Graphic Packaging Holding Co (GPK) 2016 Q2 法說會逐字稿

Good morning, my name is Kelly, and I will be your conference operator today. At this time, I would like to welcome everyone to the Graphic Packaging second-quarter 2016 earnings conference call.

(Operator Instructions)

Thank you. I will now turn the call over to Brad Ankerholz, Vice President and Treasurer. Please begin, sir.

Thank you, Kelly, and good morning to everybody, and welcome to Graphic Packaging Holding Company's second-quarter 2016 earnings call. Commenting on results this morning are Mike Doss, the Company's President and CEO; and Stephen Scherger, our Senior Vice President and CFO. 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 presentation link on the Investor section of our website which is graphicpkg.com.

I would like to remind everyone that statements of our expectations, plans, estimates, and beliefs regarding future performance and events constitute forward-looking statements. Such statements are based on currently available information, and are subject to various risks and uncertainties that could cause actual results to differ materially from the Company's present expectations. Information regarding these risks and uncertainties is contained in the Company's periodic filings with the Securities and Exchange Commission. Undue reliance should not be placed on forward-looking statements, as such statements speak only as of the date on which they are made, and the Company undertakes no obligation to update such statements, except as required by law.

Mike, I'll turn it over to you now.

Thank you, Brad. Our second quarter results were in line with our high expectations, and we are pleased with the performance over the first half of the year. In the second quarter, sales increased 4.4%, adjusted EBITDA increased 1.6%, and adjusted earnings per share were $0.19 with last year's second quarter.

We also continued to execute on our three strategic priorities in the quarter, in addition to investing $83 million of capital back into our business. We completed the Colorpak acquisition in Australia, and returned over $53 million to our shareholders, including $37 million of share repurchases. We are doing what we committed to do, and are executing consistent with our strategic priorities.

We were able to execute on our strategies and delivers solid results in the quarter, where we [took] a significant planned downtime to install a new press section and headbox on one of our SUS paperboard machines at our West Monroe mill. This was a $40 million project that is expected to generate an extra 30,000 annual tons of paperboard volume to support our existing sales, and expect it to drive higher efficiencies in our downstream converting operations. As we've said in the past, the projected financial benefit is approximately $12 million annually. This project is right in line with our asset optimization strategy of reinvesting capital to make productivity improvements and drive margin expansion.

The paper machine upgrade was a significant undertaking as we [took] 26 days of planned downtime on our number seven paper machine at West Monroe. This negatively impacted volume by about 20,000 tons and EBITDA by approximately $15 million in the quarter. As we have discussed, we built inventory in the previous two quarters to avoid any disruptions to our business and customers during the downtime. The project was completed on schedule, and we've been pleased with the machine's performance since bringing it back online.

With SUS demand increasing in both our legacy business and from recent acquisitions, we plan to utilize the extra SUS paperboard capacity in our vertically integrated operations to unlock additional operating leverage across the enterprise. Despite this large undertaking, we generated $21 million of net performance improvements in the second quarter, and $37 million year-to-date, putting us squarely on track to hit the top half of our annual target of $60 million to $80 million in full year cost savings.

As you've heard us say before, reinvesting in the business to drive productivity and expand margins is a key priority. We're also deploying a disciplined capital allocation approach that balances investments in the business, with returning excess capital to shareholders to drive long-term shareholder value. Through the first half of the year, we paid $32.4 million in dividends and through yesterday, we repurchased approximately 7.3 million shares of our stock at a total cost of roughly $92 million.

We closed the Colorpak Australian acquisition in early May, and the integrations of Carded Graphics, G-Box, W. G. Anderson, and Metro Packaging acquisitions are all well underway. The US acquisitions have enabled us to announce the closures of our existing higher cost Menasha, Wisconsin and Piscataway, New Jersey converting facilities. The timing of these closures is slightly ahead of our original plan, and will help us drive our $60 million to $80 million of annual performance improvements in FY17 and beyond.

The volume from these two facilities will be fully consolidated into lower cost locations. The accelerated timing of the closures will increase our capital expenditures by approximately $10 million this year, but as Steve will point out, our expected cash generation of $360 million to $380 million this year remains unchanged.

Core organic volumes in our global paperboard packaging business declined slightly in the quarter, and are flat with the first half of the year. When including acquisitions, volumes from ongoing businesses increased 3.5%. As a reminder, we closed the Jonquiere, Canada paperboard mill last year, and we took out the non-integrated kraft paper production at our West Monroe mill. These tons were sold last year, and will not repeat this year.

Looking to demand, ACNielsen reported that US food and consumer market volume declined in the low to mid single-digits for the majority of our categories, such as cereal, frozen food, dry and frozen foods. Our US food business performed in line with the market, our core volumes was down slightly versus last year. During the second quarter, the new labeling requirements around GMOs or genetically modified organisms were announced, and resulted in some choppiness in demand, particularly in May, as the industry began to work through the new labeling requirements.

