Graphic Packaging Holding Co (GPK) 2015 Q2 法說會逐字稿

Good morning. My name is Suzanne and I will be your conference Operator today. At this time I would like to welcome everyone to the Graphic Packaging second quarter 2015 conference call. All lines have been placed on might to prevent any noise. (Operator Instructions). Thank you. Mr. Brad Ankerholz, you may begin your conference.

Thank you, Suzanne, and welcome, everyone, to the Graphic Packaging Holding Company second quarter 2015 earnings call. Commenting on results this morning are David Scheible, the Company's Chairman and CEO, Mike Doss, our President and Chief Operating Officer, and Steve Scherger, Senior Vice President and CFO. If you'd like to follow along on today's call we have provided a slide presentation which can be accessed by clicking on the web cast and presentations link on our investor section at the website graphicpkg.com. I would like to remind everyone this morning that statements of our expectations, plans, estimates and beliefs regarding future performance and events constitute forward-looking statements.

Such statements are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the Company's present expectations. Information regarding these risks and uncertainties is contained in the Company's periodic filings with the Securities and Exchange Commission. Undue reliance should not be placed on forward-looking statements as such statements speak only as of the date on which they are made and the Company undertakes no obligation to update such statements. David, I'll turn it over to you now.

Thanks, Brad. Good morning, everyone. We had a solid quarter and our results were in line with our expectations. We continue to execute well and deliver against our full year plan in what remains a challenging operating environment and we produced 14,000 more tons in our US paperboard mills and sold and integrated those tons throughout our global system versus the second quarter of last year.

Sales in our ongoing business increased about 5% in the quarter and were driven by acquisitions, new product launches, and substrate substitution. EBITDA and margins were also strong in the quarter and we continue to be driven by ongoing asset optimization strategies, acquisition integration and strong operating performance. Adjusted EBITDA was $192 million and adjusted EBITDA margin increased over 100 basis points to 18.2% in the quarter. We were pleased with those results given that the second quarter was a particularly difficult comparison for Graphic Packaging.

We are facing head-winds from a strengthening US dollar in Europe and Japan and we took more maintenance down time at our mills for process upgrades in this year's second quarter as compared to a year ago. Also, you'll probably remember last year's second quarter benefited from a bounce-back following the Q1 2014 severe weather impacts. So to some up the quarter, we delivered our expectations despite a difficult prior year comparison and some softness across key end use markets in the US.

Overcoming end use market demand weakness is not new for us. We've used our strong cash flow and balance sheet to augment growth and deliver what we said we would do. We have divested our non-core assets in businesses to free up capital. We've reinvested in our core business to optimize our assets and our manufacturing footprint in both the mills and the converting units to drive performance improvements. We've acquired new assets to diversify our core portfolio of products, our channels, and different customers. And we have transformed the corporation top a pure (inaudible) global paperboard packaging company with a clear strategy to grow revenue and EBITDA.

We continue to see opportunities to fill out our global footprint and our pipeline for acquisitions remains as robust as we have ever seen. Mike and Steve will give you some details but the macro trends this quarter were pretty similar to what we've seen for the past several quarters and there really weren't a lot of surprises. We had a little bit of growth, we had strong operating performance that helped us overcome currency negatives and overall pricing and inflation were mostly in balance.

Most of you saw that we recently announced a $50 a ton price increase in our coated recycle Board products for August. As we have discussed before, our goal is to have price offset commodity input inflation over time. This is done through open market board price increases and price adjustment mechanisms in our carton contracts. Over the long term, these are not necessarily margin enhancing initiatives and it's been almost two years since the industry has seen any price increase for coated recycle Board.

As you may recall, earlier this year we told you about a capital allocation plan approved by our Board of Directors. Consistent with this plan, we repurchased 4 million shares of graphic packaging stock, significantly below our current trading price in Q2, and we also paid a $0.05 per share dividend in July, first time ever. Looking forward, we have not made any significant changes to our full year guidance or operating outlook. Steve will provide you with plenty of detail in a few minutes but we are still targeting EBITDA growth of between 5% and 6% and free cash flow between $350 million and $375 million for 2015.

Currency is going to continue to be a headwind. We are aggressively pursuing cost and performance improving initiatives to maintain our full year EBITDA and cash flow targets.

I'll now call the turn over to Mike Doss, our President and Chief Operating Officer, to discuss the business in more detail. Michael?

Thanks, David, and good morning, everyone. Volumes in our ongoing global paperboard packaging business increased by almost 12% in the second quarter. The increase was driven primarily by our continued European expansion and the Rose City packaging and Cascades Norampac paperboard acquisitions.

Excluding these acquisitions, volumes were up slightly as we successfully offset demand weakness in some of our US end markets with targeted gains in other areas. The integration of Europe is progressing in line with expectations, and we are seeing substrate gains in this market. In the second quarter we continued to integrate our (inaudible) Board in Europe and are on track to ship nearly 150,000 tons into the region in 2015 and ultimately are targeting to ship 200,000 tons annually.

