Earnings Call Transcript - GPK Q2 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Graphic Packaging Holding Company’s Second Quarter of 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Melanie Skijus, Vice President of Investor Relations. Thank you, please go ahead ma’am.

Melanie Skijus, Vice President of Investor Relations

Good morning and welcome to Graphic Packaging Holding Company’s conference call to discuss our second quarter 2020 results. Speaking on the call will be 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 second quarter earnings presentation which can be accessed on the Investors section of our website at www.graphicpkg.com. I would like to remind everyone that statements of our expectations, plans, estimates and beliefs regarding future performance and events constitute forward-looking statements. 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 obligations to update such statements except as required by law. Mike, I will turn it over to you.

Michael P. Doss, President and CEO

Thank you, Melanie. Good morning and thank you for joining us on the call today. I'm pleased to be with you to discuss our excellent results we delivered in the second quarter of 2020. Before we focus on financial results, I'd like to take a few moments to update you on the initiatives to keep employees and partners safe while continuing our essential operations supporting the food, beverage, consumer, and food service markets globally. Employees come first to Graphic Packaging. We continue to invest in added safety protocols, including Plexiglas barriers on production lines, face masks for employees, temperature scanners, and enhanced cleaning and sanitation protocols designed specifically to prevent the spread of viruses, including influenza and COVID-19. While we've established and implemented safety protocols for frontline employees, we've also executed technology solutions to enable our non-production employees to conduct their roles effectively from home. Workforce productivity and collaboration across our organization during these challenging times has exceeded my expectations. We have managed through the COVID-19 environment exceptionally well to date and have remained agile, approaching every day with a can-do attitude. Over the course of the last few months, we have often been recognized by customers for our flexibility, best-in-class service, and support through these volatile times. We attribute the exemplary customer service our teams provide directly to the focus we place on the well-being of our employees. Our teams have continued to perform for our customers and have gone above and beyond to provide continuity of supply. I thank everyone at Graphic Packaging for their ongoing and tireless efforts. I would also like to take a moment to discuss a very important topic at Graphic Packaging, diversity and inclusion. We believe a diverse and inclusive working environment encourages creativity, innovation, and collaboration that enhances our ability to support customers and it is vital that our global organization reflects the diversity of the communities in which we operate. While diversity and inclusion has been a longstanding practice, it is more important than ever that we listen to our 19,000 employees worldwide and have conversations necessary to ensure all the employees have a sense of place and inclusiveness as members of the Graphic Packaging team. We benefit as an organization from a truly collective and diverse viewpoint. I commend all our employees around the globe for their teamwork and the care and support everyone continues to provide to one another every day. Our organization is committed to driving positive change for employees, customers, and the communities in which we operate. Meaningful, sustainable change starts with listening. And we're encouraging the voices of many across the company and specifically with our human resources teams globally to ensure our words and actions are congruent with the values of the company. Turning now to our financials on Slides 5 and 6, I will walk through some of the highlights for the second quarter. Sales increased 4% year-over-year while adjusted EBITDA of $260 million declined slightly from Q2 last year. Adjusted EBITDA was impacted by approximately $25 million in incremental planned maintenance downtime we incurred compared to the second quarter of 2019. It was largely offset by positive price, commodity input cost deflation, and strong productivity during the quarter. Overall, execution was excellent. Net organic sales growth increased 1.5% compared to the second quarter of 2019. Positive at-home consumption trends and new product development initiatives more than offset the declines in our food service business. Net organic volume, as measured in tons, actually increased more than net organic sales dollars due to the market mix in the quarter that significantly impacted net organic tons sold on a favorable basis. We believe net organic sales growth in dollars is the best indicator of how we are performing versus our Vision 2025 goals. Excluding the impact of price and foreign exchange, net organic sales growth for the first half of 2020 was 3% year-over-year, a strong start to achieving our long-term 100 to 200 basis point growth goal inherent in our Vision 2025. Our paperboard integration rate improved 200 basis points from 68% in 2019 to 70% year-to-date. While Steve will talk in greater detail on quarterly financial results and our outlook for the year, I'm pleased to report we are reinstating full-year 2020 guidance today. After evaluating multiple scenarios in relation to consumer demand and likely spending and consumption patterns in the second half of the year, we are reinstating our full-year adjusted EBITDA guidance in the range of $1.05 billion to $1.09 billion, representing a 4% growth year-over-year at the midpoint and adjusted cash flow guidance in the range of $200 million to $275 million. The operating environment remained relatively healthy in the second quarter, particularly in the food, beverage, and consumer markets we serve. Backlogs for five plus weeks for CUK and CRB and four weeks for SBS. Operating rates for both CRB and SBS, as reported by the AF&PA were 97% of our estimated operating rate for CUK continues to be very strong at 95% plus. We continue to closely monitor demand, specifically cup demand for the food service markets. One of our paper machines in Texarkana is essentially dedicated to making SBS paperboard, which we subsequently convert into paper cups. Due to declines in paper cup demand we have taken 14 days of market downtime so far in July on this paper machine. We intend to extend our planned maintenance downtime on the same line in September, adding 14 days market downtime to the scheduled maintenance outage we have planned. We will continue to align our SBS supply with our forecasted recovery rate of the food service market. Currently, market downtime in our SBS cup paperboard production is expected to yield a reduction of 20,000 to 30,000 tons in the third quarter. In addition to taking the market downtime where needed, we have successfully transitioned and annualized 100,000 tons of integrated folding cartons from CUK SBS paperboard. This has the dual benefit of meeting increased demand for our CUK beverage packaging as well as leveraging our low-cost SBS mill platform. As a producer of all three paperboard substrates, CRB, CUK, and SBS, we are well-positioned to move products among the end-use markets to meet changing volume requirements by market when needed. Moving to Slide 7, you can see the progress we made in 2019 in year-to-date in 2020 on the price to commodity input costs recover. We remain committed to price offsetting commodity input costs over time and are pleased that we've been able to fully recover the dislocation that took place from 2016 to 2018. New product development continues with our customers even during these challenging times. PaperSeal tray solution is a product we are very excited about and you'll see the details on Slide 8. We began development a few years ago on hermetically sealed paperboard tray, as well positioned to serve a wide range of food applications, including proteins, cheeses, salads, fruits, and frozen foods. We formally introduced PaperSeal in 2019 and are making products for customers in Europe and Australia today. We expect to be commercial with customers in North America early in 2021. We are encouraged about this opportunity to move into new markets, including protein packaging with our innovative paper-based tray solutions. As we discussed in Vision 2025 last September at our Investor Day, we are well-positioned to capture sustainability-supported organic sales growth and to benefit from new product development for years to come. Work with new and existing customers and more sustainable packaging products, including PaperSeal, is reflective of the continued opportunity we see to bring new paper-based packaging solutions to the marketplace. While some COVID-related delays have been factored into the near-term outlook, multi-year sustainability-supported sales growth opportunities remain intact and we continue to see a path to our 100 to 200 basis points net organic sales growth for the next several years. We are executing multiple beverage packaging installations in Europe that will support organic sales growth in 2021 and beyond. Notably, the first Kio Clip machines have been installed for Coca-Cola European partners, and we are excited that commercial production will begin soon for this important customer. Our teams are also progressing on alternatives for polyethylene-coated containers and cups, and we are confident in the development with customers today for conversions in 2021. Premiumization and custom structural packaging design are additional areas where we are seeing increased interest from customers as they look to differentiate their products in the marketplace with end-user consumer safety in mind. We are working closely with customers and continuously finding opportunities to develop innovative packaging solutions to refresh our pipeline and strengthen long-term partnerships. To date, this has been an incredible year of change and adaptation. Our teams had to quickly mobilize and operate under the realities of the COVID-19 pandemic. Our production employees were nimble and adjusted quickly to changing demand patterns. Importantly, they maintained our continuity supply to our vital food, beverage, consumer, and food service markets amid uncertainties with the pandemic, logistics challenges, and occasional severe weather events. We entered the second half of the year with resolve to continue learning and improving from these events of this year and have confidence our teams will successfully manage the business during the current uncertain economic times. Steve, I hand the call over to you now for a more detailed discussion of our financial results.