The global beverage market remained relatively healthy in the second quarter. Strength in our US beverage market continued to be led by growth in specialty drinks, craft beer, and bottled water.

As reported by ACNielsen, for the second consecutive quarter, carbonated beverage volumes declined only slightly. Graphic Packaging's global beverage business was solid in the quarter, increasing in the low single-digits, driven by strengthen US beer, specialty drinks, and carbonated soft drinks.

New product development remains an essential component of our organic growth strategy. We had a number of new commercializations in the quarter. On the quick-serve restaurant side, we launched a new chicken McNugget container with a major supplier to McDonald's. The new container is made out of our US, out of our SUS paperboard, and features a brown natural kraft look on the outside, with a grease resistant clay coating on the inside. This replaces the previous container which made from SBS paperboard.

On the convenience side, we launched a paperboard sleeve pouch that provides portability, and an easy way to eat oatmeal from a package by just adding hot water. On the beverage side, we rolled out a new asymmetric pack to hold [four] glass bottles for our long-time Italian customer Peroni Brewery. We also placed new packaging line at Peroni's Rome facility to support this package.

Our manufacturing operations had another strong quarter. Our mills ran full, and our backlog remains stable, at five weeks for SUS and four weeks for CRB. Continued emphasis on improvement initiatives, variable costs, and operating efficiencies contributed to the majority of the cost savings in the quarter. Commodity input inflation was flat in the quarter, as lower costs for energy wood, and chemicals offset increased costs for secondary fiber.

As we discussed last quarter, we're planning to install a new curtain coater and making other improvements to one of our Macon SUS paperboard machines in the second half of the year. This work is scheduled to be complete late in the third quarter. The investment will be approximately $30 million, and should drive approximately $10 million in annual EBITDA, beginning in 2017.

Finally, I'd like to welcome Alex Ovshey to the Graphic Packaging team. Alex has taken on the new role of Vice President, Investor Relations, and will be our primary analyst and investor contact going forward. Before joining the team, Alex spent 10 years at Goldman Sachs covering the packaging sector as a sell-side equity research analyst.

I would also like to thank our Treasurer, Brad Ankerholz for his work on the IR front over the past several years. We have a strong foundation in place, thanks to Brad's leadership.

And with that, I will turn the call over to Steve Scherger, our Chief Financial Officer to take you through the quarterly financial results in more detail. Steve?

Thanks, Mike, and good morning. We reported Q2 EPS of $0.24 per diluted share, compared to $0.17 in the second quarter of 2015. Q2 results were impacted by two adjustments, a $7.1 million pretax or $4.7 million after-tax charge related to business combinations and other special charges, as well as a positive $22.4 million non-cash benefit from a one-time discrete tax item.

The $22.4 million non-cash tax benefit was related to an agreement executed with the Internal Revenue Service during the quarter. As a result of this agreement, the Company will amend its 2011 and 2012 US federal and state tax returns, and utilize previously expired net operating loss carryforwards. Importantly, the increase to our NOL position gives us further confidence that we will not be a meaningful US federal cash tax payer until 2019.

As a result of the tax benefit, our effective tax rate in Q2 was 12%. Adjusted for the business combinations [and charges] and the tax benefit, our effective tax rate would have been 36.9%, consistent with our normalized effective tax rate range of 35% to 37%.

For the remainder of my comments this morning, references to EBITDA and earnings per share will be to adjusted numbers. As Mike mentioned, despite a planned $15 million negative impact from the machine upgrade at West Monroe, we delivered second quarter results that met our high expectations. Adjusted EBITDA increased $3 million or 1.6% to $195 million. Adjusted EPS was $0.19, unchanged versus the prior-year period.

Focusing on second quarter net sales, revenue increased 4.4% driven primarily by volume from our acquired businesses. Price was lower by $6.6 million, and the strong US dollar translated to lower sales of $8.2 million.

Turning to second quarter EBITDA, the $3 million increase was driven by operating performance benefits of $21 million, and earnings from our acquired businesses. These benefits were partially offset by foreign exchange headwinds, labor and benefits inflation, and lower pricing. Commodity inflation was flat in the quarter.

We ended the first quarter with over $830 million of global liquidity, and $2.25 billion of net debt. Our net debt increased $10 million during the quarter. The slight increase was driven by capital spending related to West Monroe, the Colorpak acquisition, and $53 million in share repurchases and dividends.

The net leverage ratio in the second quarter was 2.93 times, unchanged compared to the first quarter. We remain committed to our long-term leverage target of 2.5 to 3 times.

As Mike stated, we're executing a balanced approach to returning capital to our shareholders. Subsequently to the quarter end, we repurchased another 800,000 shares for roughly $10 million. Since initiating the $250 million program in the first quarter of 2015, we've allocated $155 million to acquire nearly 12 million shares, or 3.6% of the fully diluted shares at inception.

