Graphic Packaging Holding Co (GPK) 2018 Q4 法說會逐字稿

Good morning. My name is Marcella, and I will be your conference operator today. At this time, I would like to welcome everyone to the Graphic Packaging Earnings Conference Call. (Operator Instructions) Thank you. Alex Ovshey, Vice President of Investor Relations, you may begin your conference.

Thanks, Marcella. Good morning, and welcome to Graphic Packaging Holding Company's conference call to discuss our fourth quarter and full year 2018 results. Speaking on the call will be Mike Doss, the company's President and CEO; and Steve Scherger, Executive 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 Webcasts and Presentations link on the Investors 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'll turn it over to you.

Thank you, Alex. Good morning, and thank you for joining us to discuss our fourth quarter and full year 2018 results. We are very encouraged by the progress we made in 2018, creating a market-leading North American highly integrated packaging company well positioned for ongoing profitable growth in all 3 paperboard substrates. Our momentum heading into 2019 is accelerating. Notably, we successfully integrated the SBS mill and foodservice assets, generating $35 million in synergies.

Profitability improved in our CRB and CUK mill and global converting assets in the face of significant commodity input cost inflation.

Fourth quarter adjusted EBITDA of $248 million was up $56 million year-over-year. The SBS mill and foodservice assets, including the Letica acquisition, generated $56 million of adjusted EBITDA. We are driving improved profitability across these new assets by successfully executing our synergy and integration plans.

The pricing to commodity input cost relationship for CRB and CUK mill and global converting assets was $8 million positive during the quarter and $14 million positive in the second half of 2018 as we executed on multiple price increases across the business. In the fourth quarter, we successfully executed on the planned and extensive 41-day outage at our Augusta, Georgia SBS paperboard mill and started up a new folding carton facility in Monroe, Louisiana. In addition, we repurchased $119 million of shares in the fourth quarter at a value we estimate to be below the intrinsic value of Graphic Packaging. We have repurchased an additional $31 million of shares year-to-date in 2019, successfully reducing our share count by 4% over the last 4 months.

Pricing improved during the quarter, reflecting the benefits of multiple pricing initiatives. Importantly, we successfully implemented a third open-market price increase this year in December for our CRB paperboard. The multiple open-market paperboard price increases we achieved across our CRB, CUK and SBS paperboard grades over the course of 2018 and our cost models drove $80 million in pricing. And in 2019, we now expect to drive an additional $110 million in pricing.

While we continue to anticipate significant commodity input cost inflation, we are well positioned to generate continued profitability improvement in 2019, driven by our pricing, new product development and productivity initiatives.

Cash flow was solid as we generated $469 million in 2018. Our focus on growing our cash flow and allocating it efficiently is unchanged. We continue to make progress on our overall key strategic capital allocation priorities.

Before I discuss the progress we are making on the key strategic priorities and the details of the quarter, I'd like to provide high-level 2019 financial guidance. We expect 2019 adjusted EBITDA will be in the range of $995 million to $1,015,000,000, up compared to $971 million in 2018.

Our 2019 guidance reflects a $25 million positive price to commodity input cost relationship. Our productivity and synergy capture will again exceed our labor and benefits inflation. We expect 2019 cash flow to be approximately $500 million, up compared to the $469 million in 2018. Steve will provide more color during his remarks.

Now let me provide more detail and key highlights from the fourth quarter and discuss our strategic capital allocation priorities and how we executed against them in 2018. Organic volume in our global paperboard packaging business was up slightly in the fourth quarter and flat for the full year in 2018 despite weakness in big beer brands in North America. Our organic converting volume trend continues to outperform the markets as reported by ACNielsen, reflecting the ongoing success of our new product development pipeline.

Turning to operations. Our paperboard mills ran well during the quarter. Backlogs remain at 5-plus weeks for CRB and CUK and are at 4-plus weeks for SBS. As a reminder, our CUK and CRB mill operations are highly integrated with our converting platform, consuming approximately 87% of the paperboard we produce for these grades. Industry operating rates, according to the American Forest & Paper Association, across all 3 boxboard grades remain above 95% as of year-end 2018.

Now let me discuss our strategic capital allocation priorities. We completed 3 significant strategic capital projects in 2018. We successfully started up a new folding carton facility in Monroe, Louisiana and successful executed a recovery boiler upgrade at our Augusta SBS paperboard mill in the fourth quarter. We also installed a second curtain coater on our Macon CUK paperboard mill during the third quarter.