Stephen R. Scherge, Executive Vice President and CFO

Thanks, Mike, and good morning. Moving to our sales performance, net sales in the second quarter rose 4% from last year to $1.6 billion due to acquisitions, organic sales growth, and positive pricing trends. Earnings for the quarter were $0.19 per diluted share, down from $0.22 in the second quarter of 2019. Our net income was affected by $21 million in special charges, largely due to a settlement for a multi-employer pension plan. Adjusted for these charges, net income for the quarter was $72 million or $0.26 per diluted share, which is an 8% increase from $0.24 per diluted share in the second quarter of 2019. Looking at our adjusted EBITDA for the second quarter, it was $260 million, benefiting from $5 million in higher pricing, $15 million in improvements in productivity, $10 million from decreased commodity input costs, and $2 million from favorable foreign exchange. These gains were partially offset by $2 million from an unfavorable volume mix, $13 million in inflation primarily related to labor and benefits, and $25 million in expenses from planned maintenance outages during the quarter. Regarding commodity costs, we encountered mild inflation across most categories, except for secondary fiber. OCC costs peaked dramatically from February to May and then declined in June and July. As Mike mentioned, we are committed to managing pricing to counteract rising commodity costs and will be monitoring inflation closely. We are implementing decisive strategies to strengthen our business for both present and future conditions by optimizing our mills and converting facilities, integrating acquisitions, increasing paperboard integration rates, expanding market share, and driving profitability. The facility closures we announced last quarter have been completed successfully, and the integration of our acquired assets is going better than anticipated. We are on track with energy initiatives, moving two converting facilities to lower-cost locations, and the Kalamazoo Project remains on schedule and within budget, expected to generate $100 million in annualized EBITDA improvements by 2022 to 2023. In terms of liquidity, we have $1.4 billion available. Our balance sheet is robust, ending the quarter with $3.4 billion in net debt, which is an increase of $54 million. Our net leverage ratio stood at 3.26 times at the end of the second quarter, compared to 3.18 times at the end of the first quarter. We anticipate being within our targeted range of 2.5 to 3 times as we close out 2020. Regarding returning capital to our shareholders, in light of recent market volatility affecting our stock price compared to our long-term value assessment, we have continued share repurchases in the second quarter, acquiring $38 million in common shares at an average of $12.59 each, bringing our total for the first half of 2020 to $157 million. Additionally, we are investing in our business, with capital expenditures in Q2 amounting to $154 million, which includes progress on the $600 million strategic investment in the Kalamazoo project. Now, turning to our partnership with International Paper, we can see the potential options we have for monetizing partnership units. Although there is nothing new to report today regarding monetization, this illustration shows the non-dilutive potential of using GPK stock in such transactions, granting us leniency in creating shareholder value. Before discussing our outlook, our existing shelf registration statement will expire later this month, and we plan to file a new one as per our usual practices this quarter. Now onto our current business environment and outlook; we are pleased with our second quarter performance. Our team is effectively adapting to meet customer demands, driven by consistent at-home consumption, strong results for the first half, and with an expected gradual recovery in the food service sector, we are reinstating our full-year guidance. We project adjusted EBITDA for 2020 to be between $1.05 billion and $1.09 billion, with adjusted cash flow for the year anticipated to range from $200 million to $275 million based on our guidance components. Thank you for your time today. I'll now hand the call back to Mike.