Turning to full-year 2016 guidance. Our EBITDA and cash flow targets remain unchanged. We remain committed to a 4% to 7% improvement in EBITDA versus 2015.

A few of the components have shifted modestly. On the positive side, we're executing well on our performance targets, and now expect to achieve the high end of our previous $60 million to $80 million cost reduction target. We have updated the range to $70 million to $80 million.

We've updated our pricing commodity inflation range to negative $20 million to $25 million, compared to a negative $15 million to $20 million range last quarter. The update reflects the additional $20 per ton CRB price decline reported in the May trade publications.

We have updated our FX impact range to negative $10 million to $15 million, compared to negative $5 million to $10 million last quarter. This is to reflect the decline of the British pound post Brexit.

Looking at third quarter 2016 guidance, with the upgrade to the West Monroe SUS machine and corresponding downtime completed, we expect Q3 EBITDA to show solid improvement compared to Q2, and year ago levels.

Finally, turning to cash flow, our 2016 cash flow range of $360 million to $380 million is unchanged. We are slightly increasing our capital spending range to $280 million to $290 million, from $270 million to $280 million. The modest increase is related to the accelerated closures of our Menasha, Wisconsin and Piscataway, New Jersey converting facilities. The closures will drive performance benefits in 2017.

We're also lowering our interest expense range to $70 million to $80 million, from $75 million to $85 million. While we don't provide specific guidance on working capital, we expect working capital to modestly improve, as we progress through the integrations of our recent acquisitions. The remainder of our guidance is contained on the last page of the presentation on our website.

Thank you for your time this morning. I will now turn the call back to Mike.

We had a solid second quarter and first half of the year. The business is tracking right in line with our expectations. We are investing in our core business, integrating strategic acquisitions, and returning capital to shareholders, all of which drive long-term shareholder value. We are executing well against this strategy, and remain confident in our ability to drive future profitable growth.

I'll now turn the call back to the operator for questions.

(Operator Instructions)

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

Good morning. Following Brexit, I was wondering if you could remind us what your direct sales exposure to the UK is? And more broadly, when you think about a weaker pound, and maybe even a weaker euro, how does that impact the attractiveness of shipping SUS to the UK and Europe? And does it impact about -- how you think about M&A in Europe going forward?

Good morning, Anthony. It's Mike. I'll -- a couple questions in there, I'll try to capture them all here.

But just in terms of context, our business in the UK -- well, take a step back, our business in Europe is a little over $600 million, and of that, a little less than half is in the UK. So think about that being about 7% of Company sales to be precise that is in the UK.

Relative to how we think about Europe, I mean the -- if you really think about the defensive nature of the products that we manufacture, which are largely due to beverage, what didn't change as a result of Brexit, is that there is still over [60 million people] in the UK, and over 700 million people in Eastern and Western Europe that still need to eat and drink. And our products obviously are a key part of that supply chain that allows that to happen.

Certainly, it got a little more complicated. I think we don't know the full extent of what Brexit all means yet. In the short-term, it's got some FX implications for us that Steve outlined, and we've built into our guidance here. In terms of -- specifically in the UK, one of the things that we are watching is for inflation. We're actually seeing some paperboard suppliers from outside of the UK, as a pound has devalued, looking to raise prices later this year, and into next year.

As a reminder, most of our SUS paperboard actually is for our internal cartons. We do have a small open market presence in the UK. And where we are selling open market tons, we've actually announced a price increase on our SUS paperboard. So we're confident that we can recover those costs, and deal with that price cost spread in that environment. And we remain committed to Europe, and think over the long-term, the medium to long-term for sure, it represents real opportunities for our Company.

Okay. That's very helpful. Are you still on track for the 175,000 tons integrated into Europe this year?

Yes, we might be a little bit short of that, but it's going to be incrementally up from last year for sure, and last year was around 150,000 tons.

Okay, that's helpful. Just one last one for me. Can you give any comments, or how would you characterize folding carton volumes in July?

I think we characterize them as the same as we saw in Q2, at least through the 26th here today.

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

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

Hi, everyone. Thanks for the details. Alex, welcome as well. I guess, first question I had, maybe a bigger question. You took up capital spending this year, as we would have imagined around productivity-related programs. Steve or Mike, could you comment about the longer-term outlook? And I don't expect you to guide year by year and quarter by quarter, but do you think that with the volume headwinds and pricing headwinds that you have been seeing to some degree, that there's maybe room for more capital spending, because there's more room, and maybe more need to drive productivity?

Hey, George it's Steve. Thanks for the good question.

Our philosophy around capital has not modified in many respects, in terms of $200 million to $210 million that we believe is the core CapEx for the business to drive ongoing improvement, productivity improvement, as well as our maintenance needs.