We are excited to announce the start-up of our new Monroe, Louisiana folding carton facility. The Monroe facility, which we believe will be one of the most productive and flexible folding carton facilities in the world, will replace our existing converting and warehouse infrastructure in the region. The Monroe facility is a highly flexible food and beverage folding carton manufacturing operation that is well positioned to service evolving consumer needs. The facility is strategically located near the West Monroe paperboard mill to reduce logistics costs. We plan to consolidate our 2 existing manufacturing facilities and 3 outside warehouses into this site. Over time, we expect to absorb an additional $75 million of volume from other higher-cost operations. We anticipate we will drive significant reduction in our fixed costs across our folding carton platform, utilizing world-class print, cut, glue and automation capabilities at this facility.

Total invested capital in Monroe will be approximately $178 million. $82 million of capital expenditures, mostly equipment related, have and will be incurred over the 2017 to 2019 time frame, and our balance sheet reflects a $96 million capital lease for the new facility. Once fully operational, we expect Monroe will contribute $30 million in annual EBITDA. We anticipate the facility will be relatively EBITDA neutral in 2019 due to the start-up and restructuring costs, with the benefits ramping up materially in 2020 and 2021.

Let me now discuss the Augusta SBS mill upgrade we completed this quarter. The extensive project was executed on plan and was completed in 41 days. The total investment in the project was $68 million. We successfully rebuilt significant portions of the recovery boiler. The project also entailed a significant upgrade to the mill's electrical and mechanical systems. The mill started up well in the second week in November following the completion of the project. Our team performed exceptionally well on this project. As a result of the investment, we are confident the long-term reliability and efficiency of the mill will be significantly improved. Early results have been very promising.

Let me now shift to acquisitions. We completed 2 additional strategic acquisitions in 2018 for a total consideration of $129 million. We closed the PFP acquisition in the second quarter of 2018 and the Letica Foodservice acquisition at the end of Q3 2018.

Let me briefly touch on the PFP acquisition, which we completed in June. We acquired 2 converting plants located in Tennessee and Texas. The acquisition expands our leading position in the growing paperboard-based air filter frame market, which we entered with our acquisition of Carton Craft in July of 2017. The business converted approximately 18,000 tons of paperboard, primarily CUK, and generated strong EBITDA margins on an LTM basis. Synergies from the acquisition will be driven by integration of additional CUK paperboard tons and cost efficiencies.

Shifting to the recent Letica Foodservice acquisition. We completed the acquisition on September 30. The acquisition extends our leading position in the growing paperboard-based foodservice market in North America. The transaction will further diversify our customer base, significantly enhance our geographic footprint and provide needed capacity to meet incremental demand for paper cups, resulting in the ongoing shift into paperboard solutions. The transaction is consistent with the strategy we outlined after the combination with the SBS mill and foodservice assets, specifically our intent to grow our foodservice business organically and through acquisitions to improve -- to drive improved profitability and higher integration rates across our SBS mills.

Shifting to our third strategic capital allocation priority, returning cash to shareholders. We returned $230 million to shareholders in 2018 through dividends and share repurchases. We repurchased $119 million of our shares in Q4. And to date, in 2019, we've repurchased an additional $31 million in shares. This $150 million in share repurchases was done at an average price of $11.35 and has reduced our fully diluted shares outstanding by 4%.

We announced our first formal share repurchase authorization in early 2015. Since then, we have returned $440 million to shareholders through share repurchases. Our fully diluted share count has declined by nearly 10% since January 2015. Today, we are pleased to announce our Board of Directors has approved a new $500 million share repurchase program. We will continue to repurchase our shares opportunistically when Graphic Packaging shares are trading below our estimate of intrinsic value and the returns of share repurchases compare favorably to other capital allocation alternatives.

Lastly, let me provide a recap on how we are executing on the SBS mill and foodservice integration. We completed the combination on January 2, 2018. The integration of the SBS mill and foodservice assets has exceeded our expectations to date. The SBS mill and foodservice assets, including the Letica acquisition, generated adjusted EBITDA of $233 million in 2018. This figure represents a significant improvement compared to the $210 million of pro forma LTM EBITDA, the assets generated in 2017. We captured $35 million in year 1 synergies, which exceeded our original 1-year target of $25 million. We have a high level of confidence that we will deliver $75 million in synergies by the end of year 3.

We have positioned the business well for organic growth in 2019. We expect growth will be driven by the ongoing shift to our paper-based solutions for polystyrene foam and other substrates. As I noted earlier, we successfully completed the planned and extensive outage at Augusta, which will drive significantly improved reliability at this mill.