Michael P. Doss, President and CEO

In closing, the first half of 2020 we've met the increased demand needs of our customers and have successfully overcome challenges presented by the global pandemic. Net sales and adjusted EBITDA are both up 5% in the first half of the year versus the same period one year ago. We are operating the business from a position of financial strength and flexibility, with a keen focus on customer service, care for employees, and return for stakeholders. We have reinstated our annual guidance that includes adjusted EBITDA growth and healthy cash flow for the year, maintained our dividend and share repurchase programs, all while continuing to invest for the long-term growth and achievement of our Vision 2025 goals. Thank you again for your interest in Graphic Packaging, and I'll now turn the call back over to the operator to begin Q&A.

Operator, Operator

Your first question is from Mark Wilde of Bank of Montreal.

Mark Wilde, Analyst

Good morning, Mike, good morning, Steve.

Michael P. Doss, President and CEO

Good morning Mark.

Mark Wilde, Analyst

I wondered if you can just give us some sense of kind of activity levels in July by business lines, what you're seeing in food, beverage, consumer versus what you're seeing in food service as we move through July here and also maybe a little more color on just the point between organic sales and organic volume?

Michael P. Doss, President and CEO

Okay, why don't I take the first part of this Stephen, and you can handle the second. So Mark, the way I'd characterize it, if we look at the second quarter we would say that our food and beverage business was up roughly 6%. You know, that again as you know is about 77% of our portfolio, and the food service business was actually down about 20%. As we look at what we are seeing here in July and what we essentially expect for Q3, we see that range on the food and beverage probably being somewhere between 5% to 8% based on the various verticals that we operate in. And food service probably means somewhere in the neighborhood of 15% to 20%. So it's improved a little bit, but not materially as you'd expect given all of the information that's been out in the news around some of the challenges in some of these states and staggered restarting. So that's what we're seeing right now on the ground and I will let Steve cover the volume and sales.

Stephen R. Scherge, Executive Vice President and CFO

Yeah, thanks, Mike. Good morning. Just with regards to organic sales growth, 150 basis points of growth that we saw, that's the top line number, and we felt that it was the right and actually conservative approach to how we look through our business given the mix change that we're experiencing. If you actually step back and look at it on a tons basis, our organic volume tonnage, our integrated tonnage was actually up 6% in the quarter, so quite material. But there was a pretty significant mix change that's happening inside there. Just to kind of put it into context our traditional food and beverage folding cartons, like a beverage package, would be $1500 plus per ton on average, or as a food service on balance product, a cup that includes the lid for example might be in the $4000 per ton range. So we wanted them to step back from the results and stare through the top line consistent with our Vision 2025 expectations and we are very pleased that the net result is a 1.5% growth in the quarter, 3% year-to-date on a top line organic sales basis. Integrated organic tons are actually higher than that. But it's like we are just saying as we see some return into the food service volume that kind of natural give and take of those two changes in mix we will start the level playing field over time. So we're very pleased with 1.5% and the 3% year-to-date in terms of the actual top line.

Mark Wilde, Analyst

Okay. And then I wanted to just make sure I understand what you said about SBS downtime. I think I heard you say you took 14 days in July at Texarkana on one machine and that you're going to take another 14 days along with the maintenance outage in September is that correct?

Michael P. Doss, President and CEO

You got that right, Mark. And so if you put that together, the incremental market your downtime is somewhere between 25,000 and 30,000 tons that will occur in Q3 and that's aligning our supply with our demand, as we talked about. And that's on top of the planned outage where we're putting that new head box on that machine that was already planned. And that's all in the month of September.

Mark Wilde, Analyst

Okay and is there any way Mike to just take some of that food service oriented SBS volume and just move it to other businesses? I mean, it would seem with that second quarter operating rate of 97% that you noted from the AF&PA that SBS supply would be pretty tight right now and then maybe you could just swing volume on that machine?

Michael P. Doss, President and CEO

You know, that's an uncoated machine. The cup machine itself but you are in fact actually correct with what we've done in the second quarter as you heard in my prepared comments, we talk about 100,000 tons run rate of CUK business including SBS our teams did an exceptional job of being able to make that transition very, very fast in order to service customers and capture the growth that you're talking about. So in fact part of what you're seeing in terms of those strong operating rates on the base SBS businesses is in fact we've made that shift and as you know, we're pretty uniquely positioned to be able to do that being the manufacturer of all three grades and that factors into our integration work that Steve also mentioned about going from 68% to 70% year-to-date. So it's all part of our strategy and it's working and it's being tested in a pretty big mix change, which I think shows our resiliency of the end markets that we participate in and our customers are performing through what most would consider a pretty big disruption.