And as we've said, we call out investments above that, like we're doing here today with the acceleration of Piscataway and Menasha closures. And when we see opportunity for productivity enhancement, we'll allocate the capital appropriately, particularly where it drives synergy capital acquisitions.

But overall, that one major project beyond the $200 million is still philosophically where we are. But when we do see things like this, with a couple of acquisitions enabling the closures, we took a decision to accelerate, to your point, to give us greater confidence that in 2017 and beyond, that we can once againg be in our $60 million to $80 million range. And so, yes, some of it is, of course related to the realities of the market. But for us, if we see high return potential on those projects and allocating prudent capital there, we'll do so, to give ourselves confidence that the high degree of productivity enhancement year-over-year can be maintained.

Thanks for that, Steve.

I know it's a little bit sensitive to talk about this on a public forum, but is there any way you can bracket what sort of savings you expect from Piscataway and Menasha? And do you expect to have a 95% retention ratio, or is there any way to bracket that for us, as we model out the next few quarters?

Yes, George, it is, of course, inherent in the $60 million to $80 million of year-over-year improvement. And so, it will be -- for 2017, that will be a critical component. We have a lot of confidence in the commitments we've made broadly on the acquisitions in terms of the year, first 12 to 24 months of improvement that you see in the material that's online.

Those two specific facilities, those are $10 million to $15 million improvement opportunities for us, once fully put to play. So they play a critical role in 2017, but it's within that number.

Okay. Thank you for that. One last question, I'll it turn over, and try to come back.

There's a fair amount of interest in whether the tax benefit that you reported on a GAAP basis in the quarter, whether there are implications for cash flow this year? I wouldn't imagine it would have impacted your 2Q results. But do you get any benefit from that tax benefit and that resolution with the IRS in your cash flow this year, relative to your overall guidance?

Thanks, guys.

Yes, George, no cash implications in 2016. It allows us, as I mentioned to have confidence that our NOLs will be available through 2018, and that we won't be a material cash taxpayer until 2019. No change to our cash taxes of $20 million to $25 million, no change to that guidance. And then, of course, as we mentioned, no change to our cash flow guidance of $360 million to $380 million.

Okay Thanks. I'll turn it over. I'll be back, thank you.

Your next question comes from the line of Philip Ng of Jefferies.

Hello.

How do you think about price costs going into 2017? I would imagine some of the inflation you're seeing in this year, flowing to a little more fully with your contractual pass-throughs, but box board prices have been relatively flat. So just want to get -- trying to think about 2017?

Phil, it's Steve. We're going to -- I think, with regards to 2017, it's a bit early for us to talk through what we see happening there.

Obviously, we're very clear on what we're conveying for 2016. But as you know, and as we talked about, there are a lot of moving parts to prices. You move from year-to-year, obviously inflation assumptions play a role there as well. So I'd really prefer not to try to hypothesize now. We're going to get much more clarity, as always later in the year on 2017, what we see relative to price and commodity inflation, deflation.

Okay. That's helpful.

Your backlogs for CUK and CRB looked pretty healthy to me. But the commentary, at least from Pulp and Paper Weekly has been a little more guarded around competitive landscape on the CRB front. Can you talk about what you're seeing out there? And obviously, the market receipted that full $50 price increase?

Yes, I guess, Phil, it's Mike.

I think the way that I would answer that question, as you know we run a highly integrated business, over 83% integrated of both SUS and CRB. So we're really selling the forward into packaging and we're pulling it through our mills.

As a matter of fact, consistent with what we did in Q1, we actually bought tons on CRB and CUK in the quarter to run our business, both domestically and in Europe. So I can't speak to what others are seeing, in terms of their overall demand. You see what we did in terms of our top line, and how we've been able to grow it with these acquisitions that we're bringing onboard, and integrating into our business. And they've just been stable. We're in the middle of the beverage season right now. As you know, it's been quite warm, and our beverage business is performing well. And in the CRB business, has been stable also.

Okay. That's helpful. And then, just one last one from me.

The SUS tons that you have brought on this year, do you expect to sell out those tons fully in 2017, and realize the full $10 million EBITDA benefit, or is it going to be more of a gradual ramp?

No. We expect that in 2017, we'll sell that out. Now we'll get a little bit of that towards the tail end of this year, so we'll have to tie that out as we round into next year. But we've been pleased with the start-up of the new equipment, the team in West Monroe has done an excellent job, and we would expect that we'd see those tons show up next year, and be able to take advantage of that.

Okay. Thanks. Great quarter. Good luck on 3Q.

Thanks, Phil.

Your next question comes from the line of Mark Wilby of BMO Capital Markets. Your line is open.

Good morning. Hello?

Hello, Mark. We got you, Mark.

All right. Just to come back to the cost side of the equation briefly, Steve or Mike, can you just talk with us, with natural gas prices going up, how much gas you use, how you're hedged, and how that may affect things as we look out 6 to 12 month?