We also implemented 2 open-market SBS cup stock and folding carton price increases in 2018 to mitigate commodity input cost inflation. Lastly, we completed the Letica acquisition, which increased our mill to converting plant integration rates. SBS integration rates are now approaching approximately 40%, which compares to appropriately 25% for the assets before the combination. Over time, we will continue to pursue acquisition opportunities in North America and Europe to further increase our SBS mill and converting plant integration rates.

And with that, I'll turn the call over to Steve Scherger, our Chief Financial Officer. Steve?

Thanks, Mike, and good morning. We reported fourth quarter earnings of $0.15 per share compared to $0.56 per share in the fourth quarter of 2017. Fourth quarter 2018 net income was negatively impacted by a net $21.9 million of special charges and credits that are detailed in the reconciliation of non-GAAP financial measures tables.

Fourth quarter 2017 net income was positively impacted by a $136 million benefit related to 2017 tax legislation. When adjusting for these items, adjusted net income for the fourth quarter 2018 was $69.4 million or $0.23 per diluted share. This compares to adjusted net income for the fourth quarter 2017 of $52.8 million or $0.17 per diluted share.

For the full year 2018, we reported earnings of $0.71 per share compared to $0.96 in 2017. Net income in 2018 was negatively impacted by a net $30.2 million in special charges and credits that again are detailed in the reconciliation of non-GAAP financial measures tables. Net income in 2017 was positively impacted by a $136 million benefit related to the 2017 tax legislation.

When adjusting for these items, adjusted net income in 2018 is $251.3 million or $0.81 per diluted share. This compares to adjusted net income for 2017 of $196.7 million or $0.63 per diluted share. We ended 2018 with over $1.2 billion of available liquidity and $2.9 billion of net debt. Total net debt decreased $7 million during the quarter. Adjusted for the GAAP classification change related to our receivables, securitization and sale programs that we previously discussed, cash flow from operations was a positive $815 million in 2018. We invested $395 million in capital, completed 2 acquisitions for a total consideration of $129 million and returned $230 million to shareholders via dividends and share repurchases. We ended 2018 with a net leverage ratio slightly below 3x adjusted EBITDA, within our 2.5x to 3x range.

Before I discuss our 2019 guidance, I'd like to review the 2018 price to commodity input cost relationship and our expectation for the relationship in 2019. In 2018, our business in total, including the SBS and foodservice assets, captured approximately $80 million in price. In 2018, the combined business incurred approximately $100 million in commodity input cost inflation. $100 million represents approximately a 5% rate of inflation on the total commodity input cost spent. The key drivers of inflation in 2018 were freight, chemicals and external paper. Freight and chemicals inflation were significant, $46 million and $34 million, respectively.

In 2019, we expect to achieve a positive price to commodity input cost relationship. We anticipate approximately $110 million in price in 2019, which reflects the realization of multiple price increases recognized in 2018. The $110 million does not include the recently announced $50 per ton open-market CUK paperboard increase. We expect commodity input cost inflation of approximately $85 million in 2019 to represent a 4% rate of inflation.

We continue to experience inflation across our freight spend, albeit below the rate we experienced in 2018. We anticipate modest inflation from wood fiber, recycled fiber, external paper, chemicals and energy in 2019. The wet weather in the U.S. South is significantly exacerbating wood inflation in the near term.

Now turning to full year 2019 guidance. As Mike referenced, we expect our full year adjusted EBITDA will be in a range of $995 million to $1,015,000,000. The key drivers of our 2019 guidance now reflects our entire CRB, CUK and SBS platform. As I just detailed, we anticipate the pricing to commodity input cost relationship to be a positive $25 million in 2019.

On performance, we expect base performance and year 2 synergies will be an $85 million benefit in 2019. We anticipate base performance to be $60 million and year 2 synergies to be $25 million. We anticipate our labor and benefits inflation will be approximately $45 million. We will incur modestly higher noncash pension costs and a normalization of long-term incentive expenses, which will negatively impact EBITDA by $20 million. Based on current foreign exchange rates, we expect FX will be a $10 million headwind in 2019.

We forecast first quarter adjusted EBITDA will be in the $235 million to $245 million range.

Finally, turning to cash flow. We expect cash flow will be approximately $500 million in 2019. The bridge from EBITDA reflects interest expense of $140 million, cash taxes of $35 million, pension contributions of $10 million and capital expenditures of $320 million. Our guidance is contained on the last 3 pages of the presentation on our website. Thank you for your time this morning, and I'll turn the call back to Mike. Mike?

