Graphic Packaging Holding Co (GPK) 2016 Q4 法說會逐字稿

Good morning. My name is Tiffany. I will be your conference operator today. At this time I would like to welcome everyone to the Graphic Packaging fourth-quarter and full -year 2016 earnings call.

(Operator Instructions)

Alex Ovshey, Head of Investor Relations, you may begin your conference.

Thanks, Tiffany. Good morning and welcome to Graphic Packaging Holding Company's fourth quarter and full year 2016 earnings call. Commenting on results this morning are Mike Doss, the Company's President and CEO; and Steve Scherger, Senior Vice President and CFO. To help you follow along with today's call we have provided a slide presentation which can be accessed by clicking on the webcast and presentations link on the investor section of our website at www.graphicpkg.com.

I would like to remind everyone that statements of our expectations, plans, estimates and beliefs regarding future performance and events constitute forward-looking statements. Such statements are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the Company's present expectations.

Information regarding these risks and uncertainties is contained in the Company's periodic filings with the Securities and Exchange Commission. Undue reliance should not be placed on forward-looking statements as such statements speak only as of the date on which they are made and the Company undertakes no obligation to update such statements except as required by law. Mike, I will turn it over to you.

Thank you, Alex. Good morning and thank you for joining us to discuss our fourth quarter and full year 2016 results. While our fourth quarter adjusted EBITDA was modestly below prior year period due to the accelerating commodity input costs and foreign exchange headwinds, we were encouraged by the return of core volume during the quarter and strong operating performance.

Our core volume improved in the fourth quarter relative to the third quarter, and our mills and converting plants operated well. In the fourth quarter, sales were up 3.2%, reflecting acquisitions and flat core volumes, which compares to a 1.4% volume decline in the third quarter. Our pricing was negatively impacted by the flow-through of the reduction in the [risky] CRB price index earlier in 2016, and cost model deflation.

Adjusted EBITDA declined 3.1% and adjusted earnings per share decreased $0.14 compared to $0.19 in last year's fourth quarter, reflecting the headwinds. For full year 2016 adjusted EBITDA was up 1.7% as benefits from acquisitions and strong productivity were partly offset by lower pricing, foreign exchange headwinds, and accelerating commodity input costs in the second half of 2016. Our core volume was roughly flat in 2016 consistent with prior years.

Cash flow generation in the business is strong as we generated $358 million in 2016, equivalent to 8.9% of our current marked path. Our focus on growing our cash flow and returning more of it to shareholders over time has not changed. We also continue to make progress on all of our key strategic capital allocation priorities. Before I discuss the progress we are making across the key strategic priorities and the details of the quarter, I would like to provide high-level 2017 financial guidance.

We expect our EBITDA to be up modestly in 2017, excluding the potential impact of the CRB increase we are actively executing. Steve will discuss more details in his remarks, but our 2017 guidance reflects accelerating commodity input cost inflation and the negative impact from price reductions in 2016. We expect commodity input costs and pricing headwinds to be most pronounced in the first half of 2017.

We expect that our cost models to benefit pricing in the second half of 2017. We expect a strong productivity year will offset the increased commodity costs and pricing headwinds, resulting in a very modest EBITDA growth in 2017. Very importantly, we expect 2017 cash flow to increase to the $380 million to $400 million range, up nicely compared to the $358 million we generated in 2016.

I will now provide more detail on the key operational trends during the fourth quarter, and then discuss in detail our three strategic capital priorities and how we executed against them in 2016. Core organic volume in our global paperboard packaging business returned to normal levels in the fourth quarter, an improvement compared to the 1.4% year-over-year decline we experienced in the third quarter of 2016.

The improved volume trend during the fourth quarter reflects the benefits of new integrated business won and a more normalized buying pattern by our larger customers. We consumed 85% of the paperboard tons internally in 2016 that we produced, up compared to 83% in 2015. Our core organic volume was flat for the full year 2016, consistent with our business model and outperformed market trends. AC Nielsen 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 pizza, and dry and frozen foods in 2016.

The global beverage market remained relatively healthy in the fourth quarter. The US beverage market continued to be led by growth in specialty drinks, bottled water, and craft beer. Our global beverage volume was up low single digits in the quarter and for the full year.

New product development remains an essential component of our organic growth strategy. We would like to highlight one important new commercialization in the quarter. On the brand enhancement side, we continue to make progress with the Brown Is the New Green initiative. We have shifted a bakery department of a large retailer out of an spf substrate into our CUK paperboard. The exterior of the bakery cartons will be brown while the interior will be white. This is a very similar transition to the one we executed with the McDonald's Chicken McNuggets business earlier in 2016. We expect this shift will add 7,000 tons of CUK demand to our mill system on an annualized basis, and we started production in the fourth quarter of 2016.

