Graphic Packaging Holding Co Q3 FY2023 Earnings Call

Hello, everyone, and welcome to Graphics Packaging's Third Quarter 2023 Earnings Call. All lines have been muted during the presentation, and there will be a chance for questions and answers at the end. I would now like to turn the call over to our host, Melanie Skijus, Vice Principal of Investor Relations. Please go ahead.

Good morning and welcome to Graphics Packaging Holding Company's third quarter 2023 earnings call. Joining us on our call today are Mike Doss, the company's President and CEO, and Steve Scherger, Executive Vice President and CFO. To help you follow along with today's call, we will be referencing our third quarter earnings presentation, which can be accessed through the webcast and also on the investors section of our website at www.graphicpkg.com. Before I turn the call over to Mike, let me remind you that today's press release, the third quarter earnings presentation and the statements made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the risks identified in the release and the presentation, as well as our filings with the Securities and Exchange Commission. With that, I'll turn the call over to Mike.

Thank you, Melanie. Good morning, everyone, and thank you for joining us on the call today. Let's begin with a highlight on slide 4. I'm very proud of our team's performance during the third quarter amid a very dynamic environment; we continue to make progress on our goals, deliver adjusted EBITDA growth and margin expansion, invest for the future and fulfill our purpose to package life's everyday moments for a renewable future. As customers have pointed out in recent months, the consumer environment remains dynamic, and the uncertain and evolving macroclimate has resulted in a relatively more cautious consumer in the near term. At the same time, and as we discussed last quarter, retailers are operating with more normalized inventory levels versus a year ago, as supply chain challenges have largely subsided. The combination of these factors has had a modest impact on our packaging volume. In listening to a broad mix of our global customers and given the confidence we have in our innovation pipeline; we are anticipating a return to our targeted 100 basis points to 200 basis points of net organic sales growth in 2024. Responding to external factors, our team leveraged the scale and flexibility inherent in our system and reduced paperboard production by 150,000 tons during the quarter. Through our disciplined commercial approach and active management of supply to meet demand, we met our commitments to customers and stakeholders while adapting to current volume changes. Together, our team, our capabilities, and our strong operational execution provided the path to targeted EBITDA margin levels in the quarter. Our performance demonstrates the resilience of our business and is a testament to our differentiated approach to servicing and growing consumer packaging markets. We are delivering value to customers with the packaging solutions we provide and optimizing our system to position Graphic Packaging for long-term growth. The key element of our strategy is supporting growth through advancing innovation capabilities and making strategic investments. We made considerable progress on this front in the third quarter, including new innovations that are driving category and market expansion, continued progress on our multi-year CRB system transformation, both of which I will expand on in a moment, and lastly, the completion of the Bell Incorporated acquisition. The acquisition of Bell is a good example of how we are investing in our packaging network by adding capabilities and expanding the customers and markets we serve. Acquisition integration is well underway and we are excited about the new opportunities Bell provides. As we look ahead, we are positioned to benefit from the long-term strength of demand for sustainable fiber-based packaging. We are focused on further distinguishing Graphic Packaging as the leader in recycled and recyclable consumer packaging. We have updated our guidance and continue to expect 2023 adjusted EBITDA of $1.9 billion at the midpoint of our guidance range. In addition, we are tracking to meet or exceed our enhanced Vision 2025 financial goals. We remain confident in our ability to achieve annual organic sales growth targets in the years ahead. One of the many reasons we remain confident in our organic growth outlook is the continued advancements we are driving through innovation with our customers. Slide 5 provides another example of our innovation engine at work and the continued progress using fiber to replace packaging previously created with non-renewable resources like plastic and foam. I'm sure many of you recognize the iconic Nissin Cup Noodles, a leading brand in the Ramen comfort food category. Historically, the noodle cups have been made of foam. Through our innovation capabilities and expertise in both food service and retail packaging, the fiber-based solution we developed serves as a more sustainable packaging alternative to foam and is effective in a shelf-stable retail environment. Notably, our retail cup solution for Nissan provides added convenience for the consumer as it is safe for microwave use, eliminating an extra step required in meal preparation when using foam. We are excited to share with you today a new partnership we have with Nissin Foods and the upcoming launch of their Cup Noodles product, packaged in our proprietary retail double wall fiber-based cup solution. The rollout is expected to begin in the first quarter of 2024. Aligned with consumer preferences for more sustainable packaging options, Nissin plans to convert their entire 16-ounce cup noodles product line in the U.S. from foam to our solution over time. This packaging application marks our first in microwave cups as we continue to expand the addressable market within the more than $4 billion cup and container market in the U.S. Our history serving retail markets and our ability to invest behind in scale with customers creates new opportunities across various dry food categories that today are primarily in foam and plastic. Items such as pasta, hot cereals, breakfast mixes and single-serve dried foods are examples where our fiber-based solution has tremendous potential to win. While discussing growth opportunities in the broader cup market, let me also provide an update on our program, Chick-fil-A. Last quarter, this important customer went to market with our new, highly-insulated double-wall beverage cup in approximately 10% of its stores as a potential long-term solution for its beverage program. Feedback from both stores and consumers has been favorable and phase 1 of the program continues with rollouts currently underway to additional stores. We continue to believe our innovation can be a long-term solution for Chick-fil-A and others currently using foam cups and containers. Partnering with industry leaders like Chick-fil-A and Nissin Foods demonstrates how top brands are investing to transition toward more sustainable packaging solutions. Through our extensive design and packaging network, we are partnering with leading brands to effectively transition to sustainable packaging solutions that consumers prefer. We believe long-term tailwinds support the continued demand for this transition, such as end-use consumers seeking more sustainable packaging, customers responding to demand in pursuing sustainability goals, and an increasing number of jurisdictions enacting environmental legislation requiring the use of more sustainable packaging. Moving to slide 6. Let me provide a brief update on the significant progress we have made on our CRB transformation. Since 2019, we have embarked on a multi-year optimization effort to simplify our CRB system while strategically expanding capacity and lowering costs. The end result will further distinguish Graphic Packaging as the lowest-cost and highest-quality coated recycled paperboard produced in North America. Our efforts to optimize and strategically expand capacity are the response to trends we identified early on, including growing consumer demand for packaging made from recycled materials. Our focused investments will ensure we sustain unmatched quality and cost advantage in this important category for years to come. Since the project began, we have made significant progress in our CRB system transformation, with our new 550,000-ton K2 machine ramped in Kalamazoo; we have effectively increased our net CRB capacity by 70,000 tons to support our growth. Through higher costs, less efficient facilities and our longest-running paperboard machine in Kalamazoo, the total production of 480,000 tons has been removed from the system. As noted, this total includes our recently announced permanent decommissioning of the K3 machine. Our decision on K3 reflects the incredible success of the state-of-the-art K2 machine, which has been operating at or above committed efficiency and quality levels. We look forward to replicating the success of K2 with our new CRB paperboard machine in Waco, Texas, which will expand upon our quality and cost advantages when it begins production in late 2025. As we have talked about before, the ability to cost-effectively produce higher-quality CRB allows us to meaningfully and profitably expand opportunities within new markets and those we already serve. One example of this quality improvement is the new pay center reviewer recycled paperboard, which we introduced last quarter. This new grade of the highest quality recycled paperboard available will facilitate CRB and more consumer packaging experiences across the food, health, pharmaceutical, and beauty product applications. We are pleased to have made our first sale of pay center in October and look forward to sharing many more packaging example wins in the quarters to come. The third quarter also included the release of our 2022 ESG report detailing the progress we have made towards achieving our Vision 2025 ESG goals. Sustainability is an integral part of our business strategy and our impact extends well beyond our own business. We enable customers, including many of the world's leading household brands, to transition towards recycled and more recyclable packaging solutions. I'd like to note a few key highlights from the report that can be seen on slide 7. To start, we successfully achieved our goals for greenhouse gas emissions intensity and non-renewable energy intensity three years early. We did so through investments in efficient manufacturing and expanding the scale of our packaging operations. For example, the K2 machine helped reduce emissions intensity associated with CRB production by an estimated 3% in 2022. We also highlighted we are on track with our goal to have 100% of our global facilities compliant with a fiber certification standard. Forest certification and certified sourcing programs give consumers confidence that our packaging does not contribute to deforestation or biodiversity loss. The goal demonstrates our support for sustainable forest management and forest product sourcing practices we follow to ensure compliance. We have more than 24,000 teammates worldwide and I am proud of the progress we are making as we build a more diverse and inclusive workforce. There is always more work we can do and we remain committed to fostering continuous improvement in the workplace centered around our employees' growth and sense of belonging. Slide 8 highlights a recent sustainability achievement I am very excited to share with you. We learned in early October that the Science-Based Targets Initiative approved our 2032 carbon reduction goals, which are outlined here. As an increasing number of consumers are voting with their wallets by purchasing products and brands that are doing the right thing for the planet, we are proud to be fulfilling our purpose to package life's everyday moments for a renewable future. With that, I'll turn the call over to Steve to provide more detail on the financial results. Steve?