Graphic Packaging had a transformative year in 2018. We completed the combination with the SBS mill and foodservice assets at the start of the year. This combination significantly increased our scale across the mill and converting footprint, provides a platform to grow in SBS foodservice and folding carton converting organically and through acquisitions and allows for significant synergy capture. We exceeded our 1-year integration synergy capture expectations. In 2019, we are focused on driving profitability improvement. We expect to benefit from the previously implemented pricing initiatives. We are also well positioned to drive benefits from our productivity and year 2 synergy initiatives that we anticipate will be in excess of our labor and benefit cost inflation.

We expect to generate robust cash flow in 2019, and we will continue to focus on creating shareholder value through effective capital allocation. We believe these actions will create value for all our stakeholders in 2019 and beyond.

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

(Operator Instructions) Your first question comes from the line of George Staphos from Bank of America.

I'll ask 2 questions and turn it over to be fair. First of all, Mike, when we look at productivity for 2019 and the base business being at $60 million, that would tend to be at the lower end of your normal range of $60 million to $80 million. And I was curious as to what is driving that when considering the fact that over the last couple of years, you've been spending on a lot of what appear to be relatively high-return projects. We recognize inflation sort of has gotten in the way, but what's driving that? The second question I have before I turn it over, when we look at return on capital for the company, and we can do this a couple of different ways, 2018 you saw net assets grow excluding goodwill and intangibles about 60%. Obviously, that was from the acquisition. EBITDA grew 35%. How do you intend to, over time, close that return on capital gap? Which are the tools you're going to use the most to try to improve return on capital from here given those metrics?

George, it's Steve Scherger. I'll start, and then Mike can add some additional color. I think if you look at our core productivity -- if you look at core productivity for next year, think of it as an $85 million capture of productivity, $60 million in our core and $25 million additionally in synergy capture. And some of that synergy capture does kind of flow through our core business as well as we optimized the entire footprint. So I would encourage you to think of it as more of an $85 million productivity capture, and yet it is on the lower end of what we've historically talked about. But I would actually raise it up to a conversation more around $85 million of productivity, a combination of the $60 million and $25 million. And we have a lot of confidence in our ability to achieve that. I think you raised an appropriate question on return on capital, which we agree with. And so much of what we're pursuing on a margin enhancement basis to move margins up over time so that we are returning cost of capital type returns. Margin enhancement over the next couple of years is critical. And as you've seen, the price-cost relationship moving that into a positive position this year and continuing that over time is really critical in addition to ongoing productivity above labor benefits inflation to our ability to get the cost of capital type returns.

And the only thing I'd add to that, George, relative to cost of capital, and thanks for the question there, is we have to -- now that we're kind of through the Augusta outage and some of the things we had to do to kind of position the business to handle a 41-day outage, we've got to become more efficient in our overall working capital, specifically inventory. And you'll see us continue to have that be an area of focus in 2019 and beyond.

Your next question comes from the line of Chip Dillon from VRP.

How much of those investments have to do with the Augusta project -- I mean, I'm sorry, the Monroe project? You mentioned that it would save about -- or you would receive $30 million in annualized EBITDA by 2021 with the $178 million of spend. And does that include the lost EBITDA from what every -- the old facility had or is that all incremental?

That is a net number, Chip. Thanks for that. We're really excited about what we're doing in Monroe. And really what -- as I talked about there, we're consolidating 2 existing converting facilities and 3 pretty large outside warehouses and putting it all under one roof. And we've made the investments in machinery for printing, cutting, gluing and a high level of automation that's going to result in significant variable cost and fixed cost reduction. We're not going to operate as many facilities. We're going to produce more or convert more material closer to our West Monroe mill, so we're going to have less structural logistics cost. As you saw, we'll pull in around $75 million of business from other facilities. And over the course of the next couple of years, our headcount across our system will go down roughly 250 people. So it's a big deal for us, and it's going to also be able to give us a lot of flexibility to meet evolving consumer needs, kind of growing away from some of the traditional gravure printing processes we have into a much more nimble and flexible flexography process, which we're very excited about.

And Chip, it's Steve. It's part of the confidence we have in out-year productivity 2020-'21, kind of that steady state of productivity we were just talking about on the previous question.

Okay. And just a comment. I know that it sounded -- it seemed kind of dour days when your stock was down around $10, but it was great that you took advantage of that in such a big way. My second question has to do with the CapEx at Monroe. You're missing the investments of $178 million, but a lot of it is capitalized leases. And maybe I should have boned up on my accounting, but does that portion of it flow through the cash flow statement? In other words, do you count the capitalized leased portion of that as CapEx? Or is that not going through the cash flow statement?

Yes, Chip. It's Steve. It was not part of CapEx, but the roughly $95 million shows up on the balance sheet in the form of debt as we account for it as a capital lease, and then there is inherent interest cost associated with it. So think of it as a $95 million investment, shows up on the balance sheet as appropriately relative to debt. We pay net interest, if you will, on that debt. And as Mike mentioned, then we see the significant EBITDA advantage of that to the $30 million as part of the return on the total investment.

