Graphic Packaging Holding Co (GPK) 2014 Q1 法說會逐字稿

Good morning. My name is Michelle, and I will be your conference operator today. At this time I would like to welcome everyone to the Graphic Packaging first quarter 2014 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will a question and answer session. (Operator Instructions). I would now react turn the call over to Mr. Brad Ankerholz, Vice President and Treasurer. Please go ahead, sir.

Thank you Michelle, and welcome everybody to the Graphic Packaging Holding Company's first quarter 2014 earnings call. Commenting on results this morning are David Scheible, the Company's Chairman, President, and CEO, as well as Dan Blount, our Senior Vice President and Chief Financial Officer. To help you follow along with today's call, we've provided a slide presentation, which you can access by clicking on the Webcast and Presentations link on the Investor section of our website. 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 statement as such statements speak only as of the date on which they are made, and the Company undertakes no obligation to update such statements. David, I'll turn it over to you now.

Thank you Brad. Good morning everyone. Today we report first quarter adjusted earnings per share of $0.13 compared to $0.10 a year ago. It was an interesting but somewhat frustrating first quarter, as we started the year firing on all cylinders, demand across both segments in the United States and Europe were solid, pricing was positive and building momentum, and both of our mills and converting facilities were running extremely well. Just about every key operating metric that we track was trending positively early in the quarter. Then the extraordinary weather conditions hit the Southeast, causing our two virgin fiber mills to unexpectedly lose power, creating a number of operational issues on the production side of the business, and an elevated level of unplanned costs.

I want to be very calculated about how I talk about the weather. We rarely comment on the impact of weather as it is management's job to improve the business through all types of external fluctuations. However, it was such an extraordinary set of events that had a measurable impact on our first quarter results, so we thought we needed to provide some insights for investors. You just cannot unexpectedly shut down a large chemical process and bring it back online with the flip of a switch. It's a very complicated, time-consuming and expensive process to get a mill safely back to optimal levels after an unplanned outage.

By the time you have shutdown, ramp up, you lose production tons, running efficiencies, and of course you experience increased costs. This is exactly what happened in our West Rowe, Louisiana, and Macon Georgia virgin board mills in the quarter. The West Monroe mill went down unexpectedly in early March due to a power outage that was related to a severe storm, causing a shutdown of our energy supplier's substation in Louisiana. We had no warning before the power went out and it took two days before we had full power back at the mill. When we did finally get back to full power, it took several days for us to get the boilers, liquid flows and power systems all running at optimal levels. A similar but less critical scenario played out in the quarter at Macon as well. Combined, we lost over 16,000 tons of SUS production, and of course those tons we did produce were at elevated cost levels.

We made a lot less tons, and the average cost per ton was higher than normalized levels. Dan will go through the details in his section, but all-in, weather negatively impacted Q1 results by almost $15 million. We have included in the unexpected mill outages higher cost to produce tons, and significant higher costs for energy, fiber and freight. Weather also impacted our ability to execute our continuous improvement initiative during the quarter. As we redirected our resources on getting the mills back up online and fully functional as quickly as possible. As a result, first quarter performance improvement at $8 million fell well short of our target. So in addition to the tangible costs, there were lost opportunity costs due to Mother Nature as well. Like I said, it was a frustrating quarter.

Good news is that none of this was demand-related. All of the key metrics to our business are still pointed in the right direction. It was an unpredictable temporary disruption that impacted the business. It's behind us now, and we see no lingering effects as we head into the second quarter and the remainder of the year. Our mills are now operating at normalized productivity levels, input prices particularly for natural gas and wood, have come back inline. And demand across many of our markets remains solid. In addition, we see pricing continuing to build as a result of the reset mechanisms built into our contracts. We cannot get the lost production days back at our mills. We will accelerate our continuous improvement efforts, and we still expect to achieve our performance improvements at the lower end of our $70 million to $90 million target by year-end. There is positive momentum in the business right now, and it was really unfortunate we had this temporary disruption in the first quarter. This event does not deter our optimism for the rest of the year, Dan will go through our updated financial targets, but we expect to make up half of the weather-related EBITDA impact and are not backing off of our cash generation target for the full year.

Looking at our end markets, we're seeing underlying improvements in some key areas of the business. Both the big beer and craft beer segment performed well in the first quarter, and the overall beer market continues to recover. Many of you probably saw the Canned Manufacturers Institute reported that beer can shipments were up 4% in the first quarter year-over-year, reflecting much better take home demand. We also so pickup in frozen pizza and away from home sector in the quarter. Demand of soft drink sector remains challenged. But soft drink packaging continues to be a smaller percentage of our total business, as we expand into newer segments and newer geographies for food and beverage packaging.