Thanks, Mike, and good morning. Let me start on slide 9 with an overview of the key financial highlights for the third quarter and the first nine months of 2023. Overall, our results demonstrate the resiliency of our business and ability to operate effectively through a very dynamic macro environment. Net sales declined 4% year-over-year to $2.3 billion. As Mike discussed, sales during the quarter were impacted by some fluctuations in consumer purchasing behavior and by efforts from retailers to adjust inventory levels. Those headwinds will be partially offset by positive pricing execution and the impact of foreign exchange. Net organic sales growth adjusted for the same number of shipping days as in the prior-year period was down 4.6% during the quarter. We now expect net organic sales to be plus or minus 2% in the fourth quarter, with an anticipated return to our targeted 100 basis points to 200 basis points of net organic sales growth in 2024. We remain confident in our innovation pipeline and our ability to execute on commercial opportunities to fuel our organic growth in the years ahead. Our expected four-year cumulative average organic sales growth rate of approximately 2% from 2019 to 2023 remains at the high end of our annual range established with Vision 2025. Our top-line performance is benefiting from our diverse portfolio of end markets and customers. While sales for the food, beverage, and consumer markets decreased 6% in the quarter from the prior-year period, sales in our food service markets grew 8% as our packaging solutions continue to win as mobile consumers are looking for convenience when eating and drinking on the go. We are actively managing our supply to meet current demand, exercising discipline in production while minimizing the cost of doing so, and focusing on servicing long-term customer relationships with their packaging needs. Given the disciplined approach to production we exercised throughout our packaging business, reported profitability is as strong as we anticipated despite short-term fluctuations in the consumer environment. Adjusted EBITDA grew 9% year-over-year to $482 million, and adjusted EBITDA margins expanded by 250 basis points year-over-year to 20.5%. Adjusted EPS also continued to grow, expanding 10% year-over-year to $0.74. As a reminder, our sales and EBITDA waterfalls are available for reference in the appendix of today's presentation. Global liquidity remains strong at nearly $1.2 billion. Our success in driving integration rates higher was evident in the quarter with paperwork integration into our consumer packaging business at 79%. This is an increase of 500 basis points from the prior-year period. As a reminder, this is an increase of 1,200 basis points from 67% since January 2018 when we completed a combination with International Paper’s North American Consumer Packaging business. We will continue to drive integration rates higher as we capture and execute growth opportunities in consumer packaging. Slide 10 outlines our updated full-year guidance for 2023, reflecting our current expectations as well as the recent acquisition of Bell Incorporated. Most notably, the midpoints of our adjusted EBITDA and adjusted EPS guidance remain fundamentally unchanged. Turning to slide 11. We continue our balanced approach to capital allocation, which focuses on growth and capital return. As discussed during today's call, we remain focused on investing for growth, such as the recent acquisition of Bell, ongoing advancements in innovation, and the new recycled paperboard facility in Waco, while also reducing leverage to the lower end of our targeted range and returning capital to shareholders. As of today, we have repurchased $54 million of stock year-to-date. Our balanced approach to capital allocation positions the business for continued success and delivers value for stakeholders. With that, I will turn the call back to Mike.