Please recall that prior to making the three acquisitions in Europe we were shipping less than 95,000 tons annually into legacy operations. The internalization of our US paperboard mills remains central to our strategy in Europe and the growth in this business provides additional leverage for our vertically integrated model. Our synergy target for the integration with Benson group remains in the $6 million to $8 million range for the year.

In North America the integration of Rose City Packaging and Cascades Norampac paperboard acquisitions is also progressing according to plan. And we see the potential to integrate 20,000-25,000 tons into these operations over a two-year time frame. If you recall, the Cascades acquisition included three Canadian folding carton converting facilities, a thermal mechanical pulp mill and a CRB mill. After a thorough assessment, we recently announced the shutdown of the thermal mechanical pulp mill in Jonquiere, Quebec. This was a difficult decision, no question, but one we felt was necessary given the high cost structure, low operating rates, and limited demands for it's specialty Board. Our synergy and board integration targets remain unchanged by this action. Please recall that we expect to combine Norampac and Rose City assets to generate $10 million of EBITDA in 2015, $20 million to $25 million of EBITDA in 2016, and $25 million to $30 million in 2017 and we are tracking to those figures.

As David mentioned, demand across many of our US food and beverage end markets has been weak for some time. Some of this is structural in nature while some of it is a result of consumers managing spending. However, there were some bright spots in the quarter. Our frozen pizza packaging volumes were up significantly with a major customer win and our overall global beverage volumes were up slightly compared to prior year with craft beer and specialty drinks leading the way.

New product development remains critical to offset demand weakness in certain markets. Numerous wins in the quarter included a major new UK serial producer utilizing our SUS Board. We also brought to market a new paperboard strength solution for a global Brewer in Europe. In the fresh produce and away from home markets, we commercialized a new paperboard produce tray for the club store channel and a new clamshell for a fresh morning breakfast item.

Capturing 1% to 2% sales growth per year for new product development remains our target. As David mentioned, subsequent to the quarter end, we announced a $50 per ton increase for our CRB grades effective August 7th. However, we will not begin to see the increase materially impact our results until 2016. While price announcements benefit our open market Board sales immediately, these sales make up a small amount of our top line. As you know, over 80% of our Board production is consumed internally and turned into cartons which are predominantly sold under long-term contracts.

And as we have said in the past, many of these contracts have price resetting mechanisms that are tied to published price board. Once published, these resets have an average nine-month lag so we will not begin to see the benefit of the resets until next year. As David mentioned, board price increases are not necessarily margin enhancing over the long term. They are mechanisms for us to recover commodity input inflation in carton contract renewal settlements over time. Turning to operations, we had another very strong quarter. Our US mills ran well across the system and produced almost 14,000 more tons than in the second quarter of last year, taking more mill downtime this quarter for maintenance and production line upgrades.

The improvements in mill efficiency this year have been a result of our continued commitment to both Lean and Six Sigma principles along with targeted high return investments. For example, our $30 million cogent energy project is expected to generate $10 million of annual energy savings at our West Monroe mill beginning early next year. As David alluded, severe weather last year pushed some business out of the first quarter and into the second quarter. We estimate the incremental pickup to EBITDA was around $8 million to the second quarter last year, making for a rather difficult comparison this year.

Looking to the third quarter, well have five additional planned downtime days due to a number of production line upgrades at our Kalamazoo Michigan CRB mill. However, our backlogs moving into the third quarter remain strong at four weeks per CRB and four to five weeks for CUK. And now Steve Scherger, our Chief Financial Officer, will take you through the Q2 financial results. Steve?

Thanks, Mike and good morning. As Mike and David shared, we had another solid quarter. Results met our expectations in what continues to be a difficult operating environment. Consistent with past practices, when I refer to EBITDA, net income and EPS, I'll be referring to adjusted numbers. Adjustments this quarter were modest, at $5 million pre tax, which related to M&A activity, integration costs and other special charges. For those of you on our website, please refer to Page 6 to follow along.

Focusing on Q2 results, our reported net sales were down $60 million compared to prior year. Excluding net sales from the businesses, however, net sales were up $48.1 million or 4.8% to $1.06 billion. Also excluding divested businesses, EBITDA increased $5.6 million, or 3%, to $192 million. Margins improved over 100 basis points, 18.2%, to 17.1% a year ago. Diluted earnings per share for the quarter was $0.19 compared to $0.20 last year.

Turning to Q2 sales, 4.8% increase was driven by improved volume and mix, primarily from our acquired businesses. Price turned slightly negative this quarter due primarily to contractual resets related to declining commodity costs and a couple of contractor renewal settlements. As I mentioned last quarter, we expect pricing and commodity inflation deflation to remain relatively in balance in 2015 and over time.

The strength of the US dollar versus global currencies resulted in lower sales of $28 million, as foreign currency denominated sales are translated back into US dollars. Turning to the Q2 improvement in EBITDA, the ongoing business increased $5.6 million, or 3%, to $192 million. Drivers of the increase include improved performance of $12.7 million driven by our asset optimization strategy, acquisition synergy's and strong operating performance. Including the $28 million of performance government to Q1, we remain on track to achieve our full year performance improvement of $70 million to $80 million.