Underlying demand trends in our European business were also strong in the first quarter for both the beverage and consumers product sectors. The European integration of Contego Packaging and A&R Beverage Packaging business has given us a sizable presence and a platform off which to grow, and we are getting share in Europe. In February we announced our intention to acquire Benson Group, a leading food and healthcare packaging company based in the UK. This is a strategic acquisition that compliments our existing food and beverage capabilities in Europe, and provides an opportunity to further integrated our SUS paperboard. Benson will broaden our offerings in our core food and beverage markets, and will extend the business into store brand market. The combination of Benson and our existing business is expected to created $700 million revenue business in Europe. Our initial synergy targets for Benson are in the $5 million to $7 million range, and we certainly expect to achieve the upper end of that number. We anticipate that acquisition to close late in the second quarter.

We had a pretty good quarter in new product development. We introduced solutions that responded to consumer needs for convenient in microwave, cooking solutions, and products in the away from home market. Additionally, Graphic leveraged the strength solutions portfolio for strong shelf appeal in a wide range of food categories. On the strength side, Palermo Pizza engaged Graphics to create two strength cartons for 2 SKU for private label pizza for Costco Kirkland brand, replacing corrugated with heavy caliber SUS. This opportunity also opened up several more projects for this fast-growing Midwestern pizza manufacturer, and the initial win was extended to include a specialty carton for Screaming Sicilian pizzas. Graphic Packaging produced a club channel carton for Materne's GoGo squeeZ applesauce. This fast-growing product needed a more efficient pallet profile, which was achieved using Graphic's constructed heavy caliber paperboard and our Z-Flute construction. For Perfection Pet, which produces Wal-Mart's Old Roy brand of dog biscuits, we created three sizes of strength cartons. In addition, onboarding activity continued for new Z-Flute and Litho-Flute business from Kellogg's in support of their club channel snack offerings. This represents significant growth and continued momentum for Graphic in our strength packaging platform.

Turning to Microwave, we remain the leader in microwave cooking solutions for our customers, new and existing products. First quarter, we assisted Tyson Foods with extending their frozen breakfast options with the launch of DayStart, a high protein consumable on-the-go omelette wrap, uses our propriety Quilt Wave solution for even heating, crispy cooking results. Another microwave product commercialized this quarter was a focused insert carton with susceptor for Heinz Smart Ones fish and chips meal.

Finally, in the Away from home sector, Starbucks VIA product, which was commercialized in Q4 of 2013, gained additional SKUs for production in Q1. Through VIA black coffee and VIA refreshers, GPI has provided Starbucks the assurance of print quality and consistency across our manufacturing platform that they demand for their high quality brands. This assurance has led to additional opportunities at Starbucks, including producing an inner carton for the Versimo pods that are shipped with Starbucks Versimo brewing machines. Talking a little bit about the segments, we remain committed to growing our core food, beverage and consumers businesses. As a result, we continue to divest non-core assets following on last year's divestiture of our URB Pekin mill.

And our flexible plastics business in Q1 of this year we completed the sale of our label business which included two plants located in Greensboro North Carolina and Norwood Ohio. Labels was not a key business for us, and exiting the business frees up capital and allows for a stronger focus on our core vertically integrated businesses. Our flexible packaging segment which is predominantly now a multi-wall bag business remains a work in progress. However, we did make significant progress improving manufacturing performance, and began to recover price during Q1. We also saw some modest improvement in demand trends in the quarter. So in total, when excluding the divested plastics business, flexible EBITDA was better than last year with margins up around 70 basis points. So, positives to build on.

We expect pricing to improve when compared to last year, and it increased by almost $19 million in the first quarter. Right now we feel good about the pricing outlook for the remainder deer of the year. Increases in board prices and commodities last year should continue to benefit both our open market board sales and our carton contract containing price escalators for 2014. Many of our commodity input prices spiked in the first quarter as a result of the severe weather, input inflation was up $13.5 million. Natural gas, wood, chemicals and transportation were all higher in the quarter, and right now we estimate weather driven inflation cost us about $5 million in the quarter alone. This weather was inflation as you can imagine was predominantly driven by natural gas, where lack of supply created very high spot prices. We hedged 60% of our expected needs, which helped mitigate the impact, but the unhedged portion proved to be very expensive.

In addition, we incurred significantly higher costs in areas like chemical conversions, managing much wetter wood and heating much colder water due to the weather. The quarter was challenging for cost inflation, but we have already seen commodity costs decline on a sequential basis to more expected levels, and our full year outlook for inflation including labors and benefits remains in that $50 million to $60 million range. Summary? There are a lot of positives in the business right now, and we are pleased with the way we have managed through some unforeseen outside events in the quarter.

While the quarter was really a bit of a setback it was not, in our view structural, so we expect the business to continue to improve as we go forward in 2014. The business appears to have normalized in the second quarter, and we remain confident in our ability to grow our sales, EBITDA and cash flow, and hit our debt levels and ratios. I'm going to now turn the call over to Dan for a more detailed discussion of our financial results and outlook for 2014.