Yes, with regards to the hedging, Mark, we're pretty hedged in the, I think 70% to 80% range here in 2016, more in the 30% range in 2017. So we're modestly hedged as we head into 2017. Mike, do you want a talk a little bit about, just where we are at on the --?

I mean, in terms of total gas usage, Mark, we're just a little bit shy of 15 million MMbtus.

Okay, all right. That's helpful. And then, just any update on what you are seeing in the secondary fiber markets? Looks like OCC has probably moved about $20 here.

Yes, we would agree with that. We've seen that, and it's been pretty steady here in July. Certainly, in the Midwest that's been the case for us. We have obviously, put that into our forwards as well, Mark.

Okay. And then, Mike, possible to talk a little bit about the M&A environment, and in particular what areas you're focused on right now?

Yes, thanks, Mark. I think really what we have spent the second quarter doing here, in addition to this rebuild at the West Monroe mill that I outlined in detail, is we spent a lot of time integrating the four businesses that we bought in the last six months.

And as you can see in some of the synergy numbers that Steve talked about, and we're starting to drive those cost savings to the bottom line. So that's been really a key part of our focus. I'd characterize the backlog of, smaller converting tuck-in acquisitions as being good. And we continue to work those things, and look for the right geographies that makes sense to us, or a niche that could be accretive in some way, shape or form, and that's really been our focus.

Okay. And if I go back, I don't know,15 years ago, I think Graphic had mill operations over in Europe. Any thoughts on whether that might be an area you'd want to look at over time, Mike?

Yes. Actually you're spot on. I think it was 2007 that we divested our last mill asset in Fiskeby, Sweden. And really what we said, Mark, is we wanted to have $1 billion business, converting business in Europe first. We wanted to create the demand. That would give us downstream opt-in if we decided we wanted to backward integrate it. It's not a necessity in the market for us to continue to grow our business profitably as you've seen, and we've demonstrated over the last few years. But it would certainly give us the option, and that's really why we continue to focus on growing our business there, as it creates a number of paths for us that we can look at, that could drive future profitable growth.

All right. And then, finally Mike, is it possible to just step back a little bit, and give us some sense of where the big puts and takes are, in terms organic volume? And, I am trying to think about issues like the push of these stand-up pouches into a lot of traditional carton markets, and how much headwind that creates for you? And then, sort of what the offsets are, where the opportunities are?

Yes, happy to do that. Resin prices are low, but paperboard has got a great sustainability story, and we continue to push that. And I guess the way we think about that, and we've talked about this in the past a little bit, is that we -- when we go up against other packaging substrates, there are sometimes where we win, and obviously there are some times when we lose.

And where we have been able to generate some wins here, in recent years for sure, and this year continues that trend is on our area of strength packaging. As you look at retail ready-packaging, and what retailers and merchandisers want to do, in terms of displaying the products, our heavy caliber SUS performs well in those environments, and we've continue to see good incremental demand for that.

And as we think about that, we're certainly monitoring the trend on flexible packaging. But from what we've seen on reported numbers, the public companies in that regard, we haven't seen a material loss of volume. And we'll continue to monitor that, but things that really make me nervous, it's certainly on the list, but it's not at the top of the list.

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

Your next question comes from the line of Brian Maguire of Goldman Sachs. Your line is open.

Good morning, Mike and Steve.

Good morning, Brian.

I had a question on the topic of imports. I know there has been a little bit of concern that some of the FBP capacity that got added in Europe, is making its way into the US. I know you've addressed it in the past, but just wondering if there is any update there, or if you're seeing any change in customer acceptance of that product in any of your -- as a competitive threat for any of your products? And if you're seeing any more willingness for folks to try out that material?

No real change, Brian, really since last quarter. I mean, Metz obviously, has their machine up and running. I assume they're doing qualifications and working through some of that stuff. But in terms of our point of view, in terms of what it means (inaudible) we haven't changed our thought process.

Okay. Great. And then, just in terms of synergies from the deals already completed, are they pretty much tracking in line with your expectations? Or are they maybe, maybe you're finding some opportunities you didn't see initially out of those deals now that you've got them under your control?

Yes, thanks, Brian, it's Steve. Overall, we feel very good about the synergy capture capabilities that are there. So in total, a total 2 to 3 turns of capture, that's very consistent for us, and the commitments that we're making internally. What you are seeing with the acceleration is, we're occasionally we work on pace. So we made, like we've done with the two recent announced closures, we're doing those at pace, because the acquisitions enabled it, and had very high quality teams and assets that allowed it to do so. So overall, very much on track in terms of where we'll land. At times, we'll accelerate like we've done here, to move with a sense of even greater urgency.

Okay. Great.