Turning to operations, our mills ran well and our backlogs remained stable at five weeks for CUK, and improved to north of four weeks for CRB. As a reminder, our mill operations are highly integrated within our converting platform as we consume 85% of the paperboard we produce internally. As we discussed on our third quarter call, we decreased CRB mill production by approximately 10,000 tons during the fourth quarter to reduce our inventory levels, specifically in CRB. With the continued rationalization of our converting footprint, less inventory is needed to service our internal and external demand.

Shifting to performance. Continued emphasis on improvement initiatives, variable costs and operating efficiencies contributed the majority of the cost savings in the quarter. We operated well and generated $21 million of net performance in the fourth quarter. We generated $73 million of net performance in 2016, right in line with our full-year expectations.

Moving on to costs. Commodity input cost inflation accelerated in the fourth quarter as we experienced higher secondary fiber, energy related and chemical costs. This marks a significant inflection point in the commodity costs as key commodity inputs trended lower from the first quarter of 2015 through the second quarter of 2016. We're up modestly in the third quarter and accelerated in the fourth quarter. With recycled fiber costs up 70% year-over-year in early 2016, we expect commodity input costs will be a headwind to EBITDA in 2017, especially in the first half of the year.

Over a reasonable time frame, we remain very focused on offsetting our commodity input costs with pricing consistent with our past practices. We recently announced a $50 per ton CRB increase, and are executing on the increase with open market paperboard customers. We also expect our pricing will benefit from the component of our business that is on cost model contracts, as higher inflation from late 2016 and early 2017 will be reflected in our pricing in the second half of 2017. We remain confident that our pricing initiatives will offset commodity inflation over time.

I will now go over three strategic capital allocation priorities and how we executed against them in 2016. Our first strategic priority is to reinvest into our business where we can generate compelling rates of return on capital projects across our mill and converting systems. We invested $295 million in capital expenditures in 2016, which we expect will drive a significant portion of our 2017 productivity. The $295 million is well above our baseline capital spend. Capital spend in 2016 included three compelling projects, which we have discussed in detail on previous calls, and I will briefly review.

In the second quarter of 2016, we invested $40 million to upgrade a head box and press section of our number 7 CUK paper machine in West Monroe, Louisiana. We expect this project to drive lower costs by reducing our energy usage on the machine, increasing CUK production by 30,000 tons and improving sheet quality, which will drive lower cost in our downstream converting facilities. In the third quarter of 2016, we invested $30 million to add a curtain coder to our number one paper machine in Macon, Georgia. As a result we materially reduced our usage of TiO2, which significantly increased in price during 2016.

Lastly, in the second half of 2016 we made $15 million of investments to upgrade low-cost converting facilities so we could transfer business from the now closed Piscataway, New Jersey and Menasha, Wisconsin plants, which were legacy higher-cost facilities. The closures were enabled by the acquisition of lower cost converting assets in late 2015 and early 2016. The Piscataway and Menasha closures will result in lower labor and fixed costs in 2017 and beyond.

The three capital projects were executed to plan and are now benefiting our earnings. We invested $85 million on those three projects, which we expect to generate over $30 million of EBITDA by year end 2017. Looking ahead to 2017, we expect our capital expenditures will decline relative to 2016 and will be approximately $250 million. There are two meaningful incremental cost savings projects we will pursue in 2017.

In the first quarter of 2016 -- or 2017 -- we will upgrade two head boxes on our number 6 paper machine in West Monroe, Louisiana mill. The project will result in a higher quality paperboard sheet produced, which will drive cost savings at our downstream converting facilities. We will also continue to invest behind our food and beverage converting plants in 2017 to drive lower costs. We will provide more detail on those projects as we execute against our internal plans. We expect the capital investments related to these project will allow us to continue to deliver productivity benefits to the mid to high end of our targeted $60 million to $80 million annual range.

Our second strategic priority is to execute on acquisitions at post-synergy multiples that are well below our trading multiple. We had a very busy first half of 2016. We closed the G-Box, Walter G. Anderson, Metro Packaging and Colorpak acquisitions. Acquisitions we closed in 2016 met the key strategic priorities that we look for in potential opportunities -- specifically, an enhanced product, customer and geographic profile, and further runway to aggressively reduce our cost base.

The integration of these facilities is on plan. We spent $364 million on acquisitions in 2016, and we estimate we paid approximately 6 times forward EBITDA, taking into account the synergies we expect to achieve. While we did not complete any acquisitions during the second half of 2016, the M&A pipeline is solid, and we remain focused on continuing to find and execute acquisitions at compelling post synergy multiples to enhance our geographic, customer, and product profiles.

Our third strategic priority is to return excess capital to shareholders to drive long-term shareholder value. We returned $229 million of cash flow to shareholders in 2016 through $64 million in dividends and $165 million in share repurchases, including $59 million of share repurchases in the fourth quarter and $16 million year to date. In 2016 we reduced our share count by 3.5%.

