Berry Global Group Inc (BERY) 2017 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Berry Global Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Dustin Stilwell, Head of Investor Relations. You may begin, sir.

Thank you, and good morning, everyone. Welcome to Berry's second fiscal quarter 2017 earnings call. Throughout this call, we will refer to the second fiscal quarter as the March 2017 quarter.

Before we begin our call, I would like to note that on our website, as before, we have provided a slide presentation to help guide our discussion today. After today's call, a replay will also be available on our website at berryglobal.com under the Investor Relations section.

Joining me from the company, I have Berry's Chief Executive Officer, Tom Salmon; and Chief Financial Officer, Mark Miles. Following Tom and Mark's comments, we will answer any questions you have. (Operator Instructions)

As referenced on Slide 2, during this call we will be discussing some non-GAAP financial measures. The most directly comparable GAAP financial measures and a reconciliation of the differences between the GAAP and non-GAAP financial measures are available in our earnings release and investor presentation on our website.

And finally, a reminder that certain statements made today may be forward-looking statements. These statements are made based upon management's expectations and beliefs concerning future events impacting the company and therefore involve a number of uncertainties and risks, including, but not limited to, those described in our earnings release, annual report on Form 10-K and other filings with the SEC. Therefore, the actual results of operations or financial condition of the company could differ materially from those expressed or implied in our forward-looking statements.

And now I would like to turn the call over to Berry's CEO, Tom Salmon.

Thank you, Dustin, and good morning, everyone. This morning, we'll be discussing our recent branding changes, our second fiscal quarter results, providing an update on our AEP acquisition and integration, our perspective on the overall markets and expectations for the back half of fiscal 2017. Afterwards, Mark and I will be happy to answer your questions.

In early April, we announced the change in our corporate name to Berry Global and unveiled a new logo, along with an update to our mission and values. Our company has transformed significantly since our brand became Berry Plastics in 1983, starting from one manufacturing facility in Evansville, Indiana, to today where we have over 130 factories and 23,500 employees around the world. During that time frame, Berry has grown from less than $25 million in annual revenue in 1983 to over $7 billion today.

These are more than just changes in our name and symbols. They represent the evolution of our company to what it is today, a diversified global leader in the health care, hygiene and consumer and industrial packaging markets. I'm truly excited about our new mission statement: Always advancing to protect what's important. We are always advancing to improve the way we work and the products and services we provide.

Our products protect health care professionals and their patients. They protect buildings, transportation, pipeline and other infrastructure, as well as what people eat and drink every day. Our new logo features a diamond-shaped icon in the upper right-hand corner consisting of 4 cornerstones representing our set of company values: partnerships, excellence, growth and safety.

Our new branding not only references our legacy business and the strong foundation that they've created, but also allows us to share the aspirations we have for the bright future that's before us. The change of our name and our logo are consistent with the strategies we're executing to expand globally where increases in growth rates are expected to be higher and to pivot our business in the developed regions to address changing consumer demand and serve segments that have higher anticipated growth.

And now turning to our results for the March quarter on Slide 3. I'm pleased to report that we had another quarter of record financial results. Milestones for both revenue and operating EBITDA were achieved of $1,806,000,000 and $336 million, respectively. Adjusted free cash flow improved 36% to $122 million. And adjusted net income was 36% higher at $0.79 per diluted share.

Additionally, I'm pleased to report that at the end of the March quarter, our leverage ratio was 4.1x, which is the lowest in our history as a public company. Mark will provide more detail on our financial results momentarily.

A number of factors contributed to our financial results for the March quarter. Our HH&S division grew organic volumes by 2%, recording strong growth in our health care and specialty-related products. Geographically, the division's strongest growth again came from our Asia region. Volumes in our Engineered Materials business, including the former AEP segments, included strength within our industrial flexible packaging and specialty film products.

Additionally, our strategy of diversifying the company to higher-growth markets, regions and products through acquisitions such as AVINTIV and AEP have transformed our overall market dynamics. While we continue to produce positive free cash flow and support the dependable food market, we have strategically diversified our portfolio from food, which now represents only 20% of our annual revenues compared to approximately 40% at IPO, to higher-growth end markets like health care and hygiene, which now represent more than 40% of our annual revenue.

Utilizing these strategies, operating EBITDA margins in fiscal Q2 were over 20% in the Consumer Packaging business, despite weak demand in packaged food in the quarter.

Our culture at Berry is rich in history and has been focused on continuous improvement while striving for operational excellence across all segments, a fundamental focus we pursue every day, despite changes in market cycles.

Before I pass the call over to Mark for more details in our financial results, I'm going to briefly highlight our progress with AEP. The acquisition, which closed on January 20, has exceeded our expectations. We remain excited about the future prospects of the plastics flexible packaging market.

Berry has a disciplined and systematic approach in integrating acquired businesses that has been developed and proven over the more than 40 acquisitions we have completed throughout our history. The AEP employees that became part of Berry have done a tremendous job of executing on the integration while providing high quality of service to our customers. The results to date have validated our expectations of the synergy potential and scale advantages through the combined businesses.

