital could go one way or the other or how should we think about that range.
Yes chip it Steve the ranges for the most part the EBITDA range as we've articulated to your Capex will be in the $600 million range our.
Interest and taxes and pension we don't expect anything necessarily material there on an operating basis, we still won't be immaterial us cash taxpayer so.
Probably the only little bit of Governor there is a little bit of around working capital and we'll we'll refine that.
As we March into the end of the year and into the guide that will provide in January will probably you will see has tightened up that cash flow range most likely.
Okay. Thank you.
You bet.
The next question is from Debbie Jones with Deutsche Bank. Please go ahead.
Hi, good morning.
Hi, Debbie.
I wanted to just ask I might've missed this but it does seem like Youre at days of mill maintenance in Q4, John based on what you had in the Q3 presentation and then Q2, we really didn't change much. So just wondering what was going on there.
Yes, thanks for that Debbie what we actually did as we added quite pigeon into the Q4 outage schedule. Obviously, we just.
Acquired a hearing Q3, so won't be in there on a year over year basis, and I guess, Stephen I actually talked about that when we saw your initial write up this morning, we're actually giving some thought to how we provide a little bit better.
Insight into what those things costs, because as you can appreciate a day of white pigeon at up 70000 tons CRB mill isn't the same as a day at making so we're going to spend a little time thinking about how we may be able to do that even a little better going forward.
Okay. Thanks for that my second question is just very briefly touched on MSG investing in the focus and your Investor day kind of driving probably from your customer behavior, but I'm wondering if you look at kind of E. G for graphic packaging is if there's anything that you've reviewed are seen that is changed your behavior and the way you operate.
Great. Thank thank you.
Well, there's no doubt we spent a lot of time talking about it internally and as I mentioned at the Investor Day, one of the great things for US is in addition to doing the right things by using less.
Natural resources these projects tend to come with savings.
I profiled a couple of them. An example, what we're doing in Kalamazoo, we're going to use 300 million gallons less water a year.
As an example, we're going to cut down on a greenhouse gases by almost 20% and we're going to we're going to use less fossil fuel.
Vectrus city generated fossil fuel electricity by almost 20%. So those all things that as you kind of take a look at our balanced capital allocation approach overtime that we do factor into how do we stack up on these CSG scores and as part of our sustainability report, which graphic we publish every other year and refresh this year will be rich.
Fresh.
So we're spending time talking about it as a management team and in the border.
Great. Thanks, I'll turn it over.
The next question is from Brian Maguire with Goldman Sachs. Please go ahead.
Hi, good morning, guys.
Brian .
Just wanted to follow up on George's question on the volumes Wonder if you could help me out by maybe breaking out the 100 basis points of organic volume growth by region and maybe even by my end market within beverages foodservice.
And if you could comment also just time kind of how it broke out between machinery incurred.
Yes, Brian it's Steve.
I'll give it to you had a bit of a high level. We don't really typically go into that level, but what we're pleased with is that the targeted areas that we've identified and that we share with you at Investor day in today's material around global beverage volumes Cups and bowls.
Thats really where we're seeing the majority of the growth that drove the the net organic volume growth. So it's in those categories. So it is Sps supported Cup and bowls. It is the UK supported beverage we're pleased with the order rate that we're seeing for machinery.
On the cumulative side that really wasn't a factor in this quarter, because that's kind of up to come.
To be growth that we've outlined for yet as we look out to 2020 with 100 plus million dollars of growth from growth from those two categories, but we're pleased with the Europe continued to see good solid.
Load I actually mid single digit.
Volume growth consistent with what we shared with you last quarter. So Europe continues to lead the way a bit.
But overall, it's in those two really those two major categories.
Okay. Thanks for that and then just on the on the cost side. The wood fiber costs continue to kind of remain elevated.
Even through the summer.
Right thinking that's mostly impacting the SBS business and.
Yes, just wondering if SBS.
It seems like of all the grades the one that may be hasn't got on the margins back to where they were a couple of years ago is is more pricing kind of needed in that market before we get back to.
Brian margin levels.
Yes, you got a couple of questions. There let me cover the would question first.
You are correct I mean, the majority of the input cost inflation, we've seen on wood through the first nine months. This year has been in fact hardwood which is used in both Augusta and Texarkana as you know what I'm happy to report is that.