Positive volumes, nearly $9 million to EBITDA is the benefit from the Benson, Cascades and Rose City acquisition flowed through our results. Partially offsetting the positive drivers were $2.3 million of lower price net of commodity deflation, labor and benefit inflation of $8.6 million, which was in line with our expectations, and FX losses of $5 million. The full year FX impact, which we had discussed previously, will be in the $25 million to $30 million range at today's rates. Our balance sheet and liquidity profile remain strong. Net debt decreased $65 million during the quarter. We ended the quarter with just under $2 billion of net debt. Our net leverage ratio declined 2.7 times from 3.17 last year.

During the quarter we contributed $11 million to our pension plan and returned over $20 million to our shareholders, with the quarterly dividend and share repurchases. Domestic liquidity remains quite strong at $960 million. Our guidance is essentially unchanged from last quarter with two minor exceptions. We've increased expected capital expenditures by $10 million, as a few high return projects later for 2016 will be started later this year. We also lowered our interest expense forecast into the $65 million to $75 million range, as short-term interest rates have continued to remain low.

We expect full year EBITDA growth to be in the 5% to 6% range and free cash flow available for M&A and our return to shareholders to be in the $350 million to $375 million range. Thank you for your time this morning. I'll now turn the call back to the Operator.

(Operator Instructions). Your first question comes from the line of Philip NG, with Jefferies. Your line is open.

Hey, guys. Historically it's really been the virgin grade that have driven box board prices higher in the market. Curious if that dynamic has changed in light of some of your recent consolidation in the market?

I don't know that I would say that's true. Over my career, the last nine, 10 years, it's been a little bit of both. I remember CRB pricing leading before, maybe three or four years ago, it was CRB first and then the other grades followed so I don't know about that. What I will tell you is that there has been no CRB increase for over two years, so probably the grade is the longest without a price increase. So it's really appropriate in light of input inflation and forward views, you know, it's an appropriate increase.

Do you share similar views on the CK side? If I heard you guys correctly, the back log is sounding even more extended on the CK side.

We'll look at each one of these grades as they along. What we'd say right now is that if you look at the inflation and the things that we've seen, it's more imperative for us to get the CRB increase out there. We'll look at these later. We'll look at C and K next for sure.

Gotcha. That's helpful. In terms of inflation, can you give us some color on how we should be thinking around this year both on the raw material and labor side, certainly some puts and takes with OCC prices starting to tick up but (inaudible) gas prices still pretty low here?

I'll let Steve get in detail but I'd say overall it's going to be pretty flat for the remainder of the year as far as input inflation. You've got some tradeoffs. But caustic soda is kind of flat and our other major chemical increases with oil at $50 they seem pretty flat as well. Our labor inflation is averaging, what, 25 to 30 a year. That has to be covered with our throughput improvement. We don't really get that back in pricing. So overall I'd say it's a flat to slightly positive environment in the pricing versus inflation category at this point.

This is Steve, just to emphasize that, we haven't seen any change in our assumptions around labor and benefit cost in that $30 million to $35 million range. And as David said, really, the trends we've seen some modest deflation but other items that have inflation, like wood and freight, those things are tending to balance out and to flat to maybe slightly negative.

Okay. I guess here's a longer term question. We're seeing a lot of the big breweries making a bigger push into Mexico and shifting to cans and exporting a lot of that production to Mexico in the US. How did that impact your business and does M&A into Mexico become a hire priority down the road?

Well, as I told you before, I don't think it can be a higher priority than it's been. I think I've been pretty clear that Mexico is an area now that we sort of did an acquisition north of the border. South of the border has been a priority for us. We've certainly that and we do a pretty good job of sporting actual cartons into Mexico. We have converters down there that we work with to provide those products locally. And you're right. It's not just in Mexico that you've seen more cans but even the craft beer segment we've seen more cans. And, hey, that's great. That means more take-home. That means more machinery. You know, more 12-packs. So we're fine and good with that change. As long as it gets wrapped in paper, you know, I'm kind of agnostic to whether it's in bottle or can.

Okay. Very helpful. Thanks a lot.

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

Hi, everyone, good morning, thanks for the details and congratulations on the quarter. Just some housekeeping. The productivity in the quarter versus first quarter, the slowdown there, I'm assuming that's just because of the year on year comparison that was created by first quarter 2014's weather? Can you confirm that or was there anything else going on in terms of the deceleration of the productivity? Obviously you didn't change your goal for the year.

Yes, George, this is Steve. You said it right. As Mike mentioned, there was about $8 million of kind of quarter to quarter comp, so really actual productivity was quite steady through both quarters. We had the weather, Q1 versus Q2. So the $40 million year-to-date keeps us on track for $70 million to $80 million for the year.