The combined teams continue to integrate the business. Our projected cost synergies are ahead of our initial guidance, and we believe this will be one of the best acquisitions in Berry's history.

Based on the progress to date, we are increasing our annual cost synergy target for the AEP acquisition to $70 million from our original estimated $50 million. As we've stated, these cost synergies are being generated primarily from our combined purchasing power, elimination of redundancy and SG&A costs and operational best practices.

We are optimistic that through further cost-reduction initiatives, along with new commercial opportunity we will find, will further provide incremental benefits that we'll communicate on, on future calls.

Now I'll turn the call over to Mark, who will review Berry's quarterly financial results in more detail. And I will come back to discuss our financial outlook for the remainder of fiscal 2017. Mark?

Thank you, Tom, and good morning, everyone. I would like to refer everyone to Slide 4 now. As Tom previously mentioned, Berry posted record net sales for any quarter in our history of $1,806,000,000, which was up $192 million or 12% over the March 2016 quarter. The increase was primarily attributed to net sales of 13% related to the AEP acquisition, along with the pass-through of higher raw material costs, partially offset by an unfavorable impact from currency translation.

From an earnings perspective, we achieved quarterly record operating EBITDA of $336 million, resulting in a margin of 18.6% of net sales. This was an increase of $19 million over our strong March 2016 quarter of $317 million.

As we discussed in our last earnings call, our March quarter is typically weaker for us seasonally. However, last year was the first time that our March quarter had the highest earnings in any given fiscal year. Acquisition and organic sales volume increases provided $20 million of our operating EBITDA improvement.

Cost-saving initiatives and productivity improvements in operations and SG&A added another $10 million. Partially offsetting those positive contributions was $9 million of negative product mix and price/cost spread.

Looking at the results of our operating segments starting on Slide 5, net sales for our Engineered Materials division for the quarter was $620 million compared to $403 million in the prior year quarter. The increase was primarily attributed to the AEP acquisition, along with a 3% increase in net selling prices.

Operating EBITDA in our Engineered Materials division was $109 million, representing an increase of $36 million or 49%. The AEP business added $24 million of operating EBITDA to our prior year quarter comparable period.

Product mix and price/cost spread provided an additional $10 million, along with lower operating expenses, including the realization of cost synergies from the AEP acquisition.

Turning to Slide 6, our HH&S division generated net sales of $597 million in the quarter compared to $601 million in the March 2016 quarter. This modest decrease was primarily attributed to a decrease in selling prices and unfavorable impact from currency translation, partially offset by a 2% increase in organic sales volumes.

Our HH&S division recorded $107 million of operating EBITDA in the quarter compared to $118 million in the prior year quarter. The decrease in operating EBITDA was primarily a result of a decrease in product mix and price/cost spread, partially offset by the impact of the 2% increase in organic sales volumes and a decrease in operating expenses.

As we discussed on our last earnings call, a combination of factors, including inflation, currency and consumer demand put pressure on our South American HH&S business. Despite these recent macroeconomic pressures, which we do not expect to continue long term, we remain confident in the growth dynamics of the region and our entire HH&S segment.

As such, we are reaffirming our previously announced capital addition in North America. And additionally, our HH&S factories in Asia are operating at high utilization rates. And as demand continues to grow in the region, we are assessing our options to increase capacity to meet our customers' needs.

Next, as noted on Slide 7, net sales in our Consumer Packaging division decreased by 3% compared to the prior year period, resulting from a 3% reduction in organic sales volumes. The division generated $120 million of operating EBITDA compared to $126 million in the March 2016 quarter.

The decline in operating EBITDA is primarily attributed to soft consumer food demand and a decrease of product mix and price/cost spread, partially offset by a decrease in operating expenses. We continue to face soft demand for overall packaged food products in North America and have proactively taken steps over the past 2 years to diversify our business portfolio, including the acquisitions of AVINTIV and AEP.

These actions have also significantly enhanced our ability to leverage our total scale as a plastic resin converter. We will continue to maintain our low-cost position in the Consumer Packaging business, while increasing our focus on segments and geographies where future growth opportunities are expected to be better.

Utilizing our strategy, operating EBITDA margins in fiscal Q2 were over 20% in our Consumer Packaging segment. Our culture is and has been focused on continuous improvement, while striving for operational excellence as we have historically demonstrated.

Slide 8 provides a summary of our income statement for our second fiscal quarter. Overall operating income increased by $10 million or 6% over the prior year quarter. This increase can be attributed to the items previously discussed that drove the $19 million operating EBITDA improvement, partially offset by an increase in business integration expenses primarily resulting from the acquisition of AEP.

Other expense was $20 million in the quarter due to a $10 million noncash charge from settlement accounting of a European defined benefit pension plan and a $9 million release of a valuation allowance related to our income tax receivable agreement. The valuation allowance expense was offset by a similar reduction in our income tax expense.