Mark Wilde, Analyst

Okay. Last one from me, I am just curious, are COVID-related restrictions on things like travel like sending technicians over to install lines for Coke and other beverage companies in Europe slowing down sort of one element of your organic growth this year?

Michael P. Doss, President and CEO

It is, Mark. I mean, we've lost a quarter or two as we alluded to on our first call, and that continues to be the case. We've gotten pretty good at being able to do things via Zoom and FaceTime, but there are some things that just have to be done by our technicians. And what I would point to, and I had that in my prepared comments too, is that we've got really our first line in Europe that will be operational here towards the end of Q3 and into Q4. We expect that to continue to accelerate as we go into 2021. The interest for that particular specification, Kio Clip, continues to be incredibly strong. It's really an issue about getting the machines installed and operational and we expect that we'll have this delay but there's no loss of interest. As a matter of fact, I would argue it's building.

Stephen R. Scherge, Executive Vice President and CFO

Yeah, the market is stable and the delays that Mike referenced are kind of timing delays. What we haven't seen is any change in the interest level with the number of placements. So it's a little bit of a delay, but there's no change in the actual number of installations consistent with our expectations.

Mark Wilde, Analyst

Okay, that's helpful. I'll turn it over, guys.

Michael P. Doss, President and CEO

Thank you.

Stephen R. Scherge, Executive Vice President and CFO

Thanks, Mark.

Operator, Operator

Your next question is from Mark Connelly of Stephens.

Mark Connelly, Analyst

Thank you. If we look at your Slide 7 and your recovery of price cost I am curious what has changed other than just the lag, if we were to experience that kind of inflation scenario that we saw in 2016 to 2018 to date how much different would the recovery period be, would it just be a third faster or is there more changing in just that lag?

Stephen R. Scherge, Executive Vice President and CFO

Mark, it is Steve. I think I will start and Mike can add on. I think you touched on one of the key components if we were to experience significant inflation on a go-forward basis. Clearly the lags would be tighter, and so that obviously is a critical part of our ability to recover. You have seen as you mentioned on Slide 7, we now have fully recovered to this location that we did experience which is important to see. I think overall though to Mike’s point the reality of the operating rates and the overall supply demand environment is of course critical relative to our view of that and that too would play into recovery going forward. And so the overall three substrates and the operating rates and backlogs of those are obviously relevant.

Michael P. Doss, President and CEO

I think Mark I would add to Steve’s comment, just again and you know this, we didn’t even own SBS not until January 1st of 2019. So now we have got all the substrates and our ability to balance those three substrates across the portfolio of business as we are doing right now, if you think about what we're doing on SBS with a 100,000 tons, we moved out to CUK, and that's a big deal for us. So that helps us balance our supply and our demand by being able to manufacture all three substrates, which is clearly different.

Mark Connelly, Analyst

When you announced the CRB hike previously, trade representatives noted that some customers were upset, indicating a desire to avoid the issues we're discussing. Is this customer reaction common, and does the general sentiment that it's an unfavorable time for a price increase influence their preferences or yours regarding contract terms, such as favoring a cost escalator or perhaps a price index?

Michael P. Doss, President and CEO

I think, and you know this, I mean really no customer is looking forward to a price increase. So the timing is what the timing is. I think in terms of what our resolve is and you saw us do that when OCC was going up dramatically and we didn't know where it was going to go, we were very aggressive on making sure that we are in front of recovering that because we want to avoid having to have another slide like the one that we just got done talking about. And so that's how we're looking at it at Graphic. I would say that the other part of that with customers is that they want to be able to plan and so costs models give them probably a little bit more ability to plan where they kind of know in the last six months what's happened. And we can kind of keep them up to speed and they can build that into their forecasts up or down. Some of our customers find that helpful and that's obviously something that we offer them. And we'll continue to do so.

Mark Connelly, Analyst

Okay, if I could just squeeze one small one in, in your strategic actions like you didn't highlight the two coders at West Monroe, is that still on track?

Michael P. Doss, President and CEO

Thank you for your question. We should have included some information on that. We are installing our curtain coater on our number 7 machine at West Monroe in September, and that should be completed by then. We expect to see the benefits starting in Q4. After that, we'll take about a year off before installing the final one on the other machine in early 2022. Our goal is to have it operating smoothly in West Monroe and fully understand the operating parameters before completing the last installation.

Mark Connelly, Analyst

Very good, thank you.

Michael P. Doss, President and CEO

Thanks Mark.

Operator, Operator

Your next question is from Brian Maguire of Goldman Sachs.

Brian Maguire, Analyst

Hey, good morning guys. Just wanted to follow-up on the reporting metrics switch just from the net organic volumes you had talked about before to the net organic sales. And I guess last quarter you reported net organic volumes that were up about 4%, excluding COVID and Leap Year, I think 5% if including COVID but excluding the Leap Year. And so are you saying that that same number would have been up 6% in 2Q so it is actually a little bit better in 2Q and related to that, are you now sort of committing to even offsetting the negative mix impact that you might have going forward to get into the 100 to 200 basis point growth range on an organic sales basis in addition to organic volume basis?