And then, just one last one if I could on the productivity targets, now I think $70 million to 80 million for the year. Has that work to achieve those largely been completed at this point, with the West Monroe expansion and the co-gen unit already in place? Or is there any work yet to be done? Just trying to get a sense of, if there is any potential for upside or downside, to that number from here?

No, I think we're on that track. I mean, if you're specifically talking about 2016, Brian, or--?

Yes, 2016.

Yes, that work has been done.

Great. Thanks very much.

Your next question comes from the line of Ghansham Panjabi of R.W. Baird and Company. Your line is open.

Hi, good morning. This is actually Mehul Dalia sitting in for Ghansham. How are you doing?

Good. How are you?

Great. Can you talk a little about your expectations for CRB and CUK pricing through the back half of the year? Is it safe to assume that with the recent OCC increases we'll see some sort of stability in pricing for CRB?

Mehul, we had a little difficult time hearing you. I believe the question was around second-half CRB and SUS pricing, is that what the question was?

Yes, exactly.

So Mehul, this is Mike. We're not going to speculate on forward pricing. I mean, we've talked about what's happened, and kind of what our price cost spreads look like for the full year, but we're not going to speculate beyond that.

Okay, great.

And next question is, what is your strategy to deal with incremental customer consolidation? For example, reports of Mondelez and Hershey looking at a combination. We know the industry has weathered customer consolidation over several decades pretty well, but how does it impact your view on driving larger scale consolidation of your own?

Well, it's certainly been something Mehul that we've dealt with really over the last decade. I mean, our customers have continued to get bigger and to consolildate, and graphics continue to get bigger and consolidate as well, as you look at how we're built out our manufacturing footprint both in North America and around the globe. So that's really why we look to do the things that we do. We have relationships with a number of these very large global food and beverage companies, that really span multiple geographies. And I don't expect that that's going to change anytime soon, and we'll continue to see that as a trend.

And to Mike's point, as we've talked before, have a long track record of managing through those consolidations when they happen. Typically, we have long-standing relationships with both companies that become one. And so, we've, when they occur, we're prepared for them and work hand-in-hand with the newly -- the new owners on, what the path forward looks like. And that actually has been a positive for us at times.

Okay, great. And then one last one. Can you talk a little bit about volumes in Europe and Mexico during the quarter? Have there been any change from the previous trend lines in either of those regions?

I guess, the way we would answer that, Mexico has been -- was solid in Q2, and that continues here into July for us. In the case of the UK, we've seen a modest reduction in demand, and it's probably attributable to the Brexit vote. The weather over there hasn't been great either, so those two things combined probably incrementally impacted that market a little bit. But I'm talking very modest in that regard.

Great. Thank you very much.

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

Yes, good morning, Mike, Steve, Alex.

Yes, good morning, Chip. How are you?

Doing well, thank you. First thing is, and I might have just missed this, but there is a footnote referencing your volumes, how you adjusted them last year for the shutdown of the number five machine at West Monroe. Can you describe when that took place, and how many tons were involved?

Yes, we shut down the facility about mid year last Q4 physically.

Jonquiere (multiple speakers)

Yes, Jonquiere was mid-year.

Shut down mid year, and then we have some inventory and sell-through that occurred in quarters three and Q4. So you will see that volume, actually continued to kind of move away in terms of the year-over-year. And so, but what we have done, Chip, in order to make it a little more apples to apples, is move that from the schedule that you're referring to.

And then in regards to West Monroe number five, Chip, the paper machine, and that was there as you probably recall, as we serviced our multi-wall bag business that we divested a number of years ago. We had a take-off agreement on there, that we honored during that duration. And then, when that was expiring, we made the decision to shut that mill down -- or shut that paper machine down, excuse me. And that did almost 40,000 tons last year, and that was shut down in Q4.

Got you. Okay, that's helpful. And then I noticed you're increasing the pension amortization assumption midyear. Is that tied to acquisitions, or maybe changes in assumptions?

No, it's not as much acquisition-related, as it is just the assumptions around pension funding. There's a little bit in there associated with Menasha. And just by way of reference for that, that increase in pension expense is all amortization. So from an EBITDA perspective, there's really no impact. It does have some impact on EBIT, because it's an amortization increase, Chip.

Got you. And then, just thinking about the -- and also just as you think about contributions, I don't think you've made contributions in the last year or so. Does that look to change if the yield curve stays where it is, next year? Or is it just too early to tell?

No, Chip, that's not accurate, and you may just be referencing to some other thoughts. But we've been funding, cash funding our pension plans in the $40 million to $60 million range for last several years. We'll do that again this year. Obviously, some of the metrics continued to work against the funding. But we're continuing on a track of working to be quite full funded over the next few years. That's a position we've taken for quite some time.

So we don't really plan to move off of our funding strategies, where we are deploying $40 million to $60 million, I think we're $53 million, if I recall last year, and we'll be in the kind of a range again this year. So it's an important use of cash, to get us into a more fully funded position, in shorter order than most would be pursuing.