Additionally, we took proactive actions in the quarter to reduce our interest costs as well as effectively managing our tax liabilities. Interest expense was $67 million compared to the prior year expense of $74 million. The $7 million decrease is primarily a result of interest rate reductions we have achieved from completed refinancing activities.

As part of the AEP acquisition financing, we closed on a new $500 million term loan due 2024 at LIBOR plus 2.5% and also increased the capacity of our revolving line of credit by $100 million. Additionally, we refinanced our $1.9 billion term loan, reducing our annual cash interest by $5 million. Our expected annual cash interest expense for fiscal year 2017 remains at $275 million, which includes a conservative assumption for an approximate 50-basis-point increase in LIBOR for the last 2 quarters, partially offset by the continued utilization of free cash to pay down debt throughout the year.

As part of our commitment to apply free cash flow to reduce debt, we have voluntarily made $300 million of early principal payments on our term loans this year.

Our effective tax rate was 18% for the quarter and was 26% when adjusting for the valuation allowance release that was offset in other expense that I just referenced. As a reminder, the company has a pre-IPO tax receivable agreement. Under this arrangement, the company remits 85% of its usage of pre-IPO NOLs to shareholders of record immediately prior to our IPO.

From a free cash flow perspective, the company is essentially a cash tax payer with a 15% discount. After utilization of our pre-IPO NOLs, we will then be able to utilize the approximate $500 million of NOLs acquired in the AVINTIV acquisition

During the December 2016 quarter, we made our annual payment under the tax receivable agreement, which was $60 million. This payment is made once per year in the first fiscal quarter. We have $123 million remaining on the tax receivable agreement to be paid in subsequent years, and we estimate that we will pay approximately $100 million of this remaining balance in the first quarter of fiscal 2018 related to our fiscal year 2017 results.

And we'll start utilizing the NOLs from the AVINTIV acquisition to offset cash taxes. We believe that we will utilize approximately half of the AVINTIV acquired NOLs over the next 5 years. Our expected fiscal 2017 effective tax rate for income statement purposes remains at 32%.

Net income for the quarter increased to $72 million compared to $59 million in the prior year period. Adjusted net income per diluted share increased to $0.79 in the current quarter, a 36% improvement from the March 2016 quarter of $0.58.

Next on Slide 9, the company generated $190 million of cash flow from operations in the quarter, up $20 million from the prior year quarter as a result of our improved operating results. Our adjusted free cash flow, defined as cash from operations less net spending on PP&E and payments made under the tax receivable agreement, was $122 million in the second quarter and $524 million for the 4 quarters ended March 2017.

Our financial guidance, including our underlying assumptions for fiscal year 2017, is shown on Slide 10. We are reaffirming our fiscal 2017 adjusted free cash flow at $550 million, which includes $925 million of cash flow from operations, partially offset by net capital expenditures of $315 million and the $60 million tax receivable payment that was made in the first fiscal quarter. Using our market capitalization as of the end of the March quarter, our 2017 expected adjusted free cash flow represents an adjusted free cash flow yield of 9%.

Within our guidance for free cash flow from operations, we are assuming other cash taxes primarily related to international jurisdictions of $80 million and other cash uses of $60 million primarily related to items such as acquisition integration expenses and synergy realization costs associated with AVINTIV and AEP.

Our $315 million of expected capital expenditures includes $120 million for maintenance and $40 million for product redesign, with the remaining $155 million allocated to product innovation, organic growth and cost reduction projects.

This concludes my financial review. And now I will turn it back to Tom.

Thank you, Mark. As we've stated before, we continue to focus on our top priority of reducing our leverage ratio through the generation of predictable and strong free cash flow. Again, as I mentioned earlier at the end of the March quarter, our leverage ratio was 4.1x, the lowest in the company's history as a public company. Our plan for fiscal year 2017 remains unchanged to reduce our leverage ratio to our target below 4x. We expect to achieve that target by the end of our 2017 fiscal year in September.

Today, we are reconfirming our financial forecasts for the full year 2017 fiscal year of $550 million of adjusted free cash flow generation. This forecast includes no changes in our guidance on capital spending, working capital, cash interest or taxes.

With regard again to the cost synergy benefits we anticipate from AEP, I'm pleased to report that these actions are proceeding ahead of plan. Once more, we are increasing our annual cost synergy expectation of $70 million and continue to believe that we will further -- find further advantages as we proceed. If this is the case, we will announce it in future conference calls.

Finally, Berry will continue to take the proactive steps to remain competitive and a leader in the markets where we participate through a relentless focus on building and strengthening our competitive advantages. Our ability to generate consistent, dependable free cash flow and earnings year in, year out, irrespective of the external market environment, provide our shareholders, employees and customers the stability and reliability they've come to depend on.

To this point, Berry has consistently provided 10-year compound annual growth rates of over 20% of revenue, EBITDA and shareholder return throughout our 50-year history. Our mission of always advancing to protect what's important will continue to lead us. I'm confident that the people of Berry will continue to drive our results and achieve our goals.