Thanks, David. And good morning everyone. To aid in our discussion this morning, I will follow our posted presentation. Let's first look at Slide 12 where you see we reported adjusted first quarter EBITDA of nearly $158 million. Adjusted EPS at $0.13 is up $0.03 over last year. Adjusted net income improved by 24%, as interest expense benefited from lower borrowing rates, and the effective tax rate on operating earnings declined. Sales adjusted for the divested businesses grew 1.7% on the strength of improved pricing. Now, as David discussed, we seldom talk about weather impacts, as we believe that good management teams work through these negative external factors and deliver improved results.

However, the weather disruptions we experienced were so significant, particularly in our mills, that we quantified the financial impact to highlight that except for the weather noise, the underlying fundamentals driving business results improved. Therefore, as a financial analysis, we'll cover in a couple minutes breaks out the impacts of the weather and business divestitures from our normal category analysis. Overall, we were encouraged with the pricing improvements, the stable demand, and strong converting plant performance. We saw in the first quarter. Additionally, based on the margin improvement we are seeing in the business, now that the weather issues are behind us, we remain optimistic about financial improvements for Q2, and the remainder of 2014. In discussing results this morning, we will start with sales, then move to EBITDA, and then on to cash flow. We will also update you on expectations for Q2 and the year.

Now please turn to Slide 13 for the sales bridge. In comparison to last year, the largest change is due to the divestitures of non-core businesses. As you remember, over the last year, we sold retail plastics the Pekin mill, and this quarter we sold our labels business. These transactions allowed us to free up capital, and focus on our core higher margin paperboard packaging business. The top line impact of these divestitures in Q1 was $45 million. On a side note, the Benson Group acquisition that is expected to close in the second quarter is expected to add $15 million of revenue per quarter, with much higher margins than the businesses we sold. Our price at $19 million was a large driver of revenue improvement, as the contractual price resets we have regularly talked about delivered as expected. We remain positive about price for Q2 and the remainder of the year. We did experience a modest volume decline which I attribute more to weather as our open market sales of paperboard roll stock showed the largest declines. Plus, we have seen these sales bounce back in April. Overall, our carton demand was solid.

Now moving to our Q1 EBITDA bridge on Slide 14, you clearly see the impacts from the divestitures and the weather disruptions. In terms of the fundamentals, the underlying business improved nearly 10% on the strength of better pricing. Performance, as mentioned earlier, at $8 million was lower than anticipated, as weather disruptions impacted production output, and we temporarily reassigned resources normally dedicated to cost reduction initiatives. We expect performance will accelerate in Q2, and through the balance of the year as we ramp up our cost reduction initiatives and integration efforts. For the full year, we still expect to achieve the previously communicated $70 million to $90 million performance target, albeit towards the lower end of the range.

The bridge clearly shows the direct weather-related impact at $14.5 million. The losses related to weather includes, as David mentioned, the unexpected mill outages, resulting in lost production, higher costs to produce tons, and temporary cost increases for energy, fiber, and freight. As we moved into April, we saw few remaining residual effects from the weather disruptions, and as a result, margins are reflecting the improvements in underlying business fundamentals. In summary, looking at our Q1 EBITDA results, we are pleased with the fundamentals we are seeing. Pricing is improving, inflation is relatively modest, and we expect to achieve our cost reduction targets. With the weather issues behind us, we expect strong Q2 sequential EBITDA improvement in the neighborhood of $25 million to $30 million over Q1, about half the improvement comes from the weather recovery, and the remainder from better pricing and performance.

Moving to Slide 15, you'll find our cash flow, debt, and liquidity summary. The seasonality of our business typically results in a use of cash during the first quarter, as we build working capital to service higher demand in Q2 and Q3. We experienced this trend again in Q1, and we used $45 million of cash. Now deducting the $70 million net cash proceeds from the sale of our labels business, we see a resulted net debt reduction of $25 million this quarter. Our full year view on free cash flow generated from operations remains unchanged at $350 million, as the weather-related losses will be offset primarily by working capital reductions. Please note that this figure does not include the proceeds from the label sale, nor the Benson acquisition cost of around $165 million. Net of this M&A activity, net debt reduction for 2014 is expected to approximate $250 million.

Looking at our Q1 CapEx spend, you will notice at $59 million, it is higher than the $33 million spent last year. This is because, in the quarter, we increased spending to finish up the remaining European integration investments, and to bring to completion several mill cost reductions and performance projects. The benefits of these investments are strong contributors to our $70 million to $90 million performance improvement target. The timing of our CapEx spending will be skewed more towards the beginning of the year than last year. We expect annual spending to decline. Our guidance range for 2014 CapEx continues to be $185 million to $205 million, which compares to $210 million in 2013. At the end of the quarter our net leverage ratio was 3.27 times, essentially flat to year-end, given our cash flow outlook, we expect to be within our 2.5 to 3 times leverage target range as we leave 2014.