Thanks, Steve, and I'd like to thank our talented team around the globe. Their strong execution positions Graphic Packaging to meet our commitments to customers, deliver value for stakeholders and continue our leadership in fiber-based consumer packaging. I am pleased to share with you that we will be hosting an Investor Day in New York on February 21st, 2024. In addition to a strategic update on the business, we will provide Q4 and full-year 2023 financial results, guidance for 2024, and looking further into the future, our new Vision 2030 aspirations and goals. We are excited to see many of you in person and look forward to providing more details on our plans for the future. I will now turn the call back to the operator to begin the question-and-answer session.

Thank you. Our first question comes from Ghansham Panjabi of Baird. Your line is open. Please go ahead.

Thank you, operator. Good morning, everybody. Mike, so just kind of looking back at 2023, it seems like this was the year price cost led margin expansion and just much weaker than forecast end markets given destocking and some level of consumer elasticity that perhaps offset many of your internal growth and productivity initiatives. Based on what you see at this point, what does 2024 look like? Would it be just better volumes just based on the comparison and some level of margin give back based on the pricing trend line in the industry and then maybe as a correlate to that for Steve, any variances you can share with us on an EBITDA basis such as price cost for '24?

Good to hear from you. I caught most of your question about volumes in 2023 and our expectations as we approach the end of this year and into 2024. As we mentioned at the beginning of this quarter, the third quarter is shaping up to be the most challenging compared to last year. However, we are almost 5% up from '22, and on an adjusted basis, our results align with what we communicated at the end of the second quarter. Looking ahead, our comparisons will ease a bit in Q4, as we were slightly under 1% up last year during this period. We anticipate a range of minus 2 to plus 2, largely because the recovery process is not straightforward and tends to be more varied than expected. Our outlook is not any clearer than what others might see in terms of when we’ll hit a turning point. Some customers foresee a prolonged recovery, while others are planning promotions for Q4, which may impact volumes. This combination gives us confidence going into 2024 regarding our capacity to achieve our medium to long-term growth targets of 100 to 200 basis points. The first point is that costs will become easier as we move past this year. Secondly, we have a strong innovation pipeline, highlighted by new products like cup noodles and the Chick-fil-A cold and gold cups, among others in our regular updates. We are actively replacing plastic and foam with fiber-based packaging, which we believe will drive growth. Thirdly, our customers have expressed their need for growth as well, as their performance relies on achieving top-line growth that translates into volume increases. These three factors give us confidence as we head into 2024. While we cannot predict exactly what will transpire in Q1, we are optimistic about growth in '24. Over a four-year period, if we evaluate our performance, we have averaged a 3% growth year-over-year for the past three years leading into this year. This year, we may see a slight decline of 2% to 2.5%, but looking back over four years, we are still matching our 2% target, which is at the higher end of our growth aspirations. We anticipated some fluctuations as outlined in our Vision 2025 presentation, but we remain very satisfied with our overall progress and expect this momentum to continue into '24.

And Ghansham, this is Steve, you want to just repeat a little bit of your question about '24 just to make sure I've got it right?

Yes. I was just curious about the variances on EBITDA, on price cost, and whatever else you can share at this point.

Yes. Thank you for that. I just wanted to make sure that's what I thought you said. I mean, listen, if we look into '24, there are some real positives that we would expect will be beneficial to the P&L if you kind of look out to next year. We'll have a full year of the Bell acquisition. We acquired that in the fourth quarter, so there will be modest EBITDA this year. Just by way of reminder, we bought $30 million of EBITDA and $10 million of synergy. So, we'll pick up probably an incremental $20 million from that next year along with the synergy. Think of that as a plus $30 million. So, when you think about that against 100 basis points to 200 basis points of organic sales growth, you know what that value perspective would be at or above our margins. As we generate, we should have very strong productivity here. We will have less planned maintenance and we expect to have less market-related downtime as we return to growth. Also, we are not planning for weather-related events, that was of substance, which we certainly don't plan for that to repeat. So, those are three very positive benefits as we go forward. Labor benefits and inflation this year running a little bit higher than normal would also be expected to normalize back toward the levels we've seen historically. If you mark to market the current price-cost environment, and I will reiterate that for you, if you look at pricing related to $80 on SBS and the $20 on other materials, we are in a very benign inflationary environment here, obviously, as we've talked, we're very committed to operating the company through a narrow range of EBITDA margins. And this year, we moved towards the 20%. We would certainly expect that we would operate in a pretty thin band around that 20% as we look out to 2024. So, that gives you some of the components. We'll obviously provide detailed guidance when we're together in February and provide that to you in a more granular level. But those are, I think, the high points if you kind of look at the year ahead.

Perfect. Thank you so much. I'll turn it over.

Thanks, Ghansham.