Thank you for your continued interest in Berry. And at this time, Mark and I will be glad to answer any of your questions. Operator?

(Operator Instructions) Our first question comes from Tom Narayan of RBC Capital Markets.

I guess the question probably on everybody's mind is with the increased AEP synergy guidance, is there a reason why you guys didn't raise the '17 free cash flow guidance to $550 million? Or is that now like maybe -- should we think of that as a 2018 event in terms of how we should think about modeling?

Yes, we're -- Tom, it's Mark, good morning. So we increased our synergy target, as you mentioned, from $50 million to $70 million. About half of the $70 million that we anticipate on an annual basis, we expect to impact 2017 related to the AEP acquisition.

Okay. Then is there a reason why, I guess, you guys didn't raise it? Or is it just kind of it's early in the year?

Yes, it's a pretty modest change in terms of what impacts this goal, 2017 versus what our prior assumption was.

Okay. And then my last -- my follow-up I guess, is we're noticing some, I don't know if it's recovery, but some improvement in the consumer -- in the processed food volumes industry data in April, obviously, after it was pretty negative in March and February. Are you guys kind of noticing something like that similarly, things sort of stabilizing there in the processed food category?

I won't state upon this. It's one data point. And clearly, the food space has been difficult for many years. And our commercial teams continue to work closely with our end users to make certain we're aligning ourselves with what people will buy and make it. I think also you heard in our commentary, we have been doing a very active job in really transitioning the company's makeup to make it only 20% of food in our total portfolio. While it's incredibly important to us and we consider our leader in that space, I don't see any near-term change that I would expect. But we're going to continue to work diligently with our end users to identify those opportunities.

Our next question comes from Scott Gaffner of Baird -- I'm sorry, Barclays.

Tom and Mark, just on the -- if I look at the price/cost spread, obviously, significantly different by segment. HH&S, minus $16 million looks like you had a relatively flattish in consumer, and EM was some improvement. How should we think about the price/cost spread as we go forward and you roll through some of these higher resin pricing and maybe some pass-through?

Yes, I think each -- Scott, good morning, it's Mark. I think each business has a little bit different dynamic. In our consumer business, it's mostly contractual pass-through. And they use both polypropylene and polyethylene. Engineered Materials has a higher percentage that is noncontractual, that is market-based, and they're predominantly polyethylene. And then you have our HH&S business, which is kind of in between in terms of contractual pass-through, and they're mostly polypropylene. And those -- if you follow those resins, you've noticed they've moved not exactly aligned. Polypropylene has been more volatile. And so as a result, you get different results on the spread dynamic by division. But it's really driven by the pass-through mechanism, the timing of them and the movements of each market. And so yes, we did have different results depending on each segment. In total, right, pretty modest impact to the company.

Okay, and so would you expect a modest impact again in the third quarter? And then as part of that, you have also got the increase in resin pricing from a working capital perspective. You were able to keep working capital flat. Maybe you could provide the offsets to that as well.

Sure. Sure. Yes, I would say so for the first half of the fiscal year, generally both of the primary resins have moved up, which would certainly put timing pressure on our earnings for the first half. I think the indices that try to project that have projections for decreases in the back half. We'll see how that plays out. We're certainly not trying to predict resin costs. I think April, there is some modest decreases out in the market chatter, which to the extent those things happen, that would provide a modest tailwind in the back half of the year. And with respect to working capital, our target remains 0 for the year. And we look to take actions to lower our working capital through initiatives within the company to the extent we have pressure from resin costs.

Our next question comes from Ghansham Panjabi of Baird.

First off within consumer, can you sort of parse out the volumes across your major end markets, beverage, food, et cetera? And also what is your updated volume assumption for the segment for 2017, if any different from before?

I'll start -- good morning, Ghansham. I'll start with a macro view. First and foremost, while food gets a lot of attention, this is a great business, very stable and reliable everyday products. It's the business that really allows us to generate the kind of consistent, dependable free cash flow that you've grown to enjoy. Food. Clearly, the food space within CP has probably been the most challenged. It's clearly why you've seen us leverage resource at the even side of CP towards some of the higher-growth areas like health care and hygiene for us. And we'll continue to variabilize that cost structure as necessary. I will say, it's unlikely we'll hit the 1% -- minus 1% volume target in CP for 2017. But frankly, we think that the variable to date -- variabilization of the cost as well as upside that we have in other aspects of the business will offset some of those weaker volumes. Our teams are well-aligned right now in terms of trying to uncover with the end users what those unmet needs are so that we can take full advantage of it. It's a space we continue to be a leader in, we're still pleased with. The portfolio for the company, though, has just changed dramatically. And 10 years ago, people wouldn't have believed that Berry would have been represented by health care and hygiene that's acting up -- making up more than 40% of its portfolio, so significant changes.