Overall, looking at our entire debt portfolio, we have an average effective borrowing rate of 3.4%, and strong liquidity of over $700 million. Turning to interest, you'll notice that the refinancing work we did last year to lower our borrowing costs is paying off, as interest expense was nearly $7 million lower for the quarter. In terms of major shareholder ownership, in February, three shareholders sold 30 million shares in a secondary offering. After this transaction, Clayton, Dubilier & Rice, and Old Town no longer own any shares of Graphic Packaging. This is the seventh such offering over the last ten quarters. Public float of our shares has now increased to 87%.

Now before turning to the outlook, a comment about our Q1 tax rate. You'll notice the rate at nearly 42% was above the range of 37% to 39% that we guided to on our last call. As part of the sale of our labels business, we wrote off $21 million of goodwill, which was non-deductible for tax purposes. For reporting purposes, this impact will be spread throughout the year, and will add approximately 2.5 percentage points to our full year effective tax rate. Our revised tax guidance for the effective tax rate is now in the 39% to 41% range. Now as a reminder, we continue to not pay US cash income taxes, and we continue to utilize the NOLs, and we will continue to do that for some time.

Now turning to the last slide, you see our outlook for 2014, the details are unchanged from last quarter, with the exception of the tax rate, which we just discussed, and the interest expense, which we revised slightly downward. If you have any questions about guidance, we will address it during Q&A, and with those comments, I will turn the call back over to the operator. Thank you.

(Operator Instructions). Your first question comes from George Staphos from Bank of America, Merrill Lynch go ahead, please.

Thanks, hi everyone. Good morning. Dave, rest up, and get over that cold.

That's something else, yes.

You sound like we all sounded here in the last week or so. I guess first question I had, housekeeping, do you happen to have depreciation amortization by segment, and can we assume that the nearly $8 million of charges hit the paperboard segment in the quarter, just as we reconciled the segment EBITDA to your adjusted EBITDA?

We're thinking. We're thinking.

We're thinking about the answer.

We can come back to that. Can you comment on where backlogs are for CRB and SUS at this juncture? I'd assume they'd be relatively healthy if demand has picked up in the second quarter?

They are. We had pretty good demand the first quarter, George, and we sold down some of our paperboard inventory for sure, and our backlogs are strong, and our inventory position is good going in. The beer business is doing well, soft drink, those are well chronicled, that's an issue for us. Europe, backlogs are very, very busy right now. We talked to Joe Yost who runs that business for us, and they're very active in all of their plants in Europe, so as I sit right now, I feel pretty good about the quarter from a demand standpoint.

Okay. Factually, though, you don't have the backlogs at hand, would that be fair?

We don't actually, we're so integrated that backlog doesn't really, it's not the same as open market sales, so we don't really talk about backlogs, because most of them are from our own plants, right?

Okay. I remember last year quarter was like 3 to 4 weeks, but maybe--?

It's no different than that right now. It's unchanged. It's generally about three to four weeks. It doesn't get much out of that range. That's probably about where we are right now. I just look at it in terms of how much inventory I have in paperboard, and I look at that and I know that I'm in that three to four weeks by how much CRB and SUS, and I see that every day, right now, based on those numbers, three or four weeks feels about right.

I appreciate that, Dave. Next, and I'll turn it over after this pricing, you've got a very nice impact in the first quarter. Obviously the momentum is billing, at least from what your comments were. I don't remember, maybe I missed it, whether the $30 million to $40 million from previous guidance, and is this anything formulaically that you know will benefit $15 million, or is that too early to even comment to?

Let's start with where we are. We're going to keep in that $30 million to $40 million, but we're going to be at the upper end of that $40 million range for sure. You remember in fourth quarter we got more pricing than we expected. We had $10 million worth of pricing in the fourth quarter, so when we start to lap that. What you can't do is take 20 and multiply it times 4. That doesn't work. But certainly at the upper end of that $40 million feels pretty good. 2015 will be, there will be some overlap in 2015, for sure, and some of that will depend upon as pricing for paperboard and costs flow through in 2014, and a lot of our board and carton contracts are cost, so as I look at inflation of $30 million or so in input costs, some of that's going to naturally roll into pricing in 2015. So, generally speaking, unless there's a deflationary impact, which is what we had in 2011, you're going to see every year some level of pricing go up, just by virtue of the way the contracts work.

Okay. Thank you, Dave. I will turn it over.

We do have the answers to your detail questions, George, in terms of depreciation. It was about $67 million for the quarter, the first quarter, about $60 million of that is in paperboard packaging. The rest of it is in our multi-wall bags. And in terms of the add backs, all of that is predominantly in the paperboard packaging segment.

Okay. Thank you.

Yes, sure.

Next question comes from Phil Ng from Jefferies. Your line is open.

Good morning guys. Good quarter. The $15 million headwind that you guide flagged for weather, can you talk about how much of that rolls off, and how we should be thinking about that going forward?