The other thing is, we did have more maintenance downtime in this quarter than we did last year, and that's an offset to performance, right? When we're in maintenance, we take that as a negative to performance. That's how we do it internally to keep ourselves honest that we've actually improved the business, you know, not just moved it from debit to credit.

Understood. And just on the maintenance side, I would imagine that, Dave, most of that is just to keep the business ongoing, but in any of the maintenance downtime that was taken, was there anything else that would be incremental to returns looking out a couple three years? Obviously you have the cogent project coming as well.

Yeah, I think the maintenance downtime we saw in the mills is really to keep the place operational. Every time we do that, like every paperboard company in the world, we optimize some portion of that machine or some portion of that mill, and you will see that in our productivity improvement. But as you can well imagine, those things are well planned from a downtime as well as improvement.

So when we tell you, there's $70 million, $80 million of improvement, some of it is because we need to do the maintenance and upgrades to be able to drive cost out for the rest of the year. So, I wouldn't say it's incremental up side. If there's a project big enough that really moves the needle, then Mike will do exactly what he said, we'll say we're going to invest this above and beyond and here are the things you should model in. That's not what was this quarter. Having said that, I will tell you, the operations ran very, very well from a tonnage standpoint. We ran our mills very well. We produced great board and we sold and integrated that board. So that's part of the productivity improvements you saw in the quarter.

Appreciate the thoughts on that, Dave. Could you all give us a bit of an update in terms of your ability to continue to continue to integrate in Europe with your CUK Board, the market's appetite for that Board, in light of what seems to (inaudible) be fairly large capacity increase from the European producers, both in folding Box in folding box board, both verge and recycle?

Yes, I think, George, we talked about this in the past, the strength caring advertise particular SUV sheet is just different than anything that's commercially available in Europe right now and so we're really positioning it into the niches, be it beverage, some of the frozen applications, similar to what we've done in the US, where there's a place for it that has a right for us to win. And that's really been the traction we've seen, as we've been able to get some of these conversions done and some of the new business ones we've talked about.

George, I mean, I know we track this and you don't, but, look, all that board capacity coming on is not the same. A lot of it is very light caliper stuff. It's 10-point board, which is great for top sheets and other food service applications, not so great for making a serial box or a frozen pizza box or anything like that because what happens there is that you have to have a lot more caliper in that grade to be able to get the strength and tear and then you have to compete with SUS, which is inherently with that pine sheet a much stronger product. So I am unconcerned about competing with the stuff coming out of Scandinavia with SUS. That's not really what keeps us out.

I appreciate the additional thoughts on that, Dave. One housekeeping and I'll turn it over. Did I hear you say that ex-acquisitions your volume was actually up slightly in the quarter versus a year ago?

Yes, yes.

Okay. Thank you, guys. I'll turn it over.

Your next question comes from the line of Anthony Pettinari of Citi. Your line is open.

Good morning. Just a follow-up on the CRB market. We've heard reports the market is fairly business and you mentioned your four-week backlogs but on the other hand the large package food guys haven't really been saying that many good things about their underlying demand. Are you seeing substitution out of other grades into CRB or can you give a little bit more color on what you're seeing in CRB right now in terms of demand?

Well, two things. One is, I did see some of the comments on consumer product companies and they're right, demand has not been great, although if you look in the quarter, actually, serial demand itself was actually pretty good across the board and we're seeing improving serial demand as well as a harbinger. The other thing is, though, you've got to remember that even in the last 18, 19 months, there's been a fair amount of capacity that's come out of the business as well, right? So it's a balance relative to backlogs. Because your question is, why do we see backlogs and they say, well, their business isn't growing, but, you know, there have been a couple paperboard mills that have shut down and in fairness, the Jonquiere closure, while it was not a CRB sheet, there's no question that some of the tons out of, that, what was it, 100,000 tons?

Yes. About 105.

100,000 tons. Some of that is going to be end up being substituted through CRB. And our packaged goods customers may not see it but others are going to. So, you know, just the overall industry backlogs are up to four to five weeks right now. We're pretty busy on the CRB side of our equation.

Okay. That's helpful. Then just following up on Jonquiere, with that closure, will you be buying more SBS externally or sourcing more SUS internally or how does that impact your board mix?

There's a small amount of additional SBS we'll purchase, Anthony, but I wouldn't characterize it as material.

Okay. That's helpful. And then just one last one. A follow-up on the full year EBITDA growth target. You reiterated the five to 6% growth. Apologize if I missed this but do you have an initial view on how you'd expect earnings to be weighted between 3Q and 4Q maybe relative to last year?

We do not. We don't out that kind of guidance on the individual quarter. I mean, at this point in time, as we said in the business, we don't see material changes in the way the flows, third quarter starts back to school, but we've got more European demand, which is not the exact same demand that we would have had a year ago because our mix would have been different. You know, less exposure in North America than we would have had in the past.

Anthony, this is Steve. To David's point, as Mike mentioned, we'll have a little more downtime in Q3 than we did last year so there's a little bit of that that will flow through for us, but overall it won't be materially different than traditional flows.