Okay. Then in terms of your initial comments, Tom, you're talking about AEP being perhaps one of the best acquisitions in company's history. Can you just give us more color on that? What is driving that view? Is it just the assets you acquired? Is it the end markets? More context there.

Yes, happy to. A common raw material platform is a plus. Common converting capability on both sides of the business, it allows us ultimately to align certain pieces of business to the best assets inside the portfolio. The commercial synergy, I think frankly are just being uncovered and I think you'll see materialize over the next 12 and 24 months in terms of the value we can bring there. And inside that business, materials science plays a large role in success in making certain that you're delivering customers the kind of feature benefits they're looking for. And frankly, we're pleased that there's great best practices being shared across both sides that we'll take advantage of in -- for the remainder of '17 and certainly into '18 and beyond. So really on all fronts, the businesses are perfectly mated to one another. And I can't say enough for the quality of the work that's being done by the teams working on the integration from both sides now acting as one Berry.

Our next question comes from Chris Manuel of Wells Fargo.

It looks like you had a pretty good quarter here. So wanted to kind of probe around a couple of areas. First, Mark, if we could talk maybe a little bit about working capital assumptions you've got. I think when I looked, you were about $90 million in the whole fiscal year-to-date and maybe about $25 million in the whole compared to the last 12 months where you were. Can you -- do you think you can get that back to flat for the year? Or what's kind of maybe the thinking or updated numbers embedded within your $550 million guide?

Sure. Yes, we have the impact to working capital with respect to resin, Chris, it's about $7 million now per penny when you include all the acquisitions. So certainly to the extent resin is up dramatically, those -- it will obviously make it tougher for actions to offset that. That's not the current view. The current view is that there will be some relief in the back half of the year with respect to resin costs. To the extent we come up short there, we obviously have some opportunities in other areas of our guidance to still hit the $550 million, even if there's pressure on working capital from resin. So there's other levers in the business that we can act on to still achieve the $550 million, just as we have in past years.

Okay, that's helpful. Second question I had was -- appreciated some of the color to the -- to an earlier question on volume stuff. But could you maybe give us a sense of what you are seeing in the engineered products, too? I mean, how is that -- the Engineered Materials piece, too? I know you didn't have the business a year ago, but is it sort of flat? Is it up slightly, down slightly? Or how would we think about that? And have you begun to find any commercial synergies to add? Or does that still represent upside to numbers?

Yes, I would say the commercial synergies on Engineered Materials will take the longest. I think that will play out, like I said, throughout the remainder of '17 and certainly well into '18 as we go to market as a combined organization. The business continues to be stable. It has been historically an incredibly stable business. Our long-term guidance on Engineered Materials was in the 1% to 3% range. We're still very confident that, that's a business that will achieve those types of growth metrics. And we feel the value proposition, frankly, got stronger with the acquisition of AEP.

Yes. I think, Chris, with respect to the synergy question, pretty modest in the quarter. It's around the $5 million synergy realization in the second quarter relative to that acquisition. So of the $70 million annual, about $5 million of it was realized in the quarter. That ramps up, Chris, pretty dramatically next quarter.

Well, Mark, to be honest, I was kind of more thinking about from the commercial stuff with respect to new business opportunities thing. So the $80 million that you guys -- or $70 million that you guys outlined, I'm guessing it's more cost takeout. Or there are also 1 plus 1 equaling 3 of finding new business and opportunities together stuff embedded in that. That's really where I was going with that.

Yes, and I'm glad you asked. That $70 million, you're exactly right. It's 100% cost synergies. There's no revenue synergy built into that $70 million. And as Tom said, typically revenue synergies take a little longer. And so it's a multiyear kind of plan with respect to revenue synergies.

And I would say so far, the customer feedback is very positive. To a large extent, people are encouraged. And the teams really have been relentlessly focused on any transitioning. Remember that the deal was just completed January 20, making certain that the quality and service aspects of the business caused no disruption. They've done a tremendous job in that regard. So you'll see things play out over the next 12 and 18 plus months on the commercial side for sure.

Our next question comes from Brian Maguire of Goldman Sachs.

Tom, just a question -- a couple of questions on the leverage target as we get closer to it. Just wanted to confirm, I think you made a comment about the leverage being about 4.1 turns. Is that -- that's including the $70 million of synergies from AEP, is that right?

That is correct.

And is that kind of a basis by which you'd declare victory on getting under 4 turns as well?

Listen, the first we've -- for the last several calls, we've been very focused. First, we're just going to get through the hurdle. And then we'll evaluate market conditions, interest rates, et cetera, to determine what the next best step is. But we think at the company, we can continue to operate below 4x comfortably, while continuing to operate as Berry has over the years, generating organic growth, looking for opportunities to innovate as well as being inquisitive in terms of acquisitions around the world.

Okay. Just my follow-up related to that, just interested in your thoughts on the M&A pipeline. I know you're -- you've taken a pause to get under the leverage. But as you get to the point where you can start evaluating those things a little bit more concretely, could you maybe give some comment on what you're seeing out there? And sort of related to that, does the name change indicate maybe a change in direction with where you want to go with those? Also, would you be interested in getting into other substrates? Or maybe even non-packaging businesses?