Thank you. Our next question comes from the line of Mike Roxland. Your line is now open. Please go ahead.

Thank you, Mike, Steve, and Melanie for giving my questions and congrats on the good quarter despite the backdrop. On your last call, you mentioned contract resets, particularly in North America, which have long durations of two years to five years. And you mentioned, I think, the way you phrased it was that there's a meaningful number of contracts out there that you still could be addressed over the next 12 months to 24 months that have yet to reflect the higher prices. So, is there any way that you could help us size that? Is that 20% of all contracts, 30% of all contracts? And the reason I'm trying to just drill down on that is because Steve just answered the prior question on some of the drivers for 2024, but wouldn't those contract resets also be beneficial to driving EBITDA growth next year?

Yes, Mike. it's Steve. To drive benefit next year, as we also talked on the last quarter, we don't tend to put those into the mark-to-market discussions that we were just having. At any time, to your point, we've got 20% or 30% of our contracts that are in negotiations and coming due. So, as those play out, we'll certainly articulate those. If there are some that play out here late this year, we can incorporate those in the guidance. But to your point, we continue to actively engage with our customers to put in appropriate value for the products that we're producing and have a long-term relationship that we have enjoyed with many of our customers.

Got it. I appreciate that, Steve. And just one quick follow-up. Any comment you have on trends we are seeing thus far in October? Has there been any improvement at all sequentially? I know one of you appeared reportedly yesterday and basically noted no improvement thus far in Q4. So, any commentary or color you can provide around what's happened thus far in October in terms of order patterns, destocking come to an end, CPD promotional activity. Anything that would be helpful. Thank you.

Well Mike, we've obviously gotten a look into October, and with October, it's consistent with the plus or minus 2%. So, we do expect to see sequential improvements quarter-to-quarter. As Mike said, we've got customers who are seeing a positive move volumetrically already. We've got others who are seeing it taking a little bit longer. We're thinking it's a good mix of customers who are starting to see some promotional activity, material items in Q4, while others aren't quite there yet, as Mike articulated earlier. But sequential improvements in Q4 we can see happening.

Thanks very much.

Thank you. Our next question comes from the line of George Staphos of Bank of America. Your line is now open. Please go ahead.

Hi everyone. Good morning. Thanks for the details. Steve and Mike, I don't know if everyone is hearing it, but your phone has been cutting in and out a bit, at least on our end. And I just wanted to make sure when you're answering Ghansham's question, did you put out at least mark to market on pricing that you see for '24? Because if you did, we didn't hear that before we get into our questions.

Yes, George, it's Steve. Our apologies if there were some technical challenges here, but let me end with line to Ghansham's question. What we did indicate is that if you just do a pure mark-to-market on price cost, we've got very little happening on inflation. So pretty benign, and if you sequentially just look at the price impact year-over-year, it's down roughly about $80 million year-over-year. And as Mike Roxland just mentioned, obviously, we've got other customer negotiations that we're always involved with and improving terms and conditions, where they are in our negotiations. Hopefully, you were able to get that response to anything that may have cut out. Did that work, George?

That's perfect. Actually, that's kind of where we were modeling and doing some back down. So, thank you for that. So, two questions here very quickly. First of all, in terms of the noodle cup and related markets, what do you think that market opportunity is for you and maybe, what kind of tonnage you expect maybe for '24 and '25 from those markets? The coding in that cup, is that a biocoding or is that a polycoding and how will you handle that? And then the other question is just sort of near term, we noticed that and again, performance was good given the backdrop. The free cash flow guide came down a little bit this year, and you mentioned labor and benefit is running a little bit hotter this year than your prior guide. What were the factors in that? Thanks guys, I'll turn it over from here.

Okay. the first part of that, George, and then all that Steve handled questions that are on working capital in particular. But the reality of it is, if you look at our total addressable market and we put out there, it's $12 plus billion, and within that addressable market, there's a $4 billion segment of it. That's what we call cups and containers. So, that's really where that sits. And it's a very big opportunity for us and one that we can work on for years to come. In fact, the vast majority of our cups, including the cup noodles has some form of a low-density polyethylene or polyethylene area or coating inside. As we talked about, what we're really excited about is our ability to take those cups back to Waco and we can process with the new vertical drum pulper that we're installing. There are 15 million of those paper cups today. With that coating on the inside, we can clean them up, take advantage of the fiber. It'll be on the top wire. It'll be the first fiber we put down, and we'll recycle those cups. So, we're working with our customers within about a 200-mile radius of the mill to have that capability. Eventually, you can expect that we'll be able to do that in Kalamazoo as well. That's our plan. So, we feel like we've got our focus.

Could that be 50,000 tons next year, do you think this new market? Just a new customer?

I don't know. We're not going to put a ton of number up there right now. I can tell you this, that the full transition of the cup noodles is 15.

Okay.

So, I mean, these are meaningful numbers that come forward. It depends on what Chick-fil-A's trajectory looks like and some of the other conversions that are out there. But over the medium term, we expect that we'll be able to make a pretty strong pivot out of our coded SBS and get more into manufacturing the cup stock, which as you know, George, the split right now is of our 1.2 million tons. It's roughly 400,000 tons to 800,000 tons. So every time we sell a cup is something that we integrate into our own operation. Did you get all that, George?

Thank you, Mike. Yes, that's perfect. Thank you. And on the technical difficulty?

Yes. Let me touch on a couple of things. Regarding cash flow, we are fine-tuning our working capital. We're responding closely to demand, and our focus has been on servicing customers, producing the necessary products, and maintaining the inventory required for that purpose. Essentially, we are just tuning our cash flow. I also want to remind everyone that when we previously discussed a 2.5 times leverage ratio, that figure did not consider Bell. As we mentioned, we need to be in the 2.6 range, which we set between 2.6 and 2.7 because we have been acquiring some shares, as reflected in the guidance we shared. Hopefully, that provides clarity on our strong cash flow generation, and as we look ahead to 2024, it positions us well to ensure we meet customer needs as they return to the bureau.