Got it. Thanks. I'll turn it over.

Your next question comes from the line of Panjabi Ghanshan of Robert W. Baird. Your line is open.

Hi, good morning, it's actually Matt Krieger sitting in for Ghanshan. How are you doing?

We're doing good.

Good, good. My first question revolves around productivity. So productivity results have been pretty strong, once again, during the first half of the year. How much of the productivity improvement is a contribution from acquisitions versus organic improvement? And then the second part of the question is, can you give us an early look at expectations for productivity in 2016?

2016? No. I have no clue. What I will tell you is this. When we sit down and do our annual operating plan, we'll bottoms up that forecast and then we'll layer that against what our capital planning will be as well. Our targets, we've been traditionally somewhere between $60 million and $80 million every single year. As I've said on earlier calls, it has been more weighted recently towards capital investments as opposed to incremental. However, with the acquisitions, what you end up seeing there is, some of the acquisitions aren't quite as efficient or as effective as we are in our current plants or they're actually doing something that we haven't done before and we apply that across to our business.

And that adds incremental improvement on the operating side of the equation. We don't really break out improvement within the acquisitions versus the core because in a very short period of time they become part of the core. As you can well imagine, the Cascades acquisition, we started moving paper, we started moving business, cartons to and from those facilities because, you know, two separate companies were sub optimized, the Canadian market. So it would be virtually impossible for us to trace back through, making the carton now in Canada that we were making in the United States and figuring out which was related to an acquisition versus which was related to ongoing. So we try to give you high level that says look, we expect to do $60 million to $80 million worth of improvements, we add the synergy's in that mix so you have a pretty good guidance in that but breaking them down further seems to me of little real value.

Okay. That makes sense. Thanks. And then you mentioned a 2Q volumes were slightly positive, so what are your expectations for organic volume growth moving forward in 2015? And can you split that up by European volumes and then North American volumes?

No. We will not. I don't break out European and US volumes. We haven't done that. We're not going to start breaking out Europe at this point. What I will tell you is, it's completely dependant upon the end use sectors, right? What we're seeing, as Michael said, beer has been positive on a global basis. Soft drink is a challenged market. Take home is a little bit better than on premise but nonetheless, that has been a more challenging segment. Frozen pizza was doing well and some of the dry food stuff is starting to improve a little bit. When I talk about improvement, you know, I'm talking about off a pretty anemic base. So what I would say is, we don't see any macro trends that are materially positive or negative in our space. So we would expect our volumes to trend slightly up because that's what we're seeing, but not materially different than what we have experienced in the first half of this year.

And European volumes are, you know, European business is doing well. We've gained some share over there. Some of the acquisitions have brought us new product opportunities that we did not have before and that's actually growing, specifically in the case of Benson, has been a great acquisition from new product stuff and growth in Europe. And as Mike said, the best way to think about Europe is the fact that three years ago we were selling 95,000 tons. Today we're over 150 and we're heading towards 200. That gives you some sort of feel for the kind of growth trajectory that we're seeing in Europe in terms of EBITDA.

Okay. Good. That's it for me. Thanks.

Your next question comes from the line of Mark Wilde, of BMO. Your line is open.

Good morning, Dave, Mike, Steve.

Good morning, Mr. Wilde.

I've got a few questions. First, just on capital allocation, I mean, your leverage is down at 2.7 times. Your stock was below $14 for much of June. And you only bought back $4 million worth of stock. Can you talk about that?

Well, you know, of course, hindsight being 20/20. We could have bought some more back and we've talked a little bit about that. I will tell you that, while we're really, really good at running operations and making acquisitions we're new to the whole deal of buying back stock. We probably missed a little bit of a window in the second quarter. However, if my stock had been trading at 12.50 today, you would have been asking the question differently for sure. What I will tell you is that I'm going to continue to stay focused on the three things in this priority order, one, investing back in the business, two is acquisitions, and three is dividends and share buy back. And that really was our priority in the quarter. Having said that, if I was grading my performance, I would say that we might have missed a little bit of window.

We did buy back our shares to maintain, you know, to keep the dilution down, which we promised to do, but we might have missed a little of the up side. We'll certain continue to evaluate our process there. Which work closely with our Board. We have a process with investment banks that we look at and we'll continue to upgrade that as we go forward.

Well, I'll just say, Dave, editorially, you know, it looks to a lot of us on the outside that, at 14, you look pretty attractive valued versus other packagers. Moving to your second issue there, which is M&A, can you just update us on the M&A environment and maybe give us some sense of where you're focused from an M&A perspective, sort of the domestic versus offshore, converting versus mills?

That's fair. Well, right now we have certainly been focused on converting in geographic. Earlier in the call I think it was George but it might have been Philip mentioned the Mexico. And, you know, Mark, we believe that is a hole in our portfolio that we're trying to do. Because you see growth down there and we see some of our customers building facilities down there. Right now we're attacking that market either from shipping from the United States or using local converting partners. We just don't have enough capacity in Mexico to do what we want to do. So we know we need to work on that.