Well, first, a couple of aspects to that question on the name change. This year, Berry will celebrate its 50th anniversary and 23,500 employees at 131 manufacturing facilities around the world. It was time. It was simply time to have a fresh start with Berry to ultimately create mission values and an operating protocol that everyone could embrace. So there's been a lot of energy and effort put to that. Clearly, Berry Global is somewhat aspirational. As you're well aware, the percentage of Berry's revenues outside of North America remain relatively modest. But we want to make sure that we're taking advantage of what is a -- still a very fragmented market, both in North America and outside of North America, to see where we can bring value. And that's what the teams are committed to do. There's really no change in strategy. We're just far more equipped today to be -- or action-oriented in that regard than we've ever been, and it was really enabled by our acquisition of AVINTIV. By having teams now globally deployed around the world, we've got a better opportunity to kind of translate the Berry success model in North America and make certain that we can try or actually determine if we can do it internationally. That being said, it's important to note that we're a conservative company. And where many people might measure twice, we'll probably measure 3 and 4 times. We want to make certain that the growth that we generate outside of North America is consistent with the operating margins we have in North America and for the company as a whole. And we'll be diligent to make certain that, that in fact is the case.

Our next question comes from Philip Ng of Jefferies.

Volumes in HH&S were actually pretty solid, but pricing dipped a little bit. Curious, are you seeing a little more competition in that segment? And have you seen trends stabilize a bit in South America?

Yes, we -- good morning, Philip. Certainly we operate in competitive markets and we have competitors in all of our spaces. I wouldn't say we've seen a material change in the competitive environment. With respect to South America, as I think I might have mentioned earlier, the region has some short-term challenges with inflation and you have a currency that's improving its value. And as a reminder, a lot of our -- the majority of our business there is priced to the dollar, which just puts short-term pressure on earnings. But we still think it's a great region for our products, for the things that we make, developing region as they continue to increase the products that Berry -- the use of products that Berry makes. We think it's going to be a great region for our company, and this is just a short-term blip that we've got to deal with.

Yes, Phil. This is Tom, nothing out of the ordinary. Listen, with -- relative to our HH&S business, we're a leader in that space. We're very fortunate to be participating in markets like health care and hygiene that are growing. And we focus every day to make certain that we earn the right to maintain and grow our share positions -- our leading share positions, mind you, with the end users around the world. And we'll continue to do just that. But nothing out of the ordinary, as Mark said.

Okay, that's helpful. And you've seen nice price mix improvement in Engineered Materials for the last 2 quarters, and it seems like it actually accelerated in 2Q. What's driving that acceleration? Is that dynamic sustainable? And separately, I know procurement and cost takeout was the big emphasis for AEP. But is it more a rational or a disciplined pricing environment a potential driver going forward?

Sure. Yes, with respect to the spread, I think we've had that consistent spread now for some period of time. Certainly, the realization of synergies are going to impact that result and will impact it going forward as we use our combined purchasing power to drive lower cost.

I think relative on the pricing front, well, I wouldn't comment, but we're always focused on making certain that we capture the value that we bring to the end markets that we serve. And we'll continue to be diligent in that regard and make certain that we capture the value. And what I believe is -- it's a better secondary flexible packaging company than it was before in terms of Engineered Materials. So we're looking forward to the opportunities inside that business for sure.

Our next question comes from Debbie Jones at Deutsche Bank.

I want to chat just a bit about consumer again. I realize that a lot of your competitors have also seen weakness in these categories. But I wanted to confirm that there's no specific share loss for Berry, number one. And then two, could you just comment on how you think the competitive environment will evolve, just given that you've seen pressure across a number of categories and potentially some underutilization in the industry.

Yes, it's a great question, and I'll start relative to the competitive behavior. This has been a competitive market as long as we've been in it. And we focus on being a leader in that space and being a low-cost provider. That's not going to change. We're going to protect the position that we have as Berry. But equally as important, make certain that we're aligning our resources around the end users that are excited about innovating, about finding ways to get greater attention to their products on the store shelves. And that's what our teams are actively aligned in and around. But I think the market is going to continue to be somewhat volatile, if you will. And from a growth perspective, I think -- do I expect on an end-user basis, more consolidation? Yes, I do. Do I think that gives us an opportunity? I do. I mean, the redundant capability that Berry has throughout its system uniquely positions it to serve larger conglomerates that might ultimately decide to combine with one another. So I don't expect that to change. Again, as I stated earlier, this is a business that the cornerstone of Berry modeling represented 20%, I know, of the makeup of the company right now. It really has been a solid generator of consistent dependable free cash flow and earnings year in, year out. And we don't expect that to change.

Okay, that's helpful. Just one clarification on the working cap assumption. Does AEP benefit anything in there? Or is it really just that you think there are other levers you have to pull in the legacy business?