If you look at where we were at the end of our second quarter relative to the amount of would we had hardwood we had an inventory at those two mills, we were pretty down from our targeted levels in what we were able to do over our Q3 was build those inventories back actually were above where we have targeted historically and at the highest level since graphic has operated those.
Mill. So we're very pleased going into the rainy season, we've been able to build those inventories back we have started to see some reduction on hardwood costs here in Q4.
But to be fair were also heading into the rainy are part of the year and but our strategy. There was to build those inventories back and we in fact have been able to do that in regards to pricing.
In margin actually dislocation, if you think about price cost spread.
At Sps, you're correct of all three grades that's the one that we're still a little behind the curve on relative to our recovery of the inflation that we we incurred between 2016 2018. So we'll actively work to find ways to reduce our input costs in overtime.
Determine what we need to do but what we don't do as you know Brian .
On a call like this as speculate about four pricing actions.
Right, yes understood. Okay. Thanks very much.
Thanks, Brian .
The next question is from Ghansham Punjabi with Baird. Please go ahead.
Hi, Good morning, this actually met Krieger sitting in for Ghansham.
Hi, Matt Hi, yes, so.
Just wanted to touch on some of the new business wins that we've talked about.
How much of your new business wins would you characterize is coming from new customers versus existing customers and then maybe could you provide some added detail on how these contractor contracts are structured in terms of price pass through mechanisms take or pay clauses and any other kind of nuances that we should kind of know about about the new new contract book.
Yes, Matt its Steve just in terms of the existing versus new many many of the customers are in fact existing customers making decisions to.
Transition into paper based solution. So like you saw on AB inbev with others.
Additional beverage providers, so lot of them, our existing but what we are finding and the cup side of the business as a good example of that where we're seeing some new customers who may have been an alternative substrate.
And we may not have a relationship with that are moving into paper based comps or bowls. So I would say the majority has been.
Listing customers, making transitions, but we are seeing a nice mix of some new the terms and conditions are very common with those that we were describing earlier from some of the earlier questions. So common terms common.
Typically two three year relationships with them.
Because we are entering into on the machinery side for example on beverage those tend to be two to four year type agreements that come along with the machinery. So I would say overall it might chime in here, but it's very consistent with what we're seed.
Across our customer base relative to the nature of the contractual relationship yes. The only thing I'd add I mean, as Steve said that the nature of the contractual relationships, we've got with our customers didn't change our resolve coming into the year to shorten that lag did and that's where we placed a lot of our commercial focus in those negotiations and that's what resulted in our ability.
Shrink that lag a little bit.
Great. That's helpful. On just a follow up on volumes a little bit I guess heading into next year. How would you expect volume growth to flow through the business kind of on a quarter by quarter basis.
Would you expect volume improvement to kind of reach its run rate by the end of this year and flatten out in the next year would you expect kind of a ramp higher as you win new business and reaching towards the end of next year.
It's a little tough to be that precise Matt because obviously folks ramp up as they do.
I think what Youre seeing is with this quarter being 100 basis points that we've kind of got to a place where the confidence around next year is 100 to 200.
Should be there really throughout the year and whether its nuanced slightly less early it's slightly more late plausible, but we really haven't gone to that granular level relative to quarter by quarter, we'll work to do that as we refine next year as planned.
Okay understood. That's helpful. Thank you.
Matt.
The next question is from around the vis one Nathan with RBC capital markets. Please go ahead.
I room your line is open.
The next one operator.
Thank you Sir the next question will come from Adam Adam Josephson with Keybanc. Please go ahead.
My conceived good morning.
Hey, Adam Hey, Mike receive one on volume and then just one on price cost on the volume can you just clarify what net organic volume growth is just not a wide and then just on the same along the same lines why were backlog is down volume growth is positive I would've thought that backlogs in volume growth.
Would move in the same direction, but at least in this case they done.
Yes, thanks, as Steve I'll take net organic and Michael touch on your backlog question for US and we were very specific in our in our definition around this net organic volume growth is that we are producing an end product that we're selling to our customers and that we could see actual tonnage and as such.
Growth.
Roll through with with excluding acquisition based and so it's meant to be as defined net organic volume, it's tonnage and volume based trackable for us in terms of the actual output.
And it's converting product so its products that we're making end products like comps bowls folding cartons.