Okay. thank you very much.

Thanks, George.

Our next question comes from Adam Samuelson of Goldman Sachs. Your line is now open. Please go ahead.

Yes, thank you. Good morning, everyone.

Hi, Adam.

I guess, the first question just to clarify is, I think, with the fourth quarter, the slides talk about organic volume mix down two to up two. Steve, it sounded like you were talking about plus 2 in the fourth quarter. And I just wanted to make sure I was talking with the same thing; you're talking about the same thing that we're seeing on the slides.

Yes. no, Adam, for clarity, and maybe, something got lost there with some of the technical issues. No. what we're saying is Q4 plus 2 to minus 2, so zero at the midpoint. And so, we will see sequential improvement over the minus 4s that we've seen over the last two quarters. It was plus 2 minus 2 and October is playing itself out consistent with that as we look towards the fourth quarter.

Okay, that's helpful. As we consider moving into next year, you've mentioned several times how optimistic you are about pay setter, the quality of that board, and the opportunities it can create for a recycled board in new applications. How should we approach the commercialization of that and the significant volumes that can transition into CRB-based products instead of CUK or SBS offerings, and what impact might that have on margins in 2024 as we think about that transition?

Yes. I think it's really a longer play than just '24. Adam, what I'm really encouraged about is the fact that we had our first sale in the quarter. It'll ship actually here in Q4, which is great. I'd tell you that customer interest is extremely high. We've got many trials underway and continue to have a lot of interest as you'd expect given its characteristics as we described on prior calls. What it really does is give us confidence as we look out towards the end of '25 and '26 as we get Waco up and going. As you know, we're adding a couple hundred thousand tons. So, we're going to be able to grow into that with the work that we're doing with the trial work and this new grade that we've got. Some of the things we have around our mailer business that we got from Bell, we expect that will grow. That's all CRB. So, we're in a really nice spot. We've optimized Kalamazoo. We're building out Waco. It's on schedule. It's coming along great. I was there a couple of weeks ago and got a chance to tour the site. All the efforts that we've got going on are really focused on making sure that we've got the demand to take advantage of that 200,000 tons of growth that'll show up when we start that machine up.

Okay. I appreciate that. I'll pass it on. Thanks.

Yes. Thank you.

Thank you. Our next question comes from Arun Viswanathan of RBC Capital. Your line is now open. Please go ahead.

Great. Thanks for taking my question. Good morning.

Good morning.

I guess, the first question around volume, I think prior to this call, you had made some comments that your customers were reducing inventories at both maybe, the brand level as well as the retail level. What have you noticed there? I mean, is that ongoing? And then similarly, do you consider any of those reductions as structural, given the high-interest rate environment and the inflation that we've seen? Would it take really reductions in those two areas to really get things going again? And do you expect that to materialize next year? So maybe, we'll start with that. Thanks.

Yes. Arun, I'll take the first cut, and then Steve can add any commentary that he's got. I think, look, what you're referencing there and what we talked about on our second quarter call was the destocking phenomenon that really in our industry started to hit the end of Q1 and kind of played out into the second quarter, a little bit of third. We view destocking largely in our rearview mirror now. We're dealing with some elasticities with pricing and some of the products that our customers are selling. That's probably having more of an impact on top-line sales than anything else right now as I talked about with Ghansham with his question. We don't see a lot of trading down in North America yet, and it makes sense if you think about it. We still have less than 4% unemployment here. Anyone that wants a job can find one, and mobility is high. That's really why our food service business actually grew organically from a volume standpoint. Of course, from a net sales standpoint, it was up almost 8% in the quarter. That's solid. We are seeing trading down anywhere in Europe, which you'd expect given the inflationary pressures they are experiencing. We're all positioned to be able to handle that there too, with the portfolio business that we have.

Okay. Thanks for that. And then just kind of a follow-on would be, have you seen the increase for promotional activity from some of these customers? And then another topic that I was just curious about was just on the side of pricing. I know that there was a reduction in SBS folding carton grades. Is that all that we've seen on the pricing front? Do we expect any more maybe some price normalization or reductions next year? Maybe, you can just address the promotional environment as well as the pricing environment. Thanks.