Stephen R. Scherge, Executive Vice President and CFO

Yeah. Brian, thank you for that. The answer is yes. The 4 and 5 percentage you referenced last quarter, this quarter was 6. So overall, year-to-date organic volume growth is up pretty materially as we mentioned, driven by very strong demand for our traditional core food and beverage business, particularly beverage as Mike mentioned, that also created these new opportunity to pivot volume from the CUK to SBS to service primarily food-based customers moving them into that product category. Yes, we would expect over time that both volume and sales growth would both be in that 100 to 200 basis points of organic growth over time. So no change whatsoever. We just felt that here as you look at it today, because of this pretty significant change in the mix of our products that we actually didn't want to kind of, if you will, what we believe over the long term might be a temporary overstatement that we actually stepped back and said, let's look at this through the sales lens. But very specifically, volume is up materially through the first half, driven by the 77% of the business where we're seeing the at-home consumption patterns stay very heavy and positive relative to volume.

Michael P. Doss, President and CEO

If you think about it, Brian, what we're trying to do is make sure that you've got more of a look-through to actually trying to run this for Vision 2025 as opposed to one quarter, which was exceptional from a tonnage standpoint. But we do expect over time and we don't know what that timeframe is, that we see that cup business come back. And that's the value per ton that Steve talked about being $4000 a ton versus $1500 a ton. It is a big shift and so we are just trying to give you a better look through on the narrative, some would call that a bit conservative.

Brian Maguire, Analyst

That makes sense. I would just ask that you would take some of the pricing out of it as your duty to recover cost inflation and pricing will move up and down. But kind of a volume mix blended number makes total sense. Just to switch gears a little bit…

Michael P. Doss, President and CEO

Brian, for clarity, the sales definition we used excluded price and foreign exchange, aligning it with the volume mix category. Therefore, it reflects the sales associated with that. We intentionally removed price and foreign exchange to ensure that our analysis is consistent, allowing for a clear understanding of how the volume of our business, as indicated by sales, progresses.

Brian Maguire, Analyst

I think that's a very good metric. Shifting to SBS, the industry operating rate has improved slightly to 97% from 95% in the first quarter, and the backlog has increased to about four weeks, compared to three to four weeks last quarter. It's clear that many changes have occurred in the food service sector. It appears that some industry data has improved, but in your own converting operations, you're experiencing some downtime, which you mentioned could affect 20,000 to 30,000 tons of board. This raises some inconsistencies between the optimistic industry data and the improving backlog, contrasted with the downtime being taken. I'd like you to clarify whether you believe the industry needs to reduce capacity in SBS and if there's a need to eliminate some upstream storage capacity.

Stephen R. Scherge, Executive Vice President and CFO

So, Brian, I'll take that one. Let me explain what we're doing at Graphic. We moved about 100,000 tons of CUK business into our general SBS, specifically the coated SBS business, and those conversions were completed in the second quarter. We are using this to balance our multi-mill system. The weakness is primarily in the uncoated cup machine because the demand in food service has decreased by 15% to 20%. To address this, we’re also conducting a significant planned maintenance outage on the head box of that machine, which will involve an additional 28 days of downtime in Q3 to align our supply with demand. The general SBS market we participate in remains strong, as indicated by year-to-date operating rates, with the AF&PA number at 95.3 compared to 91.7 last year. This also reflects the closure of one of our competitor’s mills. Within those numbers, the weakness lies in the food service grade we produce, which amounts to about 4,000 of our 1.2 million tons. We are managing our supply and demand by including some economic downtime as I just described. So please consider it that way.

Brian Maguire, Analyst

Okay, that makes sense. And just last one from me, it might be a little unfair to compare the EBITDA guidance components, the line items to the original guidance, but just looking at it, it looks like price is a $25 million unfavorable and commodity cost deflation is a $45 million favorable swing. So just wondering if you could kind of talk about it versus the original plan for the year, why price is a little bit weaker and what's driving the commodity cost to be quite a bit more favorable?

Stephen R. Scherge, Executive Vice President and CFO

Yeah, Brian, Steve, from the original guide that we provided when we announced Q4 earnings, we had modest movement down, that was on the CRB and SBS, which we took in to consideration. And then it's been obviously in this deflationary environment some of our cost models. So that's why we have the new range of price in the $0 to $20 million range. When we originally guided, we do what we felt was a pretty modest inflation for the year of 1%, roughly on the $2.5 billion spend. We actually are now guiding to some modest deflation in the $10 million to $30 million range. Obviously we are in a recessionary environment, we are experiencing some actual deflation, and most of the net of that is occurring in the areas of fiber-related costs. Just OCC cost have moved up and have now moved down, but as we talked quite a bit last year, wood was a major inflationary item for us last year, wood has normalized in the south back to more historic levels. And that's creating deflation year-over-year on the wood basket. The rest of the infrastructure of cost, logistics, chemicals, resins, etc., pretty neutral. Overall, the deflation net is generally fiber based with wood being the predominant reason for that.

Brian Maguire, Analyst

Okay, thanks very much. Take care.

Operator, Operator

Your next question is from George Staphos of Bank of America.