Well, we took, I think Debbie and Dan really took all of that in the prior quarter, so that cost we rolled it through. We didn't have any overhang in the second quarter hanging in. It was predominantly, the way to think about it is predominantly variable costs. A good portion of it was natural gas and wood that we pay. And then the freight. In some cases I think I told you will guys we had demand, so in some cases we were moving, when Macon was up, West Monroe was down, we were still filling demand, we were moving it around in the quarter inefficiently to make sure that our cartons plants ran. That freight we are never going to get back but it's also not going to repeat. So that $15 million is a first quarter one-off deal that we are not projecting to carry forward in the rest of the year, which is why Dan said, he thinks the year is a $25 million hop-up in Q2, because $15 million of it is just not repeating the impacts that we had in the paperboard mills.

Got you. And then the $5 million inflation headwind you guys called out would be imbedded in that $15 million number, is that correct?

It is. Yes, it is. It's the incremental of what we would normally would, we were hedged but we were paying, Dan would know I don't remember, but I think at some point during the quarter at Macon, we were paying $10 or something like that for the incremental natural gas.

It did get up that high, yes.

And that is expensive. The problem you get into, not that you care that much about how the paperboard mill runs, but you've got to remember, when the wood gets wet or the water that we pull out is colder, it still has to be heated to the same temperature for the paperboard mill to run, so we used a lot more BTUs in that kind of cold than we normally would. Certainly than we saw in 2013 because you remember the first quarter in 2013 was actually a pretty moderate quarter. So it's just an unfortunate thing. I think for the most part, disappointing because we really had some pretty good momentum in the business and it just got trashed.

Got you.

By virtue of the process.

So if we strip out that going forward, you guys got it down, performance improvements, it sounds like a big part of that is weather. If we look at the 2Q, 3Q, 4Q run rates, does that generally track in line with what you guys were expecting before?

We expect the performance to end up at around $70 million. The pricing in that $40 million range for sure.

Okay.

And that's why we're sort of reaffirming our cash targets.

Got you. And then from a demand perspective, this is probably one of the more upbeat quarters, I remember you guys giving color on that front. Is that a function of just demand getting better in North America, or is it more Europe related, or is it just new products, you winning, picking up market share? Can you help us understand what the drivers are?

I think you hit them all. Maybe you should do the call next time. Basically that's it. We had strong demand in Europe, and lapping European performance and the legacy Graphic is not that difficult.

Got you.

We didn't have a great business over there, and now we do. So that's a great comparison. But we did see strength in beer. We saw strength in frozen pizza. Even cereal was better. So we started to see in some of those core markets better overall demand. And even the multi-wall bag business, we started to finally see some, both strength in volume and in pricing, which is, I'm certainly more encouraged about that business than I have been in a while as well. Early in the quarter, but we're okay with where we are.

Got you. And just one last question. I know you're going to get this at some point. Pricing at least looks really strong in Q1. I could appreciate Q4 tapering off a bit, because you got some last year. If I remember correctly, Dan was talking about 3Q being kind of your peak run rate quarter, so it seems like even that $40 million upper end, your pricing guidance seems a bit conservative?

Well, as you well know, the way pricing works for us is mix, so in the quarter it changes, so we've got more pricing in some sectors than we do in others, so we kind of have to look through a prism to figure out what it's going to look like. Like I said, I'm already guiding to the upper end of the $40 million. Could it be better? Sure, but it's certainly not $80 million. You can't multiply it times four. That does not work. But yes, I think pricing is going to continue to be a positive force in the quarter, and I think as George mentioned, we'll continue to see that trend right on into 2015 because of the way the contracts are structured. But it takes us a long time to get it back. This pricing is good, but a lot of other people in the space who have an open market, they were getting these increases last year, and we're just now getting them in 2014.

Got you. Appreciate the color and get well, David.

Yes.

The next question comes from Alex Ovshey from Goldman Sachs. Your line is open.

Thank you. This is [Michelle Quanlee] on behalf of Alex. How are you?

We're doing great. Yourself?

Good. Thank you. Just on the forward demand, are you hearing anything from your customers on forward demand outlook, anything on food cost inflation impacting volumes going ahead?

Well, that is something that they talk about, but you've got to remember the stuff that we package is still cereal and rice, macaroni and cheese, we're still at the lower end of that socioeconomic, but what you're seeing on the rising food costs tend to be more of the fresh stuff, and more of the expensive stuff as having a higher proportion of the inflation. And so they'll have to figure out how that works out in their business. They're certainly worried about that, but right now it's not manifesting itself in our volume trends.

Got it. That's helpful. And just to follow-up on the Europe carton demand comments being very strong in first quarter, do you expect this to be sustained? What gives you the confidence that things are finally turning around there?