Yes. As I said around the promotional side of things, it's a bit of a lumpy situation. Some customers are doing more of that right now, while some have said they're protecting their pricing and expecting a more elongated recovery. It's a bit of a mixed bag there. I expect, as most of our customers have told us, they want to grow their volumes next year, as I commented earlier. I expect them to figure out ways to do that, which usually comes in the form of promotions or different merchandising options. I don't think this will be any different this time. That's what gives us confidence in our ability to grow 100 basis points to 200 basis points next year or room to. In regard to pricing, you mentioned the SBS folding that's decoded. That is down $80 a ton. CRB and CUK have moved down $20 in total this year. So that would be a complete summary of what has happened in terms of pricing in 2023. As you would expect, we're not going to prognosticate around pricing here on a call. But I would tell you that at Graphic Packaging, our overall operating rates were pretty good. You saw it on one of the slides, three of the four substrates that we manufacture, we were actually at 90%. That being CRB, CUK, and cup stock. Those are highly integrated businesses for us, as all of you know. The one that actually was light was the coded SBS. In our case, that was down around 70% as we chose to operate those assets to match our supply and our demand, which would be our plan going forward here too. If you really take a step back from that, and think about CUK, in terms of what's going on there, over the last couple of years, we're buying globally some additional paperboard in different geographies to run our business and service our customers. Because of some of the efficiencies we see and some of the demand adjustments that have taken place, we can now integrate all those tons into our own operation and export more tons to Europe and to Australia and New Zealand. That really helps us on the CUK side. On CRB, with our K3 machine now being decommissioned, it didn't produce in the third quarter, but we did have a very significant annual outage in Kalamazoo on both our paper machines, ranging from seven days to nine days. If you factor that seven days to nine days out, our 90% was actually in the mid-90s. We're running wide open on our CRB system, the mills we have in Kalamazoo, Middletown, and East Angus will service our business in Q4. We expect that to be the case as we go into 2021 or 2024 as well. Cup stock, as we talked about with things like Cup of Noodles, and our Chick-fil-A, our overall food service business, which grew in the quarter organically from a volume standpoint, that's a very solid business, highly integrated, over 90%. So, our challenge is on the coded SBS, which has been well chronicled. But in our case, I gave the math for George, 400,000 tons of cup, 800,000 tons of coded; of that high-level numbers, we need about 300,000 of that to run our business. So, the open market portion of it for graphics is 500,000 tons. It's about 10% of our overall volume. That's how I see it. As I've stated earlier, we're trying to find ways to continue to grow our cup business. We will meet that capacity to ultimately serve our customers as these transitions out of foam and plastic continue to occur on the fiber side. That's how I think you should look at the overall demand profile, which usually is tied to some level of pricing.

Great. Thanks for all that detail.

You bet.

Thank you. Our next question comes from the line of Matt Roberts of Raymond James. Your line is now open. Please go ahead.

Hey. good morning, everybody. My question, in regard to permanently shutting the K3 machine in a quarter, while that seems consistent with the initial plan you laid out in 2019, can you discuss how the timing has played out versus your initial expectations? And what are some of the assumptions or scenarios you're considering on the timing of closing East Angus and Middletown ahead of Waco?

Yes. thanks, Matt. I appreciate the question. From our standpoint, our plan was always to shut down our K3 facility. The question was, when could we do so and take care of our customers? With the ramp-up K2 exceeding our expectations in terms of productivity and quality, we were able to do that on June 30th. So that timing was good. As I just mentioned, we need our remaining mills and assets to run well to take care of the business that we have. We do not plan on shutting down any of those mills prior to our Waco facility being up and running simply because we're going to need the tons to service our business on the CRB side.

Yes, Matt. Just to expand on that, if you kind of step back, and we shared it on one of the slides, we've really played this out since 2019, as described. How we got there is a little different, of course, but the 550,000 tons in, 480,000 tons out, we've grown at a 2% CAGR over the last couple of years. We need those tons and we've got demand for our CRB. As Mike mentioned, we'll continue to run the CRB platform full, taking of course, our planned typical maintenance outages where appropriate. But there's a real strong outcome relative to our original commitments and just repeating something I mentioned, the same applies with CUK, because of global demand for fiber-based solutions.

Right, that makes sense. Thank you, both Mike and Steve. If I could follow on to that, thinking about maybe longer-term supply here, a competitor announced, seems like they are delaying an FBB conversion, citing market softness. How has that action changed your longer-term industry supply estimate for 2025 and beyond, if so? Thank you all for taking the questions.

I think on the margin, they're seeing exactly what I just got done describing. Where the FBB was going to compete is on the coded SBS side, which is the weakest of all the grades. So that probably caused them to take some pause. In our case, we're actually shifting out of coded SBS as we can and growing our cup stock business. We're going to have the lowest-cost platform for CRB in the Western Hemisphere; our CUK is an incredibly competitive and highly-integrated business, over 95% integrated. We're running a different race in terms of how we're putting it together. That isn't where we're going to spend our capital dollars or place our emphasis. We're a packaging company. We want to sell a cup. We want to sell a carton. We'll make the grades of paper where we can actually earn a good return for our investors. That's how you'll see us allocate our capital.

Yes, Matt, just to add to Mike's point. If you kind of step back and assume that there's a long-term delay on the project that you were referencing from a capacity perspective, there's very limited capacity that is underway in the market coming into play. There's one conversion happening with the competitor in Maine that has some incremental capacity. Obviously, we will bring on a little bit of incremental capacity to support our growth. You've actually had capacity reductions playing themselves out in SBS. They take some time to roll through the market. The Canton mill that was closed here is now fully down, and I'm sure inventory levels are being managed through. Actual capacity across all three substrates, very modest additions, if you look out over the next three to five years, knowing the timelines for any other decisions that someone may or may not make over time.

Very helpful. Thank you again.

You bet, Matt.

Thank you. Our next question comes from the line of Mark Weintraub of Seaport Research Partners. Your line is now open. Please go ahead.

Thank you. There had been quite a bit of static when you were answering Ghansham's questions, and I apologize, I didn't get everything. So, I just wanted to quickly review some of the framework on bridging '23 to '24. I think you mentioned Bell, including synergies, was about a $30 million positive EBITDA, and then 100 basis points to 200 basis points, being your kind of baseline. Those I did hear. I thought I lost; I didn't hear too much on the productivity versus labor. Historically, that used to be a bit of a wash. Did you give specifics on sort of netting those two out for next year?