George Staphos, Analyst

Hi everyone, good morning. Thanks for taking my questions. Hope you guys are doing well. Thanks for the details. I guess I have three questions, we'll go from sort of process and operations to kind of a bigger picture one. So, I guess first of all when we look at PaperSeal and we also look at in somewhat a related way, the shift of the CUK tons to SBS. What kind of changes and vulnerability are you seeing at other European loading locations or in the case of PaperSeal we had customers? Can the customers use that paper tray with existing equipment that they have or would they have to make modifications in your converting areas, are you seeing any change at all, any tweaks, any loss of throughput doesn't seem that way by the way in moving from CUK to bleach board?

Michael P. Doss, President and CEO

Okay, thanks, George. I will take that. In terms of PaperSeal that is a new line that the customer would actually purchase and our interest there is supplying the tray, the paper tray that goes in there. Predominately, as you know, and a lot of those had been polystyrene foam. So replacing polystyrene foam with paper fiber-based packaging, which is what we do. So that's our interest there. And we're working with a number of different people that actually sell those lines. And we're seeing a lot of traction on that in Europe and Australia as we reference this. It is a pretty big addressable market so we find that interesting for us and our ability to manufacture that is pretty straightforward with the existing equipment that we've got and really all of our converting plants. In regards to the CUK to SBS shift, we run all three of those substrates all the time in our facilities. So we know how to convert them. The vast majority of what we moved into SBS onto CUK came from there. And so it started, some frozen pizza and there's some other things in there that used to be on SBS and then we moved it to CUK and now we've moved it back in order to balance out our demand. We work with those customers to make sure we can meet their heightened demand levels and they've worked with us on that. So it performs well under lines. It doesn't require material adjustments to be able to do that. So, all in all the overall execution on that has been pretty seamless, as you referenced.

George Staphos, Analyst

Thanks, Mike. As far as Kalamazoo goes, I know one of the intents at least what I recall one of the intentions with that machine was to have greater fiber flexibility given the variability having seen the different grades of recovered fiber with graphic paper demand being down so much and implicitly there being longer term more inflation in sort of office papers, does that change at all probably not but does that change at all any of the return assumption that you have for new Kalamazoo machine and more broadly with this machine coming on are you seeing any increased interest from your customers recognizing you're going basically just replacing older capacity and using more CRB in their business mix from what had been previously the case?

Michael P. Doss, President and CEO

Thank you for the question about Kalamazoo. I visited the site two weeks ago, and I must say that our team is performing exceptionally well, as noted in our materials. We are on track with both the timeline and budget for this project. I appreciate your inquiry regarding the input costs for paper. We will have significant flexibility in that area. This machine, similar to our K1 machine, will feature a curtain coater, allowing us to use less white paper near the surface while optimizing the coating process. This means we will have a competitive edge in flexibility compared to others in the industry. We've anticipated this capability during the machine's design. Although we are mindful of the smaller market size for printing and writing paper, it does not materially affect the overall economics of the project; in fact, it hasn't impacted it at all. We are well-equipped to handle any disruptions better than our competitors. This project not only addresses the need to upgrade older capacities but also aligns with our customers' sustainability goals. Our new machine is expected to reduce water usage by 300 million gallons annually, decrease electricity consumption by 20%, and cut greenhouse gas emissions across our CRB platform by 18%. These are significant figures that will aid our customers in meeting their sustainability targets. We provide a unique solution that stands out in the market, combining the lowest cost and highest quality materials with a strong sustainability narrative. Our customers appreciate this approach.

George Staphos, Analyst

Thanks, Mike. I have one last question before I turn it over. Brian mentioned a bit about your guidance. It's quite remarkable to see how you've returned to your previous guidance for both EBITDA and free cash flow, especially considering the significant volatility in demand and the economy over the last quarter. It seems like you've navigated through it without much difficulty. When you reflect on how Graphics Packaging has managed to maintain and reform guidance to its previous levels, what do you think was the main driver? Is it that we've gone through a period where consumers have developed a greater appreciation for paperboard, leading to a sustainable increase in demand? Or do you think this has been more of a one-time event, with potential pantry loading? If so, might we expect a downturn in volume next year? How do you assess your ability to sustain this improvement into 2021, 2022, and beyond? Thank you, and good luck in the upcoming quarter.

Stephen R. Scherge, Executive Vice President and CFO

Thanks, George, appreciate the question. I think I’d have you look at our market participation strategies and how we have over the last decade really built this business. And if you look at our big food business and you look at our beverage business and you look at our consumer products business and all that comprises about 77% of the company. We add food service under it. Yes, food service is down now. But look, what's up. We've got the food and beverage up because people are eating and provisioning more at home to your point. So will food service come back? We believe it will come back. To what level we don't know for sure. And we don't know what period of time. But I'd ask you to think about that as a little bit of a teeter-totter. As food service comes up, you'll see a little bit of kind of the food and beverage go down, but the net impact of that balances out for Graphic and what we're able to do then is use our new product innovation and our low-cost investments that we've made to continue to grow the business. And that's what gives us confidence in that 100 to 200 basis points of growth. And so, this year has been exceptional in terms of how that is all performed and we've netted it out well. I appreciate the comment and as I referenced, I think our team has done an excellent job of executing through a pretty challenging economic backdrop. But it shows the resiliency of our customer portfolio and the operating model that we've got in place.