There are a lot of great little converting businesses right now, Mark, that are available. They're probably interesting to Graphic Packaging because we might have an older facility somewhere that will give us an opportunity to upgrade through the acquisition, or it may it be a regional business, a little bit like the Sierra Pacific acquisition for craft beer. That's kind of what we're looking at. And we're seeing a lot of it. The pipeline is really good. And good businesses. And the other thing I'll say while I'm on this is that, what I hope we can do is more of the things like we did with Benson and with Rose City.

We bought great management teams. We've learned a lot from the Benson guys and we're learning some things from the Rose City guys as well. So, you know, that's the other part of these acquisitions that I like. And we'll work more for that. You know that we would do a really good job making CRB and SUS and, you know, we buy a lot of SBS. We buy a lot of SBS. But, you know, I cannot buy something that is not for sale. But if and when SBS become available, certainly Graphic Packaging will try to throw itself in the mix because I think there's some things we can do to improve that side of the business. If you look at the SBS business overall in the US, they're run differently that side of the paperboard market could be improved from a margin standpoint. At least that's our humble opinion here at Graphic.

Okay. And Dave, just to come back on Mexico for one minute, would there be any advantage in having any mill capacity in Mexico or would you really rather just focus on doing converting in Mexico and just shipping Board of whatever type into the market?

It's a great question. I think we would lead with converting as we always have. I would never say never to additional acquisitions for mill capacity, but I don't think Mexico would be the first place I would look right now, Mark. Let us build out our converting network more and then take a different look. But for us, it would be a stair stepped sort of approach, right?

Yeah okay. That's fine. Turning to this export of more SUS Board, Dave, you've talked about, I think, having, you know, something on the order of 150,000 tons of extra pulping capacity in the system, and I'm just curious, as you are able to forward integrate more of that, is there a point here where there's a significant capital bump to allow you to convert that pulp into board?

Mark, it's Mike. I think the way we would think about that, as we've talked about, that we can run the business with around $200 million of CapEx, and where we do incremental high value projects, we'll give you transparency into those. An example of that was the Cogent that we're doing in West Monroe that will online in Q1 of next we're. We've got some projects that are in that kind of range from an expenditure standpoint that can help us drive some additional tons and convert that pulp that we've talked about into additional paper board. And they're projects are in that $10 million to $20 million range. So it's not some big capital infusion that we'd have to make. And we're ready to make those as soon as we're confident that those tons are there. We like the trends we see in Europe.

We've got pretty good line of sight to the 200,000 tons that we talk about over the next few years. And so as we kind of, you know, head into 2016, we'll continue to give you some views into what we're seeing and what that means from a capital standpoint. But it will be in line with the type of CapEx that we're spending right now.

We're just not going to get out there, making tons that we don't know are sold. There's just no good, nothing good comes of that. So at the end of the day, when we've sold those tons, then we'll make those tons. I know it's a conservative approach but that's kind of been what's worked for us, when you're running, when you need to preserve cash, you just have to be smart over the way you spend it.

Dave, if you'll look at the problems that have been caused when people get, you know, more capacity than there's a market for, I think that's a good strategy. The last question I had is just, the impact from the rising dollar in terms of competition. I mean, you've got another coated craft board producer down in Brazil, their currency is a lot weaker now. You've got a lot of recycle board capacity over in China. Can you just talk about sort of what currency is doing right now in terms of competition in the box board markets?

Mar, this is Steve. I think if you look at currency over the last year the movements that's occurred have kind of been in place for a while now and we have not seen any material impact relative to imported board. As you know, the travel costs, the move, the actual getting board from A to B is not a simple solution. You also have a place for it to go. And so generally speaking, with the long-term relationships that we have with our customers, we haven't seen that as a material impact on our business, certainly not on the CRB side where it's very limited. And as Mike said, the SUS characteristics of the Board being very positive, we haven't really seen anything there as well. So obviously there, the currency creates the question. We haven't seen that materially impact our business. Mike, anything you'd add to that?

No, I think you said it well. Remember too, Mark, we said earlier, not all Board is the same Board. What's being made in Europe is a lot different than what's being made over here. It's great Board, very light caliper, and in the United States, that ends up being predominantly litho-lam, top sheets and so and the like, or maybe some food service business where we're not heavily exposed to. The China Board, Mark, I mean, I cannot tell how many times we've talked about how scary it's going to be when all the capacity comes on in China, and in the next quarter everybody is saying it just hadn't shown up yet. And I kind of tell you, that's kind of another quarter of more capacity coming online but it just doesn't show up in the United States.

Yeah, okay. Sounds good, guys. I'll turn it over.

Your next question comes from the line of Chip Dillon of Vertical Research Partners. Your line is open.

Yes, and good morning. The first question is regarding Jonquiere, the machine that was shut down. I think you said about 105,000 tons competes basically in the CRB market. Could you talk a little bit about where the other tons went? Was it SBS type applications but maybe at the low end like cup and plate?