Yes. why don't I give it, it sounds like there was a problem with that. Let me just repeat the answer for you, Mark, just so that you have kind of the whole context again. What we indicated was that on the positive front, as you just articulated, but playing it back to you again, Bell will be an incremental positive next year, probably in the $30 million range from a combination of the business we acquired plus the synergies. We'll earn on our 100 basis points to 200 basis points of organic sales growth. So, if you assume $100 million to $200 million of top-line growth, we'll earn on that. That actually is a bit of a counterbalance to the price-cost relationship on a mark-to-market basis. So, all known pricing actions probably about an $80 million net headwind offsetting the significant price that we've executed on over the last three years. We would expect our productivity to be very strong next year. We will have less planned maintenance downtime. We won't plan for a weather-related event that occurred in 2023 in the first quarter and less market-related downtime as we return to growth. We would expect that to fully offset our labor and benefits inflation as it normalizes back toward probably more towards that $100 million range. Those were the components marked that we would see playing themselves out in 2024. So, it'll be a different year than 2023 in terms of some of the pluses and minuses. But as I also repeat, we expect to operate in EBITDA margins that are within range, a tight range, around that 20% that we're executing on this year.

Okay, great. Lastly, I have a follow-up question for Mike. You mentioned resets, and I wasn't entirely clear. Is the bias towards the resets generally positive? Is it just a matter of how much, or is that something still to be determined?

Well, this is Steve, Mark. Our bias is to the positive, obviously, because we are renegotiating if someone has been under contract for quite some time and may not have the full increases that we've executed on, because of the model they were on or what have you. The resets we would expect to be net favorable as we renegotiate them. As repeating it from earlier, we don't outlook those until we're done, until we've successfully executed on them. That's one of the reasons you've seen price generally moving beyond what might be expected, because of those successful negotiations that we've been undertaking for the last couple of years. We would continue to embark on them as you look out to 2024. I don't know, Mike, if there's anything you'd add to that.

I think you said it well.

Got it. Very helpful. And maybe, just lastly, and I hope you've already been addressing this, I totally understand the idea of transitioning some of the SBS folding cartons over to cup stock over time. You are currently operating at 70%. So, I guess there's also the potential, if that market improves next year, just selling it as coated board. Can you share your thoughts on what needs to happen for that market to improve so that you'd be operating at full capacity in that business? And is that connected to the improved productivity you mentioned earlier?

Yes. It's really two things. We need demand to pick up. There are a variety of different verticals in which that could happen. On the coded side of SBS, some of the more high-end stuff, as you know, that historically has been used for that kind of paperboard. That means we'd earn on that if we had those sales. But as we talked about here, our approach has been we're going to match our supply and our demand, and that's what we did here in the quarter. Ultimately, yes, it enters itself and we pick up under-absorbed fixed costs. That's exactly how it works if we're able to operate the mill. But we're only going to do that if we have the orders to actually match that.

Yes, and Mark, to Mike's point, as you know, SBS folding cartons, so that specific grade is the most fragmented, most global, and least integrated. Given that there was an overproduction of a little more magnitude over the last year, I think that speaks to the depth of the down, so down towards the 70%, we're matching our supply with demand. To your point, when all of that plays out, which it is, whether it plays out and you go into 2024, when it does return to a normal pattern of buy/sell, if you will, there should be value creation as you get more normalized volumes rolling into 2024.

Great. Appreciate all the color. Thank you.

You bet.

Thank you. Our last question comes from the line of Anthony Pettinari of Citi. Your line is now open. Please go ahead.

Hi. Good morning. I think you saw net organic volumes down, I think 6% year-over-year, but vol mix was a 9% top-line headwind. I was just wondering if you could talk about any mix shift you saw during the quarter. And then separately, I guess in 3Q food service outperformed grocery on easier comps. Is it reasonable to expect maybe those end markets could perform similarly in 4Q as they did in 3Q?

Yes, Anthony, it's Steve. I think the differential there that you're describing is all the open market paperboard sales which were down year-over-year. So, we outlined that on the third quarter net sales performance, you've got open market sales down a little over $100 million. So, that's matching supply and demand only producing paperboard that we sell into the open market, where we have orders at pricing that we find consistent and acceptable. That's really the point there. The organic sales, as you know, as we've described it, is on when we make an end-consumer package. Hopefully, that breaks it out for you.

Got it, got it. And then the food service versus grocery, I mean, you think 4Q would maybe play out similarly to 3Q?

Yes. I think the relationships probably yes, it'll all be sequentially better as we're articulating. I think as Mike had said and we've shared with you, the drive-through just continues to win. Fiber-based packaging through the drive-through is winning. Overall, the performance of our food service business has been very good. It was up modestly, organically in the quarter, which was a favorable outcome as part of the 8% improvement year-over-year. There's good momentum there as consumers want to be mobile. They also want to have products that are delivered to them effectively, mostly through the drive-through. So, I think the momentum there is very strong, and then it's supported by the innovation activity that we articulated to you as well here, like Chick-fil-A and others.

Okay, okay. that's helpful. And then shifting gears, there have been a lot of questions in the CPG and food service space around potential long-term impacts of GLP-1 drugs. I'm just wondering if you had any kind of high-level or initial thoughts on if or how this could impact your business or any anecdotes of consumers using GLP-1 or maybe, buying less or more or shifting their mix of products that you provide packaging for.

Yes. Many of our customers have released information over the past few weeks and have shared their thoughts on this, as they received many questions about it. It's still early with the drug, and we may not yet know all the questions to consider. Several customers have mentioned they do not expect it to significantly affect their business, and some believe it might be an opportunity for innovation. We'll need to see how this develops over time, including adoption rates. However, we haven't encountered anything that concerns us regarding our capacity to achieve our target of 100 to 200 basis points of organic volume growth in the medium to long term.

Okay. That's very helpful. I'll turn it over.

Thanks, Anthony.

Thank you. Our last question comes from the line of Phil Ng of Jefferies. Your line is open. Please go ahead.