Certainly with every acquisition, we look to improve the working capital. There's no big assumption of improvement with respect to AEP built into our $550 million in cash flow, though.

Our next question comes from Adam Josephson of KeyBanc.

Just 3 quick clarifications for you. Have your volume expectations for the year changed at all?

Yes. Adam, it's Mark. As Tom mentioned earlier, we think it's -- we have minus 1 in for CP, and we're running around minus 3. Obviously, there's probably going to be some slight miss there. EM, we still feel good about the guidance as well as HH&S. And certainly, obviously there's puts and takes amongst all the categories. But certainly, the synergy overdrive and other cost-driven initiatives that we're taking as a company are allowing us to continue to hit the $550 million.

I think overall, as Mark said, the diversification of the company right now is a unique position. And I think as Mark said, it gives us confidence that we could get that -- make that -- honor that commitment, I should say.

Sure. And just 2 other quick ones. To the extent your EBITDA expectation for the year remains the same with the $10 million additional EBITDA presumably from synergies, is there some offset to that $10 million?

Yes, it's what we just talked about, Adam. It's the weakness in CP volumes.

Okay. Okay. I just wanted to clarify that. And then just, Mark, on the resin working capital impact. You mentioned $7 million per penny change in your resin costs. Just for perspective, how much are your resin costs up year-to-date in terms of cents per pound? So -- if resin were not to go down, just trying to get a sense for what kind of impact that could have on your working cap and free cash flow.

Sure. Yes, it's -- I probably should have been more clear, Adam. The penny $7 million reference I made assumes all resin grades go up $0.01. So obviously each grade has a different dynamic. And so the -- all of them would have to go up $0.01. I think it varies again by grade and by region in terms of what's happened so far this year. My best guess, I don't have it in front of me, but it's probably a $0.05-ish up so far this year on average. And so that will be again roughly $35 million. But again, we have other things within working capital we can do to get that money back. And we also have levers we can pull with our other categories, such that we feel comfortable that should we have pressure on working capital, if resin does not come down or it even goes up, that we can still achieve the $550 million of free cash.

Our next question comes from Tyler Langton of JPMorgan.

Just had a question, a follow-up on the price/cost spread, it's the negative $9 million this quarter. And I guess if resins sort of didn't change for the balance of the year, I mean, with either sort of market-based pricing or the pass-throughs, I mean, should you start to recover that in the subsequent quarters?

Yes, I think we would have to look in the prior year period, and I don't have it right in front of me. But yes, certainly to the extent resin flattens versus a 0 recovery, you would continue to get -- you would get back to 0. Now I don't recall last year, again, pretty modest again in aggregate. These aren't big numbers. But yes is the short answer to your question. To the extent resin flattens, that dynamic would improve sequentially.

Okay, perfect. And then just last question is on capital allocation. And just as you kind of approach target, do you have any, I guess, preferences or thoughts when it comes to acquisitions, buybacks, dividends? Just any thoughts there would be helpful.

Nothing specific that we commented on the call. Again, the first focus is just getting to the target, which we're confident that we'll do. And then we'll explore all options based on the market and the opportunity to increase shareholder value.

Our next question comes from Mark Wilde of BMO Capital Markets.

Tom, is it possible for you to kind of parse for us that $20 million increase in the synergy target in general? What were the big moving items early in the deal here?

Material was one of the bigger opportunities for us, SG&A synergies as well and that the teams acted on at this point and anticipate they will act on. But those are the 2 biggest areas. The commercial opportunities, as Mark said, will play out over the next 12, 18-plus months inside the business as well as some of the best practice sharing. I would be remiss if I didn't compliment the legacy AEP team, a lot of great people inside that business with great processes. And the best practice sharing has been going back and forth on really just about every aspect of the business, whether it's quality, whether it's safety, whether it's freight, whether it's utilities, has been exceptional. So a lot of good work going on there, and the longest one to see materialize is typically the commercial side.

Okay. All right, that's helpful. And then just turning again to kind of Consumer Packaging, just a couple of questions. One, can you just talk about sort of how you're thinking about footprint there over the next couple of years? And is the decision to kind of deemphasize sort of the food area in North America, is that also going to be reflected in where you allocate capital as you grow overseas?

Good question, and I -- the term deemphasize is probably harsher than it needs to be. If you think about it, just relative to the acquisitions that we've done with AVINTIV and AEP, that business on a percentage basis has gotten smaller. That being said, we clearly believe areas like health care and hygiene can generate higher growth rates. So in our business, we look at each individual capital project individually. And the ones that generate the highest returns are the ones that ultimately get fed. And we'll continue to use that basis in terms of evaluation. Food really still is a very, very important part of what we do. It is, as I said, the cornerstone of our company. What needs to be tested is internationally, if we can translate the successes we've had in North America and other regions of the world, that's well underway right now. We're not in a place to declare victory one way or the other, but teams are being deployed. Attention is being addressed toward it. And if we believe investment is warranted, we'll consider it for sure. But we'll consider it just like we do other investment North America and other areas, very diligently, measure twice, measure 3 times before we make the move to make certain that it can generate the returns that our shareholders expect.