Yeah, so, chip, it's Mike Doss. I wouldn't characterize the 105,000 tons to be primarily on the CRB side. As Dave, I think, stated, a little bit will come into CRB. A little will come into SUS. But the lion's share it was an SBS substitution product for food service and the like.

Top sheet.

A little bit of top sheet, too. Yeah.

Gotcha. And as you think about maybe one day getting an opportunity to get into SBS, is there any aversion to getting more into food service applications like cups? Would that be part of the attraction for you or would you want to avoid that and stay major folding cartons?

No I mean, we talk a lot about folding cartons because it's easy to understand but, you know, we make a lot of these other things, right? We make trays, we make plates. We do a lot of food service stuff. The little trays and the little boats. We do a lot of those things. Any portion along that is part of our business. The issue is that for us it's all non integrated business.

So we can improve it on the converting side of the equation but we can't do much on the Board side, which is why I said earlier, Chip, to be perfectly honest, an optimized mix across that has, I think, an opportunity for margin expansion across the vertical. But, you know, we don't own it. So we wouldn't have any aversion to any portion of those end use sectors, we like them, they're growing, they're consumers based. You know, they meet some millennial trends. You can see folks on the go, all those are great trends that we capture in our core business. It's just that we don't happen to own an SBS Board mill so I don't care that much about it today.

But in terms of food service, Chip, just to build on David's comment, we already have a $250 million plus business where we're in those markets so we know those accounts.

Gotcha. That's very helpful. And a last quick question, I would imagine, with all the moving parts, you're probably up around 180,000 tons or so of SBS purchases. Could you just remind us, with all the M&A activity, where you stand in terms of your gross outside purchases of CRB? I know you sell some of what you make, I guess it's still around 15%, and you might verify that. Is that something you could share with us?

So, our SBS external purchases are in excess of 200,000 tons a year, and you're in the neighborhood on our CRB open market sales around, you know, about 15% of the production.

Are you buying any CRB on the open market?

Yes, yes.

Even though you sell some?

We do buy a little bit and we tend to buy the grades and calipers that either don't trim us off or we don't want to make. In Europe, of course, we buy all our [inaudible] Board and a little bit in Mexico as well.

If you look globally, if you answer the question globally, we are a net buyer of every grade.

Gotcha. Very helpful. Thank you.

Thank you.

Your next question comes from the line of Alex Oveshy, of Goldman Sachs. Your line is open.

Thank you, good morning guys.

Good morning.

Are you guys seeing much substitution in the US?

Well, you mean for like between the grades, Alex?

Well, from other substrates, plastics, corrugated into box board?

We've certainly grown our pie. You know that as well as anybody on this call. Mike went through a number of examples quickly but there's a whole bunch of substitution there that was from corrugated and a couple them from plastics. But you know we, I would say net on net we're gaining, expanding pie in this space. But it's about a 1% change year on year in that space across it. That's kind of our target, right? New product stuff is about 1%, acquisition is about 1%, and it moves back and forth but that's how we get our 2% annual growth and 5% in EBITDA. We had a good quarter in that space for sure.

Okay. Very good, Dave. And then have you guys given up on the idea of lower gas prices actually helping consumption for some of your end markets? Do you think you see any of that benefit at some point? Couple quarters?

You know, I don't know that I can correlate to gas prices. What I can correlate to more is, you know, jobs and you saw the jobs report today. It's okay but it's still kind of anemic if you think about where we were prior to 2009 and where we are today. And I know everybody likes to talk about a little bit of job growth and that things are down but it's been a pretty anemic recovery. And I think more than anything, Alex, that's what we have to watch as opposed to whether the individual consumers have more money to pay. We just need more people working and that's been the bigger impact on the business more than gas, more than the benefit of lower gas.

Just a question on some of the cash items. So for pension contributions and CapEx, maybe looking into 2016, is there an opportunity to maybe see those line items come down in 2016 versus 2015?

This is Steve. I mean, we'll start to give you a sense for 2016 a little bit later this year. I mean, you know the impact of interest rates bump up a bit, that they'll have some impact on pension calculations, and we'll play that out for you. And as Mike mentioned, we'll be pretty clear on our CapEx expectations going forward above that core baseline.

Very good, Steve. And just a last one on cap allocation, if both on opportunities or transformative opportunities don't really come up over the next couple of quarters, would you let your leverage fall below 2.5 or would the plug there be buy back?

As you and I know, I mean, getting down towards two is by no means an optimal capital plan for us. And you know that and even that math we can do here. So we'll have to address it when it gets there.

Fair enough. Thanks, Dave.

Your next question comes from the line of Debbie Jones and Deutsche Bank. Your line is open.

Hi, good morning.

Hi, Debbie.

I have two quick questions. First on pre-cash flow. You didn't make any changes to that target but you took your CapEx $10 million up. So I'm just wondering what needs to happen to get to the high end of that range if you hold currency constant?