Our Board of Directors declared a 50% increase in our quarterly dividend to $0.075 per share in October, and authorized a new $250 million share repurchase authorization in January. The material increase in quarterly dividend in new share repurchase authorization demonstrates the confidence we have in our cash flow profile.

And with that I will turn it over to Steve Scherger, our Chief Financial Officer. Steve.

Thanks, Mike. And good morning. We reported fourth quarter earnings per share of $0.11 per diluted share, down compared to $0.17 in the fourth quarter of 2015. Fourth quarter results were impacted by a $13.9 million pretax, or $9.8 million after-tax charge related to business combinations and other special charges.

For the full year 2016, we reported earnings per share of $0.71 per diluted share, up slightly compared to $0.70 in 2015. Full-year 2016 results were impact by a $40.4 million pretax, or $27.8 million after tax charge related to business combinations and other special charges. And positively impacted by a $22.4 million one-time tax benefit recognized in the second quarter of 2016.

For the remainder of my comments this morning, references to EBITDA and earnings per share will be to adjusted numbers. Focusing on fourth quarter net sales, revenue increased 3.2%, driven primarily by volume from our acquired businesses. Price was lower by $13 million, and the strong US dollar negatively impacted sales by $19 million. Focusing on full-year net sales, revenue increased 3.3%, driven primarily by volume from our acquired businesses. Price was lower by $34 million, and the strong US dollar negatively impacted sales by $48 million.

Turning to fourth quarter EBITDA, the $6 million decrease to $175 million was driven by lower pricing, inflation, and FX headwinds, partially offset by $21 million of performance and $5 million of volume mix. Turning to full-year EBITDA, the $13 million increase was driven by operating performance benefits of $73 million and earnings from our acquired businesses. These benefits were partially offset by lower pricing, inflation and FX headwinds.

We ended 2016 with over $1.2 billion of global liquidity and $2.1 billion of net debt. Total net debt decreased $117 million during the quarter. In 2016, we generated $358 million of cash flow, spent $295 million in capital, made $364 million in acquisitions, and returned $229 million to shareholders via share repurchases and dividends. The year-end 2016 net leverage ratio was 2.76 times adjusted EBITDA, compared to 2.44 times at the end of 2015. We remain committed to our long-term net leverage target of 2.5 to 3 times.

As Mike mentioned, we're executing a balanced approach to capital allocation, which includes returning excess capital to shareholders. Since initiating our first $250 million share repurchase program in the first quarter of 2015, we've allocated $247 million to acquire 19 million shares or approximately 6% of the fully diluted shares at inception. We expect to complete the first program later this month and will begin executing on the second $250 million plan, which was authorized by our Board earlier this year.

Turning to full-year 2017 guidance, as Mike referenced we expect our EBITDA will grow very modestly in 2017 before considering the impact of the CRB price increase we are executing. We expect our 2017 cash flow will increase to a range of $380 million to $400 million. Key drivers of our EBITDA and cash flow include the following. We expect the 2017 pricing commodity cost inflation range to be negative $30 million to $60 million. The range is relatively wide, reflecting the recent run-up in recycled fiber and energy-related costs. We expect our labor and benefits inflation to be $20 million to $25 million in 2017.

On performance, we are well positioned to achieve at least the midpoint of our targeted $60 million to $80 million range. In 2017, we will see the majority of the benefits from the three strategic capital projects that we completed in 2016.

Shifting to volume, we expect core volume to again be relatively flat, consistent with the fourth quarter and full year 2016 results. We remain focused on outperforming the market through new product development, customer and geographic expansion, and substrate substitutions -- all consistent with prior years. Lastly, we expect FX will be a negative $5 million to $10 million due to a stronger US dollar.

While we expect to show very modest EBITDA growth in 2017, we expect EBITDA will be down year-over-year in the first half of the year. The most difficult comparison will be the first quarter of 2017, as we experience accelerating commodity inflation and will have the number 6 paper machine at our West Monroe, Louisiana mill down for 19 days for the installation of two new head boxes, which will negatively impact EBITDA by approximately $15 million.

We expect Q1 EBITDA will be in the $160 million to $170 million range. In the second quarter of 2017, the positive impact of not incurring the costs associated with the machine upgrade at West Monroe in April 2016, will be partly offset by our biannual maintenance cold outage at the mill. The machine upgrade in West Monroe in 2017, will mark the end of planned capital investments at our CUK mills that require meaningful production downtime to complete.

Hence, in 2018 and 2019, we do not expect to incur meaningful production down time at our CUK mills related to capital investments. We expect EBITDA will show solid improvement in the second half of 2017, reflecting the benefits of our capital projects, strong execution, and higher pricing related to pass-through of costs in our cost model contracts.

Finally, turning to cash flow, we expect cash flow will increase to a range of $380 million to $400 million, compared to the $358 million we generated in 2016. The solid increase reflect very modest EBITDA growth, reduced capital spending and continued strong execution on working capital. The remainder of our guidance is contained on the last page of the presentation on our website.