Michael P. Doss, President and CEO

And George just to add to that, because it was an exceptional effort across the entire organization to manage significant increases in demand as well as, obviously, the areas of weakness and one of the things that hasn't been touched on, but I'll touch on is on volume mix that resulted in a modest headwind on volume mix because we were scrambling in a significant way to obviously take out capacity in our cup making business appropriately to match the needs of making actual cups. But more importantly, moving that SBS from CUK, moving production into facilities that maybe haven't made a beverage carton, but now are shifting the actual portfolio in a pretty material way, which cost a little bit on the volume mix but we now achieved that and as we continue to roll forward, we can optimize from there. So our overall, I think it's critical to what I am saying our overall belief relative to the organic growth profile of the business kind of seen through that 100 to 200 basis points, remains intact with a different mix and some phenomenal work being done across the organization to manage both the ups and the downs through this environment of people needing to eat and drink.

George Staphos, Analyst

Thank you very much.

Operator, Operator

Our next question is from Phil Ng of Jefferies.

Phil Ng, Analyst

Hey, good morning everyone. Congrats on a really solid quarter in a tough environment. Appreciating your taking the downtime to kind of balance supply and demand but curious how's the pricing environment and competitive landscape for your cups business and food service business?

Michael P. Doss, President and CEO

Phil, welcome back. In terms of our customers were you referring to our customers?

Phil Ng, Analyst

We're just trying to get a better sense of how the competitive landscape is in terms of who you compete with on the cup side. Is that when behaving nicely the pricing environment in terms of what you're selling your products, I am trying to gauge if the demand is obviously down quite a bit?

Michael P. Doss, President and CEO

Hey Phil, it is Mike. And again welcome back. We are not going to talk about the competitive rivalry out in the market. I mean, what I want you to know is what we are doing to actually compete in that space and meet those requirements. And if you heard Steve, when he just got done talking about we've right sized our converting platform in terms of the amount of people and the amount of lines that we're running to match up with the actual demand we have and then in Q3 here, excuse me, we're taking a fair amount of market-related downtime on our cup machine to balance that out. And that's all reflected in the AF&PA numbers year-to-date, so it's pretty healthy operating rate. So I think I'd point to that as reflected in my guide as well.

Phil Ng, Analyst

Got it, that’s really helpful and appreciating, if you choose to use GPK stock, it's not that dilutive at all. But the potential incremental to 250 million stake from IP potentially becoming available on the back half, are you comfortable using utilizing your cash flow on balance sheet, certainly you have a lot of liquidity?

Michael P. Doss, President and CEO

Yeah, thanks Phil. And I think what we were trying to do on Page 12 is to just remind us that we do have incredible flexibility on how we monetize an IP stake. Obviously, they began that process in the first half and the next opportunity to begin to do so is tomorrow actually in terms of the next potential for them to begin to potentially monetize. And what we were conveying was just that, we've got a great balance sheet, excellent flexibility reminding you know this, we actually bought back $157 million of the company year-to-date. Now price is in the mid 12's. We've got line of sight to leverage that's in that 2.5 to 3 times range. Our original guidance indicated that we could acquire back the second $250 million and still be at the high end of our 2.5 to 3 times. That's only modestly changed, mostly because we've acquired back the business in acquiring our GPK shares. So we really continue to like the flexibility we have in the context of our capital allocation strategies, in the context of the value of our currency. That means GPK shares so excellent flexibility depending upon how they choose to continue with their monetization, assuming they choose to do so.

Phil Ng, Analyst

Okay, that will help. Thanks guys, I will be looking forward.

Operator, Operator

Your next question is from Debbie Jones of Deutsche Bank.

Debbie Jones, Analyst

Hi, good morning. My first question is I was wondering just because your free cash flow, ranged a little wider than your EBITDA range. What has to happen for you to hit kind of the high end of your targeted free cash flow range?

Stephen R. Scherge, Executive Vice President and CFO

Hey Debbie, it is Steve. I think the high end if you kind of look at the variability we will be around working capital. I think overall that would be in terms of the cash flow. We've got very good plans for inventory coming out of the business in the second half of the year. We have materially more natural planned market-related downtime in the second half in addition or excuse me, planned natural maintenance downtime. And then, as Mike mentioned, the incremental market-related downtime. So driving inventory out of the business, the first half to second half will be a key indicator for being at the higher end of the range, assuming that kind of, if you will, that kind of a natural midpoint on the adjusted EBITDA. I think that's really the, for the most part our interest expense and taxes and pension will be in line with the midpoint of the range, roughly that we have for you.

Debbie Jones, Analyst

Okay, thanks that’s helpful. And then second question Mike, you mentioned helping your customers get their sustainability goals. Can you help us understand what percentage or ballpark of your customer base is leaning on you to help improve kind of their value chain metrics? And then what beyond the new mill that you can do to help them with that?

Michael P. Doss, President and CEO

You know, Debbie I'd say over 90%, I mean, to be really the most the smallest customers that we have, maybe perhaps some of them aren't as aggressive on some of those goals. But if you look at our top 25 accounts for sure, every one of them is getting very ambitious goal for cost takeout. Well, not just strong pickup but carbon take out if you think about it over that period of time in terms of what they want on greenhouse gases and electricity and water and those types of things. And so it's very important that we have answers that move the needle. That's part of how we're making those investments and really looking back into it. So I'd say it's the majority of them.

Debbie Jones, Analyst

Okay, thanks, I will turn it over.

Michael P. Doss, President and CEO

Thanks, Debbie.

Operator, Operator

Your next question is from Mark Weintraub of Seaport Global.