Yeah, Debbie, it's Steve. We lowered our interest expense expectations a bit, too, as well, so the two basically kind of net each other out.

Okay. There again, if you kind of look at the high end of your range, is that working cap at the high or is it operational improvements? What do you need to kind of achieve that?

It's probably working capital.

Yeah there's a little bit in working capital but for the most part, if you think about the guidance, you've got a little bit of CapEx up and a little bit of interest costs down and everything else for the most part is pretty steady in terms of the EBITDA expectations in the 5% to 6% range that we've been sharing, driving the majority of that cash flow. So no real material change.

Okay. Thanks. That's helpful. My last question is, I think on the last quarter you gave a currency headwind for the year. Are you able to do that again?

Yes. It's $25 million to $30 million is what the current expectation is at today's rate. So that's your 110, EURO, 155, pounds, and 125 yen. It's in that $25 million to $30 million range.

Okay. Thanks for that. That's helpful. That's all I have.

Thank you.

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

One last one, bigger picture to some degree. We've seen evidence that the stand-up pouch market is growing a bit more quickly than it has in the past, certainly having a little bit more impact in the market than 10-20 years ago when it first started coming out. Do you see that as a net positive or net negative? Now, intuitively you'd say, okay, it's a competing substrate versus folding cartons but I could imagine that a lot of the secondary packages that are used for pouches would be more likely to come in something like CUK versus cans and competing products to pouches would tend to be more secondarily packaged and corrugated. So how would you have us frame that, if it's frame able at all? Thanks guys and good luck in the quarter.

I think you did a pretty good job of answering your question. I think you're absolutely right. If you think about something like a Capri Sun, any time those pouches are for beverage applications, which is the predominant, paperboard usually is the package that's surrounding it. We put some functionality in opening feature. We protect the product. We make it easier for the consumer to store it. We're not anti-pouches. We want them to grow.

So in total, you see stand-up as actually a net positive for the CUK market overall?

Yeah, because some of that is actually getting at the little juice, little plastic juice bottles, which are not necessarily packaged in paperboard, but when you get to a plastic pouch, it's almost always in paperboard, so that arbitrage is not bad for us. And you're not going to be put beer in a plastic pouch.

Not yet, I guess. But, anyway.

Exactly. So that's kind of an isolated thing. It's really more of that juice sort of market and some of that is transferring from PE bottles into pouches and then paper board becomes the right way to protect that product. So that's not a bad trend for us.

I appreciate it, Dave. Thanks and good luck on the quarter.

Thanks, guys.

Your next question comes from the line of Mark Wilde, of BMO. Your line is open.

Just a follow-up. I wanted to ask about that $2.3 million price decline sort of net of commodity deflation that you had identified.

Yes, this is Steve. Just to put a little bit of color behind that. As you know, in some cases, particularly in Europe, for example, we're a net buyer of Board, and as we've seen and the early commentary around currency, we've seen some declines for example in the cost of that Board. That really is a direct pass-through to our customers. We count it ourselves as price but it's offset by the deflation that we experienced in that particular instance.

Europe ended up being a larger percentage this quarter of that total then as some of those things started to roll through. Our expectations have not altered at all relative to price. Offsetting commodity, inflation, first quarter, we were up a couple million, second quarter down. Those things tend to net themselves out and we don't see that changing, but it was a little bit of a European phenomenon for us in Q2.

But, Mark, make sure you understand, not EBITDA impact. It shows up as a price reduction because the board blows through but then you're paying less for the board. So EBITDA impact in Europe was negligible. It's just the way we account for it.

Thanks. That's helpful. Steve, since you mentioned the European business, could you just give us some sense of where you're at in terms of the improvement in operating margins that you've had out there for the European converting businesses?

Yeah, well, mark, we haven't given, we're not giving actual margins. Here's what I would tell you, is that that business operated solidly. We integrated more tons in the business and we grew that business. So if you think about the primary drivers of how margins get better at Graphic, a little bit of top-line growth, higher level of integration, and good operating results, you can assume that margins in Europe are directionally correct for us for sure.

Dave, separate from the Board integration, but just in terms of the converting businesses themselves over there, is there much of an incremental opportunity yet to just improve margins in those businesses?

There have been. Absolutely have been. They're really executing well over there. We have a really good team and they are flat running those plants. I mean, it's embarrassing, but some of our most efficient sheet bed plants right now are not in this continent.

Mark, it's Mike. If you think about it, too, we've shut down one facility, down sized another and optimized the lowest cost assets we have there, so, yeah, our overall operation efficiency in Europe is a very good story.

We're trying to translate some of that back here. Mike has got his teams working to do what we're doing in Europe in some cases, expanding that back into our sheet bed facilities in the United States.

That's helpful, guys. Thanks very much. Good luck in the second half.

Thank you.

There are no further questions in the queue at this time. I turn the call back over to David Scheible for closing remarks.

My closing remarks are to see you next quarter. Thanks for sharing.

This concludes today's conference call. You may now disconnect.