Okay, okay. And then, last question, I think you guys still make a little bit of liner board, and maybe kraft paper, maybe not. Or just liner board I think down at West Monroe. If you could just clarify that? I think it's a little over 100,000 tons a year. And just given the vertical integration in that space, and some difficulties that another company that has a sort of a naked media machine has had, what are your thoughts about that machine? Obviously, you have an export option being where you are close to the Gulf, but just didn't know if there is any thoughts of any changes in strategy regarding that.

No. So really what you're referencing there, Chip, is we run a media machine in West Monroe and have for a long time, and it's solid kraft fiber, and it's very strong. What that, where the application has been useful is in combination with a number of these recycled liner board combinations that have been coming online. And we manufactured about 120,000 tons of that every year. It's been real steady, in the terms of overall production on the machine.

It is a key grade that we actually manufacture there, and we actually incorporate that, a fair amount into our own operations. As you know we run a number of [ozitrods] in our converting operations. We have three in North America, and a couple of Mexico, and we actually vertically integrate that material into our own operations. So in some ways, it behaves a little bit like how we run the play on CRB and SUS.

Okay, that's great, very helpful. Thank you.

You're welcome.

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

Hi, good morning.

Good morning, Debbie.

I was hoping you guys could talk a little bit about the FX impact. It was a bit greater in the quarter than we were expecting, and then the revised guidance just based on current rates. Maybe that's just something with my model. But I just wanted to get your sense, if there was something hedging related there, just as I think about the impact for 2017 as well?

Yes, Debbie, it's Steve. The revised guidance of the $10 million to $15 million is at rates that you would see fundamentally today. Kind of [1.10], [1.30] euro, pound and [1.05] or [1.06] for the yen, and then obviously the currencies following along. That will be in that $10 million to $15 million range for us.

Most of it has occurred through the first half of the year at those kind of assumptions, and so FX will be more modest for the remainder of the year. So it may have just been a minor modeling component there. I think last year, we did have a one-time FX that may have caused some year-over-year impact here. But for the most part, most of our FX, at the rates I just described, is will, is in the first half, and will be relatively modest in the second half of the year.

Okay. And then, is it fair to say with your comments about Q3 EBITDA, that the growth we should expect sequentially and year-over-year, would be a little bit greater than what you've seen in this second quarter, and more in line with the annual EBITDA guidance growth rate that you've given, that was unchanged in the slides?

Yes, Debbie, it's Steve. That's pretty fair, given that from Q2 to Q3, we'll not have the $15 million of planned downtime from the investment. We are making a curtain coater investment in Q3 that will have a $5 million or so impact, as we've discussed. But we would see some good solid sequential improvement, Q2 to Q3 that would be as you said, more in line with the full-year guidance, and kind of [plus $15 million], [minus $5 million] in that kind of range, is what you would expect to see Q2 to Q3.

Okay, thanks. And just a quick question on the commentary, you made about the new labeling requirements. I think that was for North America. I couldn't quite tell how material that was, and if that's something that could impact you in the third quarter as well?

No. We've got it largely in our review mirror, Debbie. It's just the normal things, when customers have to go through labeling requirements, we have to run inventory down, and then we get a bunch of orders. And that really largely occurred in May, and we were largely caught up by the end of June.

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

(Operator Instructions)

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

Hi, thanks for taking my follow on. Maybe segueing off of Debbie's question, my question was, could you quantify at all what the impact of the labeling change was, in terms of volume and food in the second quarter? And taking a step back, what caused the -- it seems like deceleration of the food volume of your customers for packing demand versus the first quarter. I know it's going to be all the same sort of issues over the last couple of years, but was there one issue in particular, other than the labeling law that you thought hit volume?

No, I think, George, is that we would take a look at the first six months, and say we're pretty much flat, if you take a look at our core organic volumes along those lines. And the labeling piece of this, when that kind of stuff happens, there's a little bit of disruption, in terms of how we manufacture the material. It's just not quite as smooth. But I wouldn't characterize, I mean, if we had any sales, it would be de minimis that we did not achieve in Q2, and they wind up in Q3, but very small.

Okay. Fair enough.

The second question I had, looking at your business, and how you longer term adjust pricing -- and I'm not trying to get you to make a forward pricing call, where do you stand in moving your business from price indices to longer term pass-throughs? I remember thinking something like 50/50, but did you make any incremental progress of that in the quarter? And what kind of progress would you hope to have over the next two to three years?

Yes, I mean, as we've talked in the past, George, that remains a strategic priority for us, in terms of our negotiations, and how we approach that with our customers, who are also interested in that kind of transparency, as again, we've outlined on previous calls. I'd characterize it, we continue to make progress with our discussions and negotiations and settlements that we've had year-to-date.