Before I turn the call back to Mike for closing remarks, I would like to say that we are looking forward to a robust set of interactions with the investment and analyst community in 2017. We have updated our investor presentation material and will post it on our website shortly after completion of the call today. Thank you for your time this morning. I will now turn the call back to Mike.

Thanks, Steve. Well, the full year 2016 results only grew modestly, and the first half of 2017 will be challenging. We remain confident in our business model and the ability to execute with excellence. We are keenly focused on recovering commodity input costs inflation through pricing and expect to make significant progress on this initiative in the second half of 2017, and into 2018.

We will plan for flat volume, and if targeted plans in place to outperform the market through new product development and substrate substitution consistent with previous years. And we will continue to be well positioned to generate productivity that is well in excess of labor and fixed cost inflation.

Lastly, and very importantly, we will continue to execute on our key strategic capital allocation priorities, specifically reinvesting in our business to drive strong cash returns on cash invested, executing and integrating strategic acquisitions at compelling post-synergy multiples and returning cash to shareholders through dividends and share repurchases, all of which drive long-term shareholder value.

I will now turn the call back to the operator for questions.

(Operator Instructions)

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

Yes, good morning.

Good morning, Chip.

Fist question has to do -- I might have missed this within all the -- and again, thanks for all the details. In terms of the guide for 2017 did you give us a volume number? And I'm thinking organic volume.

When you look at 2016 you mentioned how your volume, I think you said, was flattish while the industry was down low single digits at least on the food side. Can you point to anything that allowed to you sort of grow faster than the market, or am I just misreading that because you're including the beverage side as well?

Yes, thanks, Chip. This is Steve. I will just give you a couple of numbers, then Mike can follow up with some of the market context. Yes, our core volumes in 2016 ended the year flat overall consistent with prior years. Our guide for 2017 is that will continue. So our core volumes will be relatively flat.

We will get a small pickup, $5 million or so from the timing of acquired businesses, given that we acquired a couple of our businesses last year, midyear. So we will get a net modest $5 million or so EBITDA pickup from those acquisitions on a timing basis, but we are assuming that our core volumes will be basically flat.

Yes, Chip, just a little more color on that. Global beverage as you know grew about 1% last year. So that is a positive.

And then the other part of that is our new product development work, as you know, we target about 1% volume growth with those projects on an annual basis, and I gave an example of one where we are converting a bakery carton into our SUS paperboard at 7,000 tons. We string together a number of base hits like that, and that is how we are able to outperform the market.

Got you. And then I know you've said in the past you were a net buyer of -- and I might get this number a little bit off -- but a couple hundred thousand tons or so of leased board? Could you update us on that, what you see for 2016 and what you see for 2017? And do you see the recently announced merger of a couple -- at least one producer and one consumer affecting your supply there?

So your numbers are right. We actually purchased in excess of 200,000 tons of SBS. We buy another 100,000 tons of FPB board in Europe, which essentially are very similar grades. Look, we're a net buyer of those grades.

We've got long-term contracts with a number of producers there. We're able to get good pricing and steady supply. So we don't anticipate any changes because of that recently announced merger.

Got you. And then lastly, on the integration level you mentioned how it moved up, I guess to 85% from 83%? How should that look in 2017? I assume it would be a function of more converting acquisitions, but even without those, would that still move up at all next year?

Yes, there will be a natural slight bias up as we finish up the integration work that we're doing. And as you stated, our strategy is to continue to find tuck-in acquisitions that over time allow us to continue to integrate our own paperboard that we manufacture.

Got you. Thank you.

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

Hi, everyone. Good morning. Thanks for all the details and congratulations on the progress and the year. I guess the first question that I had, could you update us on the amount of your volume that is currently priced relative to commodity baskets, relative to what's driven ultimately by published indices?

I remember the figure being roughly around 50/50. At least, that's what you were driving to. If you could give us a bit of color on that, that would be helpful, then a couple of other questions.

George, this is Steve. Just briefly, we're still at that 50/50 range as we exited out of the year. As we mentioned, we'll continue to move that number up as contract negotiations continue to come around. But we're still in that 50/50 range.

Okay. Thank you, Steve. Second question, I noticed that pension income -- or expense fund to pension incomes -- I assume that's discount rate but can you provide a bit more color? Obviously it is non-cash, but just some thoughts there would be helpful.

Yes. There's a couple of things there on pension. You are right that there are some rates that have moved that have overall closed the gap that we had on pension. We were at about $200 million a year ago. That gap has moved down to about $160 million.

On the movement in pension expense, you are correct, it is mostly amortization. We have done some very good work consolidating pension plans, and it has resulted in some changes in amortization. So the $21 million reduction in amortization is mostly due to consolidation work that we have done on our existing pension plans. We will get a small uptick on the EBITDA component of pension, about $5 million year over year.