And that's important for us as well given the integrated nature of the business. So we're going to continue to refine and be specific about that definition, but thats when we talk about it its.
Volume is converting.
It's actual product out the door that we're producing.
Yes, Adam just in regards to your question, which is a good one relative to backlogs. We would agree overtime you would expect if you see organic growth the backlog should grow or at least production should grow year on year, but if you take a step back and think about it for a minute and look at our experience here, we were actually minus one on organic growth in Q1, we are flow.
In Q2 and were plus one here in Q3, so we just inflected on this.
And we expect that you'll continue to be the case here in Q4, and obviously into 2020 as we have hung our target out there of 100 to 200 basis points. If you look at actual the three substrates as I mentioned earlier Sps production is down 40000 tons year on year, which little less than 1% CRB coated recycled paper.
Board is essentially flat.
A year on year in terms of production and see UK, even though you can't see it graphic is actually up and so we are starting to see that kind of come through in terms of volume of the substrates that we're making but I would expect as we go into next year Q1 in particular once there is some of the noise relative to our competitor shutdown of one of their.
Mills that kind of all flows through as you know it usually takes three or four months for that to occur that you into Q1 will start to see some of that reflected in the backlogs. Thanks, Mike just on the price cost issue. I think you. Previously you said you expect at about a positive 70 for the year our year to date as positive 67, so you're basically.
They're already can you just.
Just remind me what your expectation was and if you think theres going to be considerably more such that you'll end up.
North of the seven day.
Yes, Adam it's Steve.
Relative to the pricing pricing momentum is positive as we said heading into fourth quarter relative to 120 million. We are lapping some of the positive pricing that we.
And last year in Q4, but overall I confidence there as you mentioned on inflation year to date. We're now just under 40 million work still guiding to 50.
There may be some modest positive there if we had about $8 million of inflation in Q3. So there's some potential for that number to move up modestly, but I'd put it in the context of the all within the 1.03 billion that we're guiding to we're not seeing a movement in that there is obviously puts and takes.
Among the pieces, but.
We've started to see as Mike said earlier some positive.
Woodside year finally in Q4.
We're entering into the rainy season, we'll see if that Uphole upholds itself for the remainder of the quarter and into next year.
Thanks, a lot Steve.
You bet.
The next question is from Daniel Rizzo with Jefferies.
Hi, guys you mentioned wood and also just wondering what your other chemical intermediate costs are doing in what you expect going forward.
Just in terms of currently Dan pretty pretty benign inflation as you would as you would know on chemicals.
Energy logistics costs have all stepped back a bit relative to the significant inflation that we were enduring so.
In the quarter pretty neutral.
For us relative to year over year inflation for those major categories.
For us the inflation in the quarter was driven by would as we talked about as well as some of the external paper that we buy.
We haven't provided forward thinking yet with regards to those costs, which will do in January .
And then you mentioned and you've talked a lot about the shift in the sustainable initial shifting to paper from plastic but is there specifically and product specific area, where thats happening more than others is this something is leading the way.
Well I just point back down to some of the pictures. We included in the graphics. We included in our Investor day material, I mean, and Steve talked about this earlier too I mean, it's really conversions out a phone both cups and containers in paperboard solutions conversions of hi, cone rains in the beverage side of the business into our Q clip as.
An example conversions out of you'll see pad trays into our paperboard press paperboard trays those are the areas, where we're spending time in our focus because we have good intellectual property that allows us to protect those sales.
And they tend to be margin accretive to our overall profile. So thats why were for spending time in those areas in demand from consumers and customers has been high.
Alright, Thank you very much.
You bet.
The next question is from Mark Weintraub with Seaport Global.
Thank you maybe just first quickly following up on on that I did notice that Carlsbad and Denmark's exploring paperboard packaging for their beer are you actually seeing interest from either class or cans to go paperboard.
Mark we saw that too I mean, I think what you're referencing is there they're doing like a paperboard bottle.
We're obviously, we'll watch that but thats not something we're actively participating and right now okay, and maybe just circling around some of the ingredients of the full year EBITDA. It does seem that pricing.
Is playing out perhaps as well or better than what was the embedded in that guidance and.
I guess on the flip side it looked like performance in synergies.
It would be a stretch to get to the to the number provided in the.
During the Investor day.
Am I reading that right or were there any surprises in the third quarter right. It sounded like you had suggested not so just wanted to kind of got to better take on some.