Well, you've got to remember that unlike the first quarter here in the weather, they had a great, all of the warm weather that was supposed to be in Atlanta moved to the UK, and so that helped materially. Do you remember our business in Europe is heavily weighted towards beverage, and now moving towards consumer food, and the weather really supported that kind of demand. So we don't see a drop-off right now. Our backlogs in our carton business on a go forward basis look very, very good. Now we're a much smaller player in a share standpoint in Europe than we are in the United States, but we're busy. All of our carton plants are busy, and we're shipping paperboard over there on a regular basis, so I feel pretty good about European demand right now. March was good and April is strong.

Thank you. One last one. Could you remind us how much bleach board you buy annually and how much year-over-year cost increase are you factoring into your inflation estimates?

In the first quarter I had, I think, in the first quarter I think we had about $3 million worth of external purchased board or something like that in our inflation numbers. I'll have to look that up. That's pretty close. And we buy somewhere between 175,000 tons and 200,000 tons of SBS globally.

Got it. So basically you do have some increases built in from all of those price hikes, right?

Of course. Yes. Absolutely. They're in our inflation numbers on a go-forward basis. I think I said we expect our inflation to be around $60 million for the year, including labor and benefits, the drivers will be energy, I think we will pretty much flatten, and outside paperboard purchases will be $3 million to $5 million of that.

So are you factoring in the entire announced price hike, or whatever has been realized so far in April?

I'm not going to talk about exactly what prices we purchase our external board at. You didn't miss the part where I said we bought 200,000 tons, right?

Right.

So yes, exactly. The increases are going through, we're certainly paying more, but what Graphic pays independently is for Graphic to know.

Okay. Thank you.

Your next question comes from Ghansham Panjabi from Baird. Your line is open.

Hey guys, good morning.

How are you?

Good. Good. Good. Thanks. I guess weather is making an impact on you, too, David.

Yes. Like the business, I'm under the weather.

Can you first off remind us how you're sourcing paperboard raw materials in Europe? You're obviously expanding in the region with Benson. Longer term, how do you see your global paperboard production footprint evolving?

You can't make SUS any cheaper than you can make it in the Southeastern United States, it's just not possible. The pine forest is there, they grow fast, energy is reasonable, and getting chemicals into those facilities are great. We have great ports in Savannah, and in New Orleans, so we're going to continue to expand our export tons. We export over 100,000 tons of SUS to ourselves in Europe. I'm going to be really disappointed in the next three or four years if we don't double that demand. We buy locally over there. CRB type products or SBS type products we call it folding boxboard in Europe, we buy CRB from a whole bunch of folks, we're not going to be exporting CRB. That makes absolutely no sense. We don't have the capacity anyway to sell it. We buy CRB. So it makes no sense for us to export it. Bull we will continue through our own operations to export SUS. On the other hand, we are not an open market seller of SUS to any real numbers at all in Europe.

Okay, that's helpful. And then in terms of the weather impact, you've kind of gone back to that, if I missed this I'm sorry, but did you split out the various buckets, mill down time, higher utility costs, et cetera, to get to that $15 million?

No. What we did is we aggregated the buckets, and told you how it added up to the $15 million.

We did say that $5 million of it was inflation, the rest of it is just, well, there's just all sorts of stuff in there.

If you do it, the list is so long, that it doesn't become as meaningful as grouping it into broad categories.

One final one on foreign exchange, Dan, maybe this is for you. Positive on sales and then negative on EBITDA. Can you take us through that dynamic?

I think it's really the mix of where it comes from. I mean, we'd have to look into it further. It's not a big number for us. But I'm sure it's a mix in terms of which countries are involved.

I'm sure it's the end because we have a pretty big business in Japan, so I'm sure it's in Japan. Trying to figure out what the yen is going to do has become increasingly difficult.

Thanks so much.

Yes. I am sure that [Havi] has got a whole different thing going on over there. Operator, are there any other questions?

Your next question comes from Debbie Jones from Deutsche Bank, your line is open.

Good morning.

Good morning.

Can you just talk a little bit more about the flexible packaging business, and what the strategy is now? Maybe over a two to three-year time frame, now that you've divested part of this business, I'm just wondering if you see opportunities to grow in this business, or if the focus now is on cost reduction and business optimization?

Well in the short-term, it really is trying to make it operate effectively. We've got a business there that can generate double digits margins if we just operate it more effectively. So we have gotten rid of the noise in that system. We've moved a lot of really good people into that business from our core business, so the folks running it at the plant level, at the senior level, within the mill, are folks that have been successful in our carton business, and you're starting to see it. What you're seeing is pricing and demand improving in that business, and the converting plants ran really, really well. The Pine Bluff, Arkansas mill had some weather-related issues. We didn't detail all of that stuff out, but they also had a couple million dollars tied into weather-related stuff in the quarter. So I'm more optimistic around that business. I'm not going to say we don't have work to do in it, but we expect the EBITDA to grow materially in 2014 based on our internal plans. And that's without a lot of market movement, so if the market continues to improve like it has been, then that will be a much better business for us.