Thanks, Steve. Two last ones, and I will turn it over. Obviously this is a transition year, given some of the headwinds that you have been talking about for the last couple of quarters. No surprises there.

As we think about capital allocation at the moment, given where rates return are for your stock, as it is discounted in the market, relative to the productivity that you have coming this year, both from the investments last year and the ones that you have coming this year as well. Do you think the return to the equity holder will be more driven by the performance improvements and the productivity, or do you think that the value return could keep up with it from a return to the equity holder over the next 12 months?

That's question number one. And question number two, can you update us on how you are working with your customers, how you're altering your mix of business and customers relative to what has been the ongoing transition from center of store to perimeter of store? Is there any way to quantify what benefit or headwind that's been? Thanks, guys.

George, it's Mike. I want to make sure I get both of those. In regards to your first question, we really believe that this balanced approach that we've talked about relative to capital allocation is really what drives the best long-term shareholder value.

We've got very high return capital projects that have high teen cash on cash returns, and those are the ones that we're executing, and really what gives us confidence that we can continue to execute at the mid- to upper end of our range, that $60 million to $80 million that we talk about each year that we've got to knock out.

And then we did, as Steve said, we allocated $364 million of capital last year to buy some tuck-in businesses. Those are right on plan. We look at the forward multiple there, as I stated in my prepared remarks, 6 times, so very accretive.

And then lastly, we did allocate roughly $229 million that we returned to the shareholders through dividends and obviously, what we talked about relative to share repurchases. So we think that those three priorities are the right ones for us. And balancing them, given a year, and what our priorities are for that particular year gives us the flexibility to adjust and really be responsive to what we see in front of us.

In regards to the second part of your question, around center of the store versus the perimeter, that's really where our new product development work takes hold. That bakery carton I talked about is really driven by the perimeter side of the store. Retailers are upscaling their offerings, more baking in stores, more prepared meals in stores.

We're working with those customers to find solutions that really allow them to merchandise those products in a way that has eye appeal and shelf presence that really gives them market lift. So we're actively participating in that process, and we'll continue to do so here in 2017.

Mike, beyond new products is there any way to quantify the benefit -- sorry about that Stephen. Thanks again.

No, the 1% is the right number for us, George. It's been that way over the last few years. As you know, we've been able to outperform the market with that model. We think it's the right one for us going forward.

It's really that 1%, George, that allows us to offset some of the natural erosion that's occurring center of the store. That's really that balanced approach that gets us back to flat.

Thank you, guys.

Thanks, George.

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

This is actual Matt Krueger sitting in for Ghansham. How you guys doing today?

Good, Matt. How are you?

Good. So what is the typical lag between an inflection in your cost basket and the associated cost pass through? It appears as though the cost model contracts should trend positively by the second half of the year? But will you still be behind on price-cost given the more recent raw material inflation that we have seen?

Yes, Matt, this is Steve. As we have talked before, our typical lag on pricing, up or down, tends to be about nine months. And so as we are kind of in this inflection point right now, which we have started to experience in Q4, we're about nine months from passing that through on the cost model basis.

So as we mentioned during the remarks, second half of the year is when we should start to see some of those come back our way in terms of recovery on cost models. And then obviously the CRB price increase that we're executing on, assuming that rolls through, that would have an impact later in the year as well.

And so the nine-month lag for us continues to be roughly the right trajectory as we watched it on a deflationary basis roll through 2016, and now moving back towards inflation in 2017. The acceleration that you are talking about, it would be the same thing; the news from yesterday of accelerating OCC, for example. We would start to pass that through, if it stayed at those levels later this year.

Okay. That's helpful. And then touching on productivity briefly, how much of your $70 million plus in productivity stems from M&A activity in 2016? And then how much of the planned productivity benefit is from, say, organic productivity on a year-over-year basis?

Yes, we don't break it out precisely as that, but as we've talked in the past, we get a solid 33% to 40% of our productivity from capital investments that are good, strong returning capital investments. We get 335 plus or minus, depending upon the amount of acquisition work that we have going on from synergy capture, and then the other 33% just from day to day blocking and tackling with our Lean Six Sigma cost productivity efforts.

So they tend to really fall into those three buckets, which is why the deployment of capital at very strong returns is so critical for us, along with the tuck-unders, which gives us confidence in that being well in the range of $60 million to $80 million.

Okay, that's very helpful. That's it for me. Thank you.

Thanks, Matt.

Your next question comes from the line of Ketan Mamtora with BMO. Your line is open.

Two questions. First, I want to come back to the published price sources cost base contracts? Can you remind us where you can get back 50/50 number over the next two to three years, what your target is?

Yes, hi, Keton, it's Mike Doss. I would say, as we've publicly said in the past, our internal target that we have established over the next couple of years is to move towards 70% of the contracts on our internally produced paperboard that would be cost-model based.

Got it. And you think you will get in that the next couple of years?