And we expect to have progress to continue into 2017 and 2018. We're never going to get 100% off of it, because we have an open market component as we've have outlined previously. But we certainly should be more towards that 70%, maybe even a little higher, it just depends.

Okay. I'm sorry, Steve, I'm sorry. Mike, you said by 2017, 2018, you think you can be in that range?

Yes, I'd say by 2018.

Okay. And then, one last question on cartons versus stand-up pouches, segueing off of Mark's question, I remember from past conference calls, you viewed it as a push, because stand-up pouches obviously, they need a secondary package. So to the extent that you get growth there, you get the growth in the secondary package. But then obviously, there's a threat of flexibles longer term. So if we just think about stand-up, do you think that actually winds up being a net positive for your carton business going forward, or not really, or kind of too hard to say at this juncture?

I wouldn't say it's a net positive for us. I think it, like I said, I mean, we compete against stand-up pouch as an alternative to our carton in some cases, and there are times that we actually lose out to that, and customers make a decision to go that specification.

The point I was making with Mark, was if you really think about the other part of that, where we see the retail ready also growing, in some of the strength applications, and people really wanting to get out of tertiary packaging, that's where we've been able to win, and in some cases disproportionately. And that helps offset some of the losses we've got in other spots, and we have been able to play with a draw.

Okay, Mike. That's fair. Last one for me. I'll throw it out there. I'm not sure you will be able to really comment too much to it. But traditionally you have a, let's call it, a mid-single-digit EBITDA growth outlook in most years. And we know how the formula works, and productivity is a big component of that.

Given what's been still a sluggish volume outlook -- we were talking about this just now, and given what has been probably more negative than positive pricing, do you think that in the normal range of expectations, that you'll be probably more in the lower end of your normal range, the next couple of years? Or do you think you can offset that through productivity, as we build out our models over the next couple years? Thanks, and good luck in the quarter.

Yes, it's Steve. Again, I want to be a little cautious on trying to hypothesize at this point around 2017. But what you do see us doing is investing back in the business, to consistently drive that $60 million to $80 million of productivity, which is right in the core of how the model operates. And over time, we would expect pricing and commodity cost inflation deflation to be, to offset. We will deal with periods of time, like we're in right now, where those get on, for some periods of time out of balance. And we're in one of those periods now, due to the deflationary environment that we've been experiencing.

But if you look past, over the last five years, we are still at net neutral on price and commodity inflation. Deflation, we, two years over the last four that were flat, and one up, one down. And we don't see that changing. And we would expect that to be the case over the mid-to long-term, setting aside the fact that in 2016 here, we're going through one of those periods, where it's modestly negative

All right. Thanks for your patience with the question. Good luck in the quarter. Talk to you soon.

Thanks a lot, George.

Your last question comes from the line of Mark Wilby BMO Capital Markets. Your line is open.

I've got just couple of follow-ons.

One, Mike, I wondered if you can talk about G-Box, and how that's positioned to take advantage of the big growth that we're seeing in the Mexican beer business. And it looks like, especially the Mexican beer business increasingly moving towards cans.

Yes, happy to do that. I mean, again, just a little primer and a little more detail if you will, about our business in Mexico. We actually have three converting locations there, one we've had for a long time in Quetro, which was largely focused on our food business.

And then, with G-Box we acquired a facility in Monterrey, and also one in Tijuana. The facility in Tijuana was recently constructed, and actually has a fair amount of capacity that we've been selling out, and plan to do so over the next 12 to 24 months, in terms of the opportunities that we're getting in Mexico, Mark. One great aspect of what we have in Monterey, is one of our customers is actually building a very large bakery there, and they're moving some volume down there.

And so, we will have an opportunity to obviously to be able to continue to grow there as well, and they're not alone. There's other customers of ours that have continued to expand their operations in Mexico, and we're able to take better advantage of that now, having a much larger footprint than what we had before, and redundancy which is also a key consideration for customers, as you know when they place business.

In terms of beer, we've seen some incremental growth in our beer business. And we would expect that we'll continue to be able to take advantage of that trend. And you're right, it is largely in cans, and that tends to fit our wheelhouse a little bit.

Okay. The other question I had is just over in the SBS market. The US export volumes, in most categories of SBS are down pretty sharply this year. I wondered whether that's having any impact in terms of how SBS producers are facing the domestic market?

It's great question. As you know, we don't make the grade, we buy a lot of it, and our actual purchases year-on-year are actually up slightly, and that's largely driven by our acquisitions here We see (inaudible) what you see. And I think the operating rates, what producers have been doing, is dialing those back to basically to try and match supply and demand a bit. But I, beyond that, I'd be speculating.

Okay. That's fine. Good luck in the second half of the year. Thanks, Mike.

Great. Thank you, Mark.

And that wraps up our Q&A portion of the call. I'll now pass the call back to Mr. Doss.

Thank you for participating on the call today, and we look forward to talking to you again in October.

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