Our next question comes from Anthony Pettinari of Citi.

Just following up on HH&S and Lat Am, I was wondering what your Lat Am HH&S volumes were in the quarter. And then some packaging and consumer companies have seen maybe at least hints of some stabilization in Brazil. As you move through the 3 months of the quarter and then into April, were you seeing anything like that? Or is there any color you can give there?

Volumes in South America were positive in the quarter.

Okay, on HH&S?

Yes, correct.

And did they grow through the 3 months of the quarter? Or was there any kind of exit rate that was much stronger than at the beginning of the quarter?

Yes, I don't think there was a huge change in the monthlies. I would say, again, the bigger factor is what I mentioned. It's the cost structure and the currency. The cost with respect to inflation and the currency not devaluing were the bigger drivers of the earnings. And as Tom said, our revenue was actually higher year-over-year.

Okay, that's helpful. And then following up on an earlier question, Tom, you talked about growth opportunities in HH&S. I was just wondering if you could talk about preference for growth in that business through buying versus building. Are you seeing potential acquisition targets at reasonable valuations? And how would you characterize those opportunities versus just building out additional capacity?

Yes, so I think people have grown to realize I think acquisitions are a core competency at Berry, and it's something that we've done extensively over the years. We evaluate both, to be very honest with you. Obviously, we're not going to follow up with high valuations. And in some instances, valuations have gotten quite frothy, and we're not going to chase those. So we'll be very patient. If the opportunity presents itself that an investment in a region makes more sense, we'll consider it based on what the acquisition environment might be, all keeping ourselves under the 4x lever target that we've ultimately communicated and that we'll commit and honor. But we've got a kind of an open book on both sides. I don't have a preference one way or the other. But obviously, anytime you have an opportunity to consolidate a space at a reasonable valuation, it makes good sense. It's just about lining those opportunities and timing together.

Our next question comes from Jason Freuchtel of SunTrust.

How should we think about D&A going forward? And did purchase accounting have an impact in your D&A for the quarter?

I don't think we're prepared to give specific D&A guidance on the call. Yes, we did have some purchase accounting impact on D&A in the quarter, not a full year impact -- not a full quarter impact, I should say, because the transaction didn't close until January 20. We're still finalizing the valuation, but we booked a preliminary adjustment to D&A to reflect again the estimated valuation. And it was from January 20 to the end of the quarter.

Okay. And do you have an expectation for when that valuation will be finalized?

Yes, it should be done by the end of the fiscal year.

Okay. And I guess, lastly, have you found any best practices from AEP's business that you plan on implementing in your legacy portfolio?

Yes, we won't be specific, but it's been on a number of fronts. We've seen operational benefits. We've seen formulation benefits and advantages they brought to bear. And their people are an active part of managing that business day-to-day. So we're very excited about the opportunity. And as we look at those plant sites throughout their system, we think there's great synergy. But in any acquisition, it's both ways. They learn from us and we learn from them. And it's consistent with what we've seen with AEP, very excited about it.

I think it's a significant strength of the company. We try to take the best from -- and I would say virtually in every case of our 40 acquisitions, we've taken something from that company and taken it to the entire company. And I think it's a real strength of our company that we're kind of the best of all the companies that we've bought and we've applied it to the entire company. AEP is not an exception.

Yes, we will steal shamelessly great ideas. And the acquisitions just provide a wonderful opportunity to do that as well as benchmark ourselves.

Our next question comes from Lars Kjellberg of Crédit Suisse.

I just want to return to AEP cash flow. If I recall correctly, the last time you spoke about AEP in terms of cash in 2017, it wasn't really a -- it's like a net neutral. Can you confirm that? And the second question, given that you upped your synergies now, should it be approaching $100 million free cash flow number as opposed to the $85 million you talked about on the upfront?

Lars, good morning, it's Mark. You are correct. The increase in synergy will provide a modest increase in the cash flow from AEP. That's contributing to the $550 million, again, offset by potential weakness in the food business. And you are right, that increase actually takes the annual free cash flow, on a pro forma basis, to right at about $100 million from the AEP acquisition on annual free cash flow.

And in 2017...

Yes, $125 million and it takes it to $100 million, that's right.

And in 2017, it's actually close to a neutral?

No, it's positive. It's positive. It's a positive contributor to the $550 million. It was a modest contributor before, and now it's an even larger contributor. So again, we're talking $10-ish million additional.

And just a final one, to get those incremental $20 million of synergies, do you expect the incremental cash spend to get there?

No, we do not. We still feel comfortable that we can realize the synergies without additional cash cost.

This concludes the Q&A session. I would like to turn the call back over to management for any further remarks.

I'd like to thank everyone for your interest in Berry Global. We look forward to our next call. Take care.

Ladies and gentlemen, thank you for your participation in today's conference. You may disconnect. Have a wonderful day.