Some of these moving variables.
Yes target Steve.
Overall like I said, the overall 1.03 is intact for the full year, you're correct, there's probably a little bit of some of the momentum on price cost, but overall, we were very pleased with the third quarter. We had about the texarkana impact was about negative $25 million.
For the quarter and as such the kind of minus 20 that you saw was more of a plus five and if you go underneath that as we've mentioned before between pension and incentives. There's about a 10 million dollar headwinds. So actual kind of core productivity was around $50 million, so that met our expectations for the core.
Sure.
So the quarter there were no no major surprises.
Okay, and I, just I guess I'm, just trying to understand if given the price cost maybe work out a little bit more favorably if some of the variables that are going to keep the number where it is as expected for this year, but are more easily recoverable into next year. So that you might actually have a bit of wind at your back for next year given.
And though the way the dynamics are playing out this year a fair assessment.
Well I think it to the degree it's within the range that we provided market at 10 40 to one 1 billion, it's pretty wide range to be fair, but it's also.
Early in Q4, and like can happen between now and the next time, we talked at the end of January So we'll be in a position to put a finer point on all of that.
We finished the year here, we've got confidence in the Tenthirty that we've outlined here I think Steve did a good job of articulating the puts and takes there and that's how it how we'd ask you to think about it okay. Thank you.
You bet.
The next question is a follow up from George Staphos with Bank of America. Please go ahead.
Hi, guys. Thanks for taking the follow on two quick ones first of all with.
Continued focus on shipping on container and.
Hi off.
By Etailers and related are you seeing any kind of increased demand foresee UK as a corrugator replacement for are you seeing actually the reverse that you're seeing some of your primary packaging and boxboard being.
No.
Losing share to things like corrugated or other materials allows that playing out and on a quick follow on.
I think net net on the margin we view that as a slight positive for us as we talked about our investor day, there's certain categories.
Like pet food and others were heavy caliper saw us as an example can in is participating in this IOC you movement that you've described but where we actually see the sustainability side of that is a bigger leveraging item for us and that's where we're spending more of our resources. We are participating for some of the retailers and.
Being part of their process to make sure we understand what they need and how we can participate but.
I'd focus you a little bit more we're going to spend our time is on that.
Sustainability side of the equation George.
Mike realizing it might be two side of the same coin is it more resources.
People to push these different initiatives or is it you think the size of the the pie so to speak as bigger in terms of sustainability as opposed to CEOC is it just and it's probably both.
Just a function in fact, you are having enough resource to push the other side because as a bigger opportunity for you right.
I think that way I'd ask you to think about as we just think the prices bigger on the sustainability side of the equation we've done gotcha.
Bob of identifying what products were going after there and why.
Okay, and I had one question related to your guidance for cash flow for next year and I recognize it's still early you'll put more of a finer point on this and fourth quarter, but and you may already mentioned at the analyst and I forget what the commentary was but given the starting point of free cash flow. This year. The 525, given the the ramp and Capex.
I wish you called out relative relative Kalamazoo, you said the other line items more or less would stay the same so working capital is perhaps the flocks.
Do you need to start building. Some inventory ahead of what will ultimately be no line outages as you transition to Kalamazoo, where you're not really doing that yet because kalamazoo doesn't come up until the first quarter of 22, and if so what else do I need to do to bridge from 525 to maximum given the way you're putting it to 75.
Capex is only a 250 million decrement. Thank you and good luck in the quarter.
Thanks, George So I'm going to comment on your question regarding inventories and let Steve comment on the free cash flow implications that.
2020, the room really being no impact on overall inventories related to the Kalamazoo ramp up as we get towards 2021, the end of 2021.
We'll be looking at okay, how do we ramp that machine up and as we outlined during the Investor day, we'd expected to be a pretty vertical ramp up and again, we're going to continue to operate the mills.
We are we're planning to.
Close once we have that machine running and so we'll do qualifications in what we're doing qualifications will continue to run the other machines oneseven materials been fully qualified than we'd look to ramp those down. So I would I would not have you think a very large inventory build our large treat grain on working capital as a result that will be modest and it will be.
In early 2022.
Yeah, George just in terms of that obviously like I said earlier will tighten up the range on cash flow and provide more detail in January but there may be a modest use of working capital driven by growth agenda. So there may be some working capital coming from.