That's certainly what our aspiration is and what we're working commercially to accomplish.

Understood. And then switching to the earlier question, on kind of the lag that you have, and you said it is about nine months? I'm especially wondering on the cost side, is there any way you guys could reduce that gap from the current nine months? Have you guys had any discussions around that?

Yes, certainly. Not all contracts are at that nine months. That's kind of an average, as we talked about in the past. We obviously want to migrate that closer in. And we work on that, but right now our current contracts, the way they reflect that is, they're at nine months.

Okay. And then switching to M&A, I mean, you mentioned that the M&A pipeline is pretty strong. Where are you guys most interested at the moment, whether it is mostly in North America or Europe or South America?

Yes, so we're laser focused on bolt-on acquisitions in North America and Europe that fit the strategic profile that I talked about in my prepared remarks. We're also -- we also look at opportunities in Mexico, and to a degree in Australia and New Zealand where we have strategic presences, as you well know.

I would characterize our pipeline as being full and active. As we've mentioned in the past a number of these businesses are owned by families, and timing tends to be a little bit lumpy along those lines, but we have the balance sheet capacity. We also have the managerial bandwidth to execute on those when we find an opportunity that is compelling and we believe the strategic profile and synergies are there.

Okay. Sounds good. I will turn it over. Good luck in 2017.

Thanks.

Your next question comes from the line of Adam Josephson with KeyBanc Capital Markets. Your line is open.

Thanks, Mike and Steve. Good morning.

Good morning.

One on the CRB industry fundamentals. Do you have reason to expect them to improve in the foreseeable future? And if so, why? And just relatedly, just given where industry backlogs are, compared to historical averages, what is your reason for thinking that the price increase will be successful?

Yes. So Adam, I guess let's spend a few minutes talking about that. If you really look at the year-over-year production published by the AF&PA, it's flat, year on year. Backlogs have actually started to improve against a difficult comp here in the last 90 days, if you look at the published data along those lines. In our case, we've drove up our integration level almost two percentage points, as you heard us talk about.

So we're running a little different play than others along those lines. We're also now seeing the return of what I will call, much more volatility on the secondary fiber side of things. We haven't seen this level of volatility on secondary fiber since mid-2011. And so there's an upward pressure on costs that just we haven't experienced over that period of time. So we are actively out there pushing this increase to recover the input costs, inflation that we're experiencing.

Sure. Thanks. A couple of others. If the increase were to succeed and fall, can you help us with what the EBITDA benefit would be to you this year alone, just given the lag that you mentioned earlier?

Yes, Adam, it's Steve. I think as we were just talking about, some of the nine-month lags, I think you would expect it to be relatively modest this year, if you kind of play out the natural progression of what we're executing on starting next week, the natural timing of when it would be broadly recognized, and then the flow through.

So I think overall, it would be relatively modest. And as we've talked with our cost model and overall models, you would expect roughly half of our volume would be impacted by that, as it flowed through.

And Steve, relatively modest, you're talking $10 million or less, I'm assuming?

Yes, low millions of dollars, yes.

Right. Okay. And just two others. What are your precise OCC cost assumptions for 2016? Are you flat lining the February price, or what exactly are you assuming compared to the February price and compared to the 2016 average?

Yes, Adam, if you look at the guidance that we provided, kind of the $30 million to $60 million headwind, if you go midpoint on that at $45 million, there's a $15 to $20 net on average recycled fiber cost increase inherent in that, is kind of how would you think about it. So it wouldn't necessarily represent yesterday's uptick. It would have been more what we've seen up until that time.

So, through January. Okay, Steve. One last one. The very modest EBITDA growth to which you guided, is it fair to assume that's in the single-digit millions?

Yes, I think that's a fair assumption. If you look at the guidance we've got a balance of positive news in the $70 million, $75 million range through productivity and modest acquisition volume offset with the price cost, labor and benefits, and FX headwinds. So they're relatively in balance if you look at the primary assumption set going into 2017.

Thanks a lot, Steve and Mike. Best of luck.

You bet.

Thank you.

Your next question comes from the line of Aaron Viswanathan with RBC Capital Markets. Your line is open.

Great. Thanks. I just want to follow up on that point. I guess you noted that price cost would be $30 million to $60 million of a headwind. If you were at the greater level of that, say $50 million or $60 million, would you still be able to achieve the very modest growth in EBITDA?

No, I mean, I think if you went all the way to the high end of that obviously given the midpoint, I think you would be flattish to very modestly down. Just being practical at the $45 million midpoint, if we were 15 higher than that, to the earlier discussion, that might balance it down very modestly down.

However, obviously we've got price initiatives that we're working through, the pass through of cost models, as well as the CRB price increase that we're executing on currently. But in the current set of assumptions as just defined, you would be correct.