Okay. Thanks. Next question is, on the domestic beverage business in terms of demand and packaging format trends, what are you seeing and how might that affect your business? What are your customers telling you about promotional activity over the next few quarters? I'm just trying to get some expectation for the balance of the year in that business that you're exposed to?

Well, what I would say is, the beer business continues to be good, both Kraft and imports, and its mean Kraft not just what a small kraft beer would do, but also the kraft beers that are being made buy Anheuser-Busch Miller Coors. They have a lot of what we consider kraft. They're all doing really, really well. You probably read some of these flavor trends and fruity beers that are having a great impact on the female segment of the market, and that's why beer is up. I'm unconcerned really about the trends in beer. I have the same concerns in soft drink that anybody does. Particularly the diet side of the equation is difficult. And there is certainly an increased promotional activity and it's no, Coke did significant promotional activity over the Easter holiday, and we saw that in our sales. We saw April sales for Coke, Diet Coke, and those do really, really, really well. So we'll see. But our forecast details, correlates with what our customers see in that business, which is declining soft drink demand in the US.

Thank you very much. That's helpful.

(Operator Instructions). Your next question comes from Anthony Pettinari from Citigroup. Your line is open.

Hello, it's actually William Mitchell filling in for Anthony. I was wondering if you could talk about a little bit more about what capabilities Benson gives you, and more broadly how you're thinking about managing and growing the European business now that you have a footprint of about $700 million in sales?

Yes, in our current, Benson is interesting for us because in Europe, as you well know, the private label of business and the food service business is a much bigger component than it is here. Still in our country, private label is still a much smaller portion, but in Europe it's almost 50%, in the UK even a little higher. So we didn't have a real good access to that market, so had a couple of different options, one, we could build our own plants and sort of force our way in, or we can buy the guy that's doing the best job, and that's exactly what we did. So Benson gives us a great avenue to take our product lines and our technology into that space. Relative to how we're managing it, they have a great management team over there, and we're going to leverage those guys. Mark knows the business in the UK and we're going to expand that. The guy that is running Europe for us is Joe Yost, he was the head of our supply chain here. He works at our CPD organizations for over a decade, he knows cartons, he knows bills, and he knows sourcing, and right now he and his team are heading that up. So we have ex-pats at the very top, and the rest of the resources over there are local European resources that know their business. So we are managing them separately in Europe. We're augmenting them with resources here, in terms of purchasing or supply chain and continuous improvement. We just installed a new table in our [Snake] facility that were analogous to what we done in our web facilities in the United States, so we're taking technology and translating it over there. We're letting them install it, upgrade it, and work for their market. So that's our long-term strategic plan for Europe.

That's helpful. Thank you. I'll turn it over.

Your next question comes from George Staphos from Bank of America, Merrill Lynch. Your line is open.

Thank you. I was wondering, Dave, if you could give us some color on what the private label market is growing at roughly, versus--?

In Europe?

versus the broader holding market?In Europe?

The private label business in Europe it depends on whether you're in the continent or the UK, but it's probably growing 6% a year over there. Here in this country it's growing, too. It's growing faster than normal food chain, but still off of a pretty small base.

Do you expect the European folding carton market should grow more or less in line with the US market, so in total both private label, or is Europe growing a little more quickly or slowly than US?

I think they're both developed countries, right? I think for the most part their growth rates maybe we have a little bit better demographics longer term in the United States, because our immigration policies allow for more growth in terms of population than Europe, but in some ways that is the averaging of a small number.

Understood. If you had to go back to your expectations for the macro environment or the demand environment in Europe, as you were finishing up the work and closing on Contego and A&R, and relative to where it is right now, has the continental Europe, has the UK picture been better ultimately than you would have expected, or is it more or less in line with your expectations? Just trying to get a feel for how things have developed for you from that point?

I would say, Dan and I and Mike Doss would say that the European demand is a little better than we expected when we put our projections together, that it's held together, they had a good weather forecast in the first quarter, which who the heck can look at that, and honestly, the assets that we purchased were really, really good, and we've been able to leverage those faster than we expected. So right now as we sit here , we would say local customers and support from North American customers, who we now can support in Europe, that we could not before, has led to a positive outcome. Look, we knew that we were in a tough place in Europe, but Dan, I did not have the money. I mean, we were 6.8 times levered. We couldn't be investing in Europe. So when we got to a place we could, we bought the assets that made sense, including the management teams, and so we feel better about what our prospects are in Europe, and we continue to want to add on to that business for the right target.

Sure. One last question, I'll turn it over and come back to queue. Totally switching gears, can you quantify, or at least give some color on the impact that Tite-Pak is having on the glass market? And I guess particularly within beer. Thanks, guys.

Tite-Pak has been great but I can't give those numbers out because I'd have to give customer stuff and that's not allowed, so what I would simply say is that we are very happy with the scale-up in Tite-Pak, and it is definitely accelerating. It's a great product. You reduce glass breakage which is expensive, and difficult for our customers to deal with, you're going to sell the product.