Mark Weintraub, Analyst

Thank you. You had mentioned the teeter-totter between cartons and food service and hopefully that's going to teeter back the other way. Is food service more profitable? Is that one of the issues on the impact to mix as well? And so does that become a favorable if it does go back the other way?

Stephen R. Scherge, Executive Vice President and CFO

Mark, it is Steve. No, I wouldn't necessarily go down that path. Overall, as you know, our economics, the big platforms have some commonality to them. We've been improving the overall economics of the SBS platform and the cup business since acquiring that business two and a half years ago. So I don't think you'll see material movements in terms of that impacting volume mix. It really goes back to what we talked about a moment ago. We had a lot of activity here in the quarter adjusting to both the ins and the outs. But overall, we still would expect over time to earn volume mix positive across the portfolio of products as we look out over the next several years. So I wouldn't characterize it as a difference in profitability. It's more a difference in the kind of the top line mix and the tons that are utilized to support that business.

Michael P. Doss, President and CEO

Hey Mark, the only thing I'd add, of course we're going to spend $12 million. We expect to spend $12 million in the quarter in terms of that market economic downtime. So obviously that would go away when food service comes back. But that isn’t our guide.

Mark Weintraub, Analyst

Okay and two other real quick ones. One, you had a couple of acquisitions which presumably wouldn’t have been in your original EBITDA. Of course, you didn't have FX as a negative either, but order of magnitude on the acquisition how much might that be contributing to the 2020 numbers?

Michael P. Doss, President and CEO

Consistent with our initial guidance, we are on track with our acquisitions and commitments, which is a positive indicator for EBITDA based on our early projections announced after Q1. We are pleased with the synergy capture, as we are consolidating some facilities into lower-cost locations and improving logistics across the CRB platforms. Overall, we are aligned with our commitments for both the Grief's business and the Quad businesses we acquired, meeting our expectations for EBITDA and synergy capture over the next couple of years.

Mark Weintraub, Analyst

Okay, great. So Quad was included in the original guidance back in January, which I didn't realize. Thank you. Lastly, regarding the favorable commodity input costs, are there any contractual concessions, or is wood handled differently compared to other input items? Alternatively, will you look to offset this in other ways? How should we consider this?

Stephen R. Scherge, Executive Vice President and CFO

You know, the vast majority of our contracts would use virgin wood and are Arkan based. So it is not impacted by any reduction there nor if it runs like it did last year it has recovered Mark. So I ask you to think about it that way. Those kind of contracts are more on our recycled business or our CRB business across lines.

Mark Weintraub, Analyst

Super, thank you.

Operator, Operator

Your next question is from Anthony Pettinari of Citi.

Anthony Pettinari, Analyst

Good morning. There has been some commentary in the trade press about slightly more pressure on SBS than CRB. It sounds like most of your SBS markets are strong and you're taking adjustments where you need to. Just wondering if you had any thoughts on influence or whether that is something that you are sort of basically coming up against?

Stephen R. Scherge, Executive Vice President and CFO

Yeah. Thanks a lot, Anthony for the question. It looks great down really into all three substrates in terms of working off the census data, which is the best we have in terms of imports. And if you start with CRB in the beginning when you look at CRB, most of the CRB historically has come from either Canada or Korea, a little bit from China, but not much of in recent time. And actually those numbers are down year-to-date on the CRB in terms of imports into the U.S. So, on that one, that would be case. Of course we operate one of those mills in Canada that makes CRB so some of that could be just a shift in our business around over time. If we look at our CUK or CEK equivalents specifically from South America the combined production and imports last year were roughly 50,000 tons. And you could date up to 2000 tons. So pretty small. I mean less than 2% of the overall market if you think about it that way. In regards to FBB, that's been the biggest one as you know, principally coming out of Europe, you got Sweden year-to-date. Best we can tell are up about 30,000 tons that's consistent with, really what our expectations would have been. But that's been partially offset by a pretty significant drop off in ivory board from China. So, the net-net of all that is it's very de minimus in terms of imports.

Anthony Pettinari, Analyst

Okay, that’s extremely helpful detail. And then just following up maybe on George’s earlier question, I mean in your view is any of the food and beverage demand that you saw in 2Q seem to be strong, was any of that sort of pantry loading or stockpiling or channel fail that doesn't show up in 3Q or do you think I mean, roughly that rate of demand should be fairly processed into 3Q?

Stephen R. Scherge, Executive Vice President and CFO

You know it's a great question and I don't know if we have a perfect answer. But what we can tell you is we're seeing a similar trend here in July to what we saw in Q2. So I'd answer it that way. I mean, best we know, it's holding up about the same. People have worked through that stuff at home I would think. And there is just more meals being eaten at home right now and less meals being eaten out. And it shows in our numbers. But the great thing about the resiliency of our portfolio is that, that balances out in a way that we are still able to generate economic value gift for our shareholders.

Michael P. Doss, President and CEO

Yeah, I think Anthony it is tough to argue a pantry load five to six months into a pandemic. I think things do turn over pretty naturally.

George Staphos, Analyst

Great, that's very helpful. I'll turn it over.

Operator, Operator

And at this time, I would like to turn the call back to Mike Doss for any closing remarks.

Michael P. Doss, President and CEO

Thank you for joining us on our earnings call today. We'll look forward to talking to you again in October.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation, you may now disconnect.