Growth in the business.
200 basis points in guidance modest working capital use.
Most of this year, where we've got some net working capital.
Thank you Steve.
Thank you.
The next question is a follow up from chip Dillon with vertical research. Please go ahead.
Hi, yes.
Had a question about owes cc. It's obviously just accepted that China is going to continue to reduce their purchases and yet we know given the size of their economy. They have to get the fiber somewhere they don't have it in their country.
Whether it's in border recycled pulp we've also notice that one of their begun the biggest player there has postponed some recycled pulp projects here in the states. So my question is.
What's the real issue with pollution as you all see it do you do you all in your processing of a million tons of Oh cc have a lot of problems or challenges landfilling or otherwise.
Dealing with the whatever's left over when you process FCC.
Well, let me talk about the million tons that we actually process, because that's what I can actually speak to and what I would characterize those markets is obviously theyre, they're very favorable for US right now we're able to get the tonnage that we need when we needed we're actually able to get cleaner tonnage than we were getting even a year or so ago because of the situation you just described.
Having said that our new machine will actually have the most modern up today cleaning equipment.
That's commercially available because we want to have the flexibility dilute obviously use.
Low cost fiber going forward, and we think that positions us well for the future.
The modern machine that we're putting in his I've outlined earlier is going to have an excellent footprint from a carbon standpoint that I just talked about so I won't go through that again, but I guess beyond that chip.
I don't really have a point of view on the impact in China in regard to that you'd be in a better positioned than I would be to probably answer that.
My question really had to do with what what are the challenges in dealing with what's left over so you process. So cc and when issue the Chinese of mentioned at least in their statements is that they want to reduce landfill and other pollution and I I know that Europe , which is a very environmentally conscious.
Area in general.
And I know this industry is certainly move has moved a lot in that direction is there really a challenge to dealing with the floods or whatever is left over from processing FCC.
Well I think look when markets are really high the amount of contaminants that you can get away with in the material is obviously much more when markets are reduced and people are being more picky, they're able to kind of parse through that and find as I mentioned in our case cleaner material at lower prices and so what I think people who process that stuff, we'll have to do over time.
I am just take a look at the arbitrage on the cost to get a cleaner versus what they are able to sell it for that'll be a natural economic type driven.
Wage in there and what we're trying to do chip is being a position to always be able to take.
Lower quality material and produce higher quality product and that's why we're investing in the most modern and up to date cleaning systems on that machine. So thats what were doing about it.
Great. Thank you.
You bet.
The final question is from Mark will do with bank of Montreal. Please go ahead.
Yes, Mike just back on its wastepaper issue I mean, Im just curious with the expansion at Kalamazoo, I mean, you're going to be using a lot a lot of weights on one side.
Advantage to you and maybe trying to set up some long term supply agreements right now with kind of municipalities that might be struggling at the moment kind of figure out what they do with their recyclables.
Yeah, It's a good great point, Mark and we are actually we have some of those already in that region of the country and we'll look to continue to scale. Those one thing as we mentioned at the Investor Day that was a positive for us and why we selected Kalamazoo as if you look at the two mills that will shut down there in that that fiber basket. If you will so we're not pressuring that fiber basket anymore.
What we want to be able to do is be kind of the go to spot for where that material goes and we're going to have the ability to quick turn those loads and you really take advantage of that so that infrastructure I think will bode well for us overtime and we will seek ways on long term contracts is we're going to pull.
Appoint close to 900000 tons and that in that facility.
To be able to take advantage of our size and scale.
Okay just.
One more point on that I mean with.
A lot of mills going into that part of the country. They are using a lot of mixed waste.
And with the printing and writing paper volumes falling off pretty significantly is that a concern at all but if we think about the long term.
We always watch that's a pretty carefully and if you take a look on the Sps side to your point, we've seen a new entrant come into this space. So there is competition that you'll make decisions and does those types of things, having said that the integration rates of CRB are quite high in our case as you know we're approaching 90% on CRB.
And so that's why it's such an important strategy for us to continue to drive our integration levels up overtime, and you'll see us to that both organically and inorganically as we've done this year.
At this time I would like to turn the conference back over to Mike does for any closing comments.
Thank you for joining us on our earnings call. We look forward to speaking with you again in January have great day.
Ladies and gentlemen, thank you for participating in today's conference call you may now disconnect.