Okay.

You'll see more of it this quarter. Each quarter this year you'll see more and more Tite-Pak in the stores. That's what I'll say.

Okay. Alright. I'll turn it over. Thank you.

Your next question comes from Joshua Zaret from Longbow Research. Your line is open.

Thank you. One thing I didn't hear on the discussion on Pine Bluff was where the integration level is at the mill, so can you remind us what it was last year and then tell us what it was in the first quarter, and what you expect for this year?

It's about 60% integration, and it's not materially changed quarter on quarter. I don't think it's changed materially. About 60% integrated to ourselves.

But what was it last year?

About the same. It hasn't really changed much.

And you expect it about the same this year?

Yes we did. The year before was 30% or 40%, so the big change was last year.

Right. And is that where you want to be, at 60%? Is that your target, or are you going to take that higher?

I think that's probably about where we are. It's a good paper market to sell into, so we'll continue to sell kraft paper.

As long as I'm on this subject, you probably saw that, which I didn't like the speculation that pulp and paper had on Pine Bluff in this week's edition. One, they said that you were reportedly buying a significant amount of kraft paper on the open market, two, that you were still having, you were rumored to be having operational problems, and three, that you could be producing another grade on a swing basis. Is that all wrong?

Well, we're going to start with, this whole industry works really well. Innuendos half truths and rumors, but it's never been my policy to augment it, so I'm just going to say we're comfortable with what we're doing in Pine Bluff, and what somebody else says about what we're doing is interesting but not commentarily worth it.

But the question is, from your point of view, are any of those correct?

No, we had some weather in Pine Bluff, and yes, we buy tons all of the time on the outside for that depending upon, I won't say that we swapped tons, but we use the greater arbitrage to buy from some suppliers, because what happens, the further away you get from the mill, you eat up your profitability in freight, so with do that from time to time. And with the weather impact, that accelerated it, but it's certainly not a strategic question for us.

Okay. Great. I thought it was very speculative the way they put that the in there, but I had to check it. Thank you.

Yes.

The next question comes again from George Staphos from Bank of America Merrill Lynch, your line is open.

George, you get no questions in the second quarter.

I had to catch up from the last quarter's conference call.

Okay.

I promise it's the last one. Maybe segueing on Josh's line of discussion. With flexibles overall, can you give us a hoped-for timing for when you do ultimately get to double-digit EBITDA margins in the segment?

Yes, I would say based on our forwards, we should be at that run rate by the end of the year.

Okay.

We won't see that in second quarter, but by the end of the year we should be there.

And recognizing that you want to earn a return on the investments that you've made in Pine Bluff and broadly in the business, and you've done culling of the portfolio there, that has yet to show up in returns that you hopefully will get paid for--?

Yes.

How should we think about flexible as being a really strategically core business to Graphic Packaging overall, and its obviously much larger paperboard packaging business?

I mean, at this point in time what I would tell you is that we still, it generates good cash, and the fact of the matter is Graphic needs cash to get its debt structure correct. So right now that makes it very, very core strategic. Do I feel long-term I have to be making multi-wall sacks? Not necessarily, but at this point in time it makes perfectly good sense for our portfolio, and quite frankly, we need to fix it. We need to get it to a place where we, that it's a generating contributor to the overall business, and we've got some work to get that done. And that's really what our focus has to be right now.

Okay. Last one. Obviously you said Tite-Pak is doing well in the market, but to some degree glass is swimming upstream in the beer market, at least given some of the share data that we've been looking at, both obviously in terms of CMI data, and some of the point of sale data, so if that trend continues where cans are continuing to gain market share versus glass, that's an assumption, I recognize, do you think Tite-Pak will be as successful as you hope it to be, realizing it's a very subjective question, and for that matter, do you think glass may actually be able to regain market share versus cans in the next couple of years? Thanks, and good luck in the quarter.

Yes, what I would say is we're more heavily levered towards cans than we are bottles anyway, across our beer business, so go get them, cans. But what I will tell you is that if you're doing the bottle pack, there are two ways that you're doing it, one is in six-pack carriers, which we're by far and away the largest manufacturer of that, and if you're making a 12-pack, you might as well make it with one that reduces your costs, so whatever bottle packs are going to be sold, it doesn't seem to make a lot of sense not to use a Tite-Pak, which saves you cost in your process. And that's kind of where I think we are. But we sell a higher level of cans in take home, and that's fine by us, because we're more highly leveraged to cans in our business as well.

Thanks for the thoughts, guys. Good luck in the quarter.

Okay.

I have no further questions, thank you. I turn the call back over to the presenters for closing remarks.

Okay, guys, you know what? We're going to get back to work on the second quarter, we will talk to you all in July. Take care.

Thank you everyone, this concludes today's conference call. You may now disconnect.