Okay, great. And then another question on volume, looks like you have been trending a little bit better. Maybe you can just go into that a little bit, exactly why that is? And then I also had a question on down time, I know you took some in Q4, and maybe your competitors did as well. Do you think that's resolved, any oversupply issues in CRB, and that leads you to have more confidence in the price increase going through?

So I'll take your question around our down time. We did take 10,000 tons of down time in Q4 as we publicly stated here, and we announced that we were going to do that at the end of Q3. And really that was driven by the fact that with our more efficient supply chain, we just didn't need that inventory in our system, so we took it out.

We were going to continue to focus our production on meeting the demand that we have gotten. If you think about our demand, our demand was flat year on year in our core business, and it was up a little bit with the acquisitions we made. So we actually need a little more CRB flowing through our business. That's why we went from 83% to 85%.

So that is why we don't see the big swings in terms of the backlog. It tends to be fairly consistent. And right now our CRB backlog is around four weeks.

Your next question comes from the line of Phil Ing with Jefferies.

There's certainly been a lot of noise on the cross-border tax dynamic? Can you talk to us on how we should think about the impact on your business? I would imagine there's puts and takes with imports potentially being limited on the FEB side, but you do export some on the CK side yourself, and you've got some exposure to Mexico. Any color would be helpful.

Imports into our business tend to largely be chemical, commodity type things, and that's relatively small, and capital equipment that we would run in our business. We do export a fair amount of our CUK SUS paperboard, over a couple hundred thousand tons, as you know, Phil. So we are actively watching that and how that all develops and plays out. As we speak, I'm sure, like most others are doing.

Your next question comes from the line of Gail Glazerman with Roe Equity. Your line is open.

Hi, good morning. Can you talk a little bit more about what you are seeing in the waste paper markets? We did see the big spike in February, was that something you were expecting? What do you think is driving it? I'm just trying to get a sense of sustainability.

Gail, if I was that good I would be doing something else. I think I can give you at least what we see the facts being. If you look at what China pulled last year on OCC, it was really flat year on year, 2016 to 2015. However, in November, December, and into January, we did see an increase in exports.

And I'm assuming that when we see the published data here for all of January, that, that trend continued, and that's really what is driving the most recent announcement yesterday. We know that URB and CRB ran relatively flat. We know container board ran a little more steady in Q4, kind of making up for Hurricane Matthew.

So if you put that all together, there's certainly an upward projection on that, but I think that's the big question, is it a timing issue related to kind of some restocking that's going on in China, or is there a real healthy demand there that will continue to keep that secondary fiber running like it's been doing.

Your next question comes from the line of Danny Moran with Macquarie. Your line is open.

Hi, good morning, guys. Thanks for taking my questions. In terms of your productivity guidance, does that include the West Monroe down time headwinds last year? And then based on your internal projects, do you think you could remain at this level over the next few years?

It's Steve. Yes, it does. We've taken that into consideration. And that's one of the reasons also that the guide for Q1 is impacted by that investment. But, yes, it is -- the $15 million of approximate costs that we will incur is inherent in the $60 million to $80 million. So to your point, we will actually operate above that.

By another $10 million or $15 million within or above the range, if you will. And as we mentioned, these are important projects for us. We completed last year and this year, we will complete some very important projects on our CUK mills. And we have confidence that those investments will yield the benefits we expect, and we don't expect the same level of down time in 2018 and 2019 as we look out.

So critical investments for us. They do have a cost. But the return profile, as Mike mentioned, is exceptional and important to us. It's also important from a quality perspective in terms of the quality of the product that we produce and compete with on a global stage.

So yes, it's inherent in the productivity that we provided, and we do have confidence that it will continue into 2018 and 2019 as we look at the returns we expect on those investments and returns we have in the pipeline for future CapEx.

Got it. Thanks, Steve. And not to get too far ahead, but in terms of your cost pass-throughs, I think you mentioned you expect to recoup some of this in the second half 2017? Just given the lag, do you expect to get even more back in the first half of 2018? Thanks.

Yes, that would be the natural progression, I think, as you start to move into 2018, given current inflation realities. So if you assume those going forward that would be a fair assumption.

Your next question comes from the line of Mark Connelly with CLSA. Your line is open.

Thank you. You made several comments on inflation. You said you're committed to offsetting commodity input inflation with productivity. You said that you expect price to offset commodity inflation. You said productivity in excess of labor and all that. Can you parse that for me in terms of your short term and your longer term thoughts about costs and productivity?

Mark, this is Steve. Let me try it on a long-term basis first, then we can come back to the short term. If you look back over the last six to seven years, we have successfully had price offset our commodity input costs over time. And we've had dislocations that have occurred like we're experiencing now because of the lags, where we've had $40 million, $50 million in a given year, either plus or minus, relative to that spread.

And so just as Mike was talking about earlier, we're going through that inflection point now, and we would expect to turn that corner as we roll out of 2017 and into 2018. On a current basis you're correct in that, that spread instantly is right now probably at its maximum, given that we were in that deflationary environment and now inflected back towards an inflationary environment, particularly as it relates to recycled fibers.