Hey, guys. I appreciate you squeezing me in here. Sorry to harp on this, I mean, the non-integrated tons are obviously quite small for you, but you've given some color on how your volume strength has progressed through October and since you stripped that out in your net organic sales number, and certainly, SBS folding carton seems to be a little more under pressure. How do you kind of see the open market tons progressing through the year? I'm curious if you've seen any more impact just broadly on imports, at least RISI seems to be dialing up comments around that, and maybe it having more impact and making its way to the Midwest.

I think the way we're dealing with the open market, particularly on the coded SBS side, as you've seen in terms of the 70% operating rate for graphic is, we're matching our supply and our demand, and we'll continue to do that. That's a plan relative to how we would operate the business. I've already told you our CUK and CRB, and uncoded cup business, those are strong businesses, highly-integrated, our operating rates are solid there. I'd expect that to be the case, particularly as we get some growth.

Yes. I mean, it's a great question around imports. When you read some of the trade journals and how they talk about imports, it sounds like there's a wave coming. I was particularly interested in the most recent one relative to CRB coming from Western Europe. So, our team went back and pulled all the census data. We looked back a couple years in terms of what it looked like. Phil, 20,000 tons or less a year for the last three years. It's a two-million-ton market. It's like 1%. What's most surprising to me on that is just the amount of airplay that got because we don't see it in the marketplace, and we're out there every day with the biggest producer of coded CRB, as you know, and we're getting bigger. If we thought selling CRB to ourselves, where we buy over 100,000 tons of material in Europe was a good long-term plan, we'd be doing it and we're not, because it just isn't economically profitable over the cycle to be able to do that. So, there's some stuff maybe around the margin out there, it gets a lot of airplay, but when you really look at the data and the numbers, it doesn't support the hype.

Okay, that's helpful. That's great information. Since you mentioned Europe, I'm curious about how your business is performing there, specifically regarding your conversion efforts. I wonder how you're managing pricing costs in the medium term as well.

Our overall volumes in Europe were substantially similar to those in the United States. Our strategy is working there. If you look at how we're doing it, we've got a non-integrated business there, where we're one of the largest buyers of paperboard in Europe and that puts us in a great spot right now, where the markets are a little bit softer as you've mentioned here. We're buying paperboard very effectively. We're able to export our CUK into that market profitably and have for a long time as we continue to grow our beverage business. When you really look at it, and Steve and I talk about it a lot, having a non-integrated business over there, we don't have as much capital tied up to drive the revenue line in our European business. Look at our return on invested capital and compare Europe to North America, which is obviously heavily integrated, in our own paperboard, they're on top of one another. Our overall strategy is actually delivering good results for shareholders.

Okay, appreciate the color. Thank you.

You bet.

Thank you. Our last question comes from the line of Gabe Hajde of Wells Fargo Securities. Your line is now open. Please go ahead.

Mike, Steve, good morning.

Good morning.

Good morning.

I had a question about backlogs. I know you guys don't necessarily express it this way, but the three to four weeks I think historically speaking, you guys have talked about being towards the low end of what you'd consider to be sort of a healthy-balanced market. I'm just curious for this time of year, taking into account seasonality, is there anything different, unique about that number? You called out the 15,000 tons that would be associated with Nissan, and I appreciate that was, I think, full adoption. So, more thinking about Chick-fil-A, I think you've identified that as maybe an 80,000-ton opportunity, and correct me if I'm inaccurate. Is there anything in that backlog number, sort of for a pipeline fill into '24 associated with those two products? When we were talking in February, would you expect to see that backlog number change materially from where we're at today again, just taking into account seasonality?

Well, I'll answer the second part of your question first. The overall numbers you talked about are accurate relative to what some of those full conversion adoption rates would be; they are directionally correct, at least for your modeling. In regards to backlogs, I think you got to take a step back and think about we're talking about operating rates now and you're taking downtime to match supply and demand. So, backlogs, quite frankly, are artificial because they can be whatever you want them to be based on the amount of downtime that you take. The more germane point is as we try to articulate here, Gabe, out of three of the four substrates, we're very busy on three of those. It's the coded SBS, that's the one that's got the biggest challenges for us for the reasons we've already chronicled. So, I wouldn't get overly hung up around whether it's three, four, five, or six weeks. That matters when you're running full. Particularly on the coded SBS side, we're not. I’ve watched those operating rates and really watched to see what our overall growth development looks like here in Q4 and into 2024, because as we grow 100 basis points to 200 basis points, that's where those tons come. I already mentioned the other thing that is out there is that we're no longer going to buy as many tons internationally on the CUK side, so that will actually help try some of that back too.

Yes, Gabe, it's Steve. On the first component, the incentive compensation year-over-year is very similar. So, there's not anything there that there is a headwind or a tailwind. It's all pretty consistent from '22 to '23 and it's all in the guide. I don't have the exact number in front of me. But yes, to get to the midpoint of our working capital, there'll be some use of cash on the working capital front, as we dial in kind of where we want to end the year on inventory levels, where do we want to run supply to meet demand? So, I'm sure your model on the use is knowing where interest expenses, where pension expenses, where taxes are, you may be a little light on taxes; our cash taxes this year are moving up as we become a U.S. cash taxpayer. We are on the right to do that. We'll provide more detail as we work out modeling for next year. But I think the key is that we're going to generate, at the midpoint of that cash flow, and our leverage is going to end the year at the lower end of our range. By the way, that's a raw leverage calculation. It's not pro forma; it's the real leverage of the company after spending $260 million acquiring Bell.

I appreciate it. Thank you.

Thank you.

Ladies and gentlemen, thank you for joining the Graphic Packaging's third quarter 2023 earnings call. Have a great rest of your day. You may now disconnect your lines.