Okay. And just one more question. If you look past these current CapEx projects, would you assume that the future CapEx that Steve just referred to is going to be more heavily oriented towards mills or box plants?

So Mark, it's Mike. I think it will be a combination of both of those as we look at our plans going out. We've got a number of projects on the converting side of the business that allows us to continue to consolidate our footprint, take out variable costs and fixed costs in the form of locations.

On the mill side, the major projects that we wanted to do, these head boxes in particular, we've now done them in Macon and West Monroe, finished those up this year. We put a curtain coder on in Macon. We've made a lot of progress along those lines. As Steve said, the major down time will be behind us after this year for those types of projects in our mill system.

Super. Thank you.

Thanks, Mark.

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

Good morning. Mike, I was hoping you could comment on how volumes have trended so far in 2017? Whether they're consistent with what you saw there in the fourth quarter and 2017 volume outlook? And tied to that, we've been reading about some of your customers in the packaged food area, rationalizing some SKUs in response to the weak environment. Just wondering if you think that had any impact on the choppiness in volumes over the last couple of quarters?

I think it probably did over the last couple of quarters. What I would say, Brian, is that we were pleased to see our largest customers come back and buy at a more normal pattern here in Q4. And that trend has continued year-to-date here in 2017.

Just one follow-up on the M&A environment, I know you said it's strong. Just wondering, with all the uncertainty around taxes, border taxes and trade flows, some of the currency moves that we've seen as a result of the last couple of months, if there's a little bit of hesitancy to pull the trigger on anything until we get some of this sorted out? Or if you think that's not really going to be material to how you act on things?

I would characterize anything outside of the US, that it just requires a further level of scrutiny and diligence, Brian, and that's really how we're looking at it. We want to continue to evaluate those opportunities and work those relationships. I think a lot of this stuff gets cleared up in the next 6 to 12 months, and we'll know how that all looks like.

But there's more diligence that is done there to make sure that we understand what the potential implications are. Having said that, we're running low-cost facilities in those geographies where we are currently located, and if we can find ways to continue to improve them, we want to be able to do that.

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

Good morning.

Good morning.

Looking at your guidance, I was wondering if it's possible to put a finer point on how much of a headwind price is in the first half? I think on the previous call you mentioned CRB might be $25 million. Can you quantify the cost model deflation on top of that, if that's the right number, or any color you can provide would be helpful.

Yes, I think it's fair to say, Anthony, that the majority of our price headwinds are going to play themselves out in the first half of the year, and then we'll start to turn that corner in the second half. So in terms of the spread, if you will, of price cost, given also that we were still in a deflationary environment in the first quarter of last year, that spread is more material.

It's most material in the first quarter, then it will begin to tighten up as the remainder of the year plays out. Clearly, Q1 will be the most substantive. I would characterize it as the majority of the price sensitivity or erosion that we've seen will play itself out in the first half.

Okay. That's helpful. And then the price increase last year in CRB that ultimately got rolled back? At the time there was a lot of reference to independent converter market being highly competitive. I was wondering, understanding it's still pretty early in the process, how you would compare what you are seeing in the marketplace today versus when that previous price increase was realized?

So, Anthony I can't speak to what others are doing, but with our input costs continuing to move up, we're aggressively pushing our price increase with our end-use paperboard customers. When you take a look at input costs being up 70% year on year, that's material. It's material for us, and I assume it's material for everybody else.

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

Hi, good morning, guys. It's actually Kyle White filling in for Debbie. Apologies if I missed this, but have you given the cost savings or annual savings from the recently announced projects for 2017 that you're expecting?

We haven't specifically, other than that the kind of return profile would be consistent with other capital investments that we make, and it would be inside of the $60 million to $80 million of productivity. So we haven't called them out as specifically -- for each of those two, but the return profiles are similar.

There is some quality investment inherent in the head boxes as well that's important for us, and that drives downstream benefits in our converting assets. But similar return profiles inherent in the $60 million to $80 million.

And Kyle, just to build on Steve's comments, those kind of investments are what give us confidence that we can be in the mid to upper end of that range over time. They're important for us because they really drive downstream converting improvement. As you know, we've got a very big converting business.

All right, thank you. That's helpful. Is there any working capital expectations in your cash flow for 2017?

There is, Kyle. There's modest improvement assumed in the cash flow, as you do the walk down towards the $380 million to $400 million of cash flow. We see some positive impact from working capital in the tens of millions of dollars that's inherent in there.

Cash taxes and pension cumulatively are similar to prior years overall, and work in the CapEx is down as we have talked. And so we've got very good work happening and teams engaged on working capital, and it's an area that we expect to see as a source in 2017.

I will now turn the conference back over to our presenters for closing remarks.

Thank you for joining our earnings call today, and we look forward to speaking with you again in April. Have a great day.

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