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

A couple questions. First, is it possible on that $110 million of price benefit this year, is there any way to just help us parse at least roughly the amount that's kind of contractual pass-throughs versus market-based price increases?

Yes, Mark. It's Steve. If you kind of back up from it, all of the increases are, of course, contractual in nature in terms of they occur because we have successfully raised prices either in the open market or are incurring inflation. If you stand back from that, where that doesn't apply is in our open-market sales, which would be a -- the open-market sale of paperboard, which would be a relatively modest component of the $110 million. So the majority of it is contractual pass-through on converted product through to our customers, probably well into 60% to 70% of the total, with the remainder being the increases we have to pass-through for the sale of open-market paperboard, if that helps with your question, Mark.

Good. Yes, that's very helpful, Steve. The second question I had, just a little broader picture. I'd like to get your thoughts on whether these rising prices are inviting new capacity globally. We've had Stora talk about potentially converting a big machine in Finland to a CUK-type board. We've got Norske Skog talking about carton board up in Norway, and we've got I think Klabin talking about another carton board machine down in Brazil. So I'd just like to get your thoughts on if your -- if that's a piece of your thinking when you think about pricing strategy.

Yes, thanks for that, Mark. It certainly is. And I guess if you just take a step back though and think about last year and this year and what we're talking about, we will have incurred about $185 million of inflation and we're going to have about $190 million of pricing. So yes, prices are going up, but input cost inflation is also going up, and anybody that would make those types of products would feel that kind of inflation. So that would be the first point I'd make along those lines. I guess the other part of it is if their decision is made for those assets to be built and put into service, we're probably talking 2 to 3 years between start and finish of getting it done. And as you know, sometimes things are announced and then they get delayed a little bit. So it's hard to know exactly when those would come online if, in fact, they do. And then the other part of that, that we think through is certainly, there would be some portion of that, that could wind up in the North American market, but the more likely scenario, particularly for the producers you talked about in Europe, is that those tons stay in Europe or probably wind up in Asia and some spots. So yes, look, we continue to track the increases in terms of imports. Alex does that through U.S. census. And year-over-year, it's up 10,000 to 20,000 tons on FBB net. And so we are just not seeing a lot of imported paperboard come into this market, at least at this time.

Okay. Mike, is there any CUK produced right now in Europe?

There are some lightweights. For things that would be probably 18 points and under, there are some producers that would do that. It doesn't have the same strength and tear characteristics of us, but it's good paperboard. I mean, it's printable and we use it on certain applications ourselves. As you know, we buy a fair amount of tons in Europe.

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

I was wondering if it's possible to talk a little bit more about market conditions in box board and maybe kind of the customer response to the recent CRB and CUK hikes. You've had 8 hikes since the last year. And then maybe just following up on Mark's question. You identified $110 million in 2019 benefit from price. Given you have some longer lags, is it possible to say just kind of marking to market what level of price benefit from the announced hikes might flow through in 2020?

Okay. Why don't I go ahead and kick the first part of that question? I mean, from a customer response standpoint, of course, as we've talked about in the past, I mean, anytime you raise prices, those are challenging conversations. But we're doing it with operating rates that are very good on CUK, CRB and SBS. And the other part of that is it's supported by the amount of inflation we're seeing flow through the business, as I just kind of outlined for Mark. So that's kind of part and parcel to the conversations we're having with those customers. As you know, some of our pricing is driven by cost models, and that inflation is flowing through that as well. So that's how we're approaching those conversations with customers. And over the course of a 2-year period, we will raise our prices to them by $190 million.

And Anthony, it's Steve. It's early to talk about flow-through into 2020 from quantifying that. But clearly, we will see price benefit roll through 2020 based upon the lags and the more recently announced increases. I think a couple quarters from now, that will probably be the right thing to begin to give line of sight to. But yes, there is flow-through into 2020 that we know will occur at this point.

Okay, that's very helpful. And then, Mike, just following up on your comments. I mean, you've talked about getting customers off Pulp and Paper Week and more onto cost indices and you've talked about shortening lags. I'm just wondering kind of in the beginning of 2019, where are you in that process, both in the legacy business and the SBS business? Have those efforts kind of run their course? Or is there an opportunity to make meaningful progress in 2019? And is 2019 a year where you have maybe a larger number or maybe a smaller number of contracts that are up for renewal relative to recent years or a normal year?

Yes. Thanks, Anthony. Look, from our standpoint, every year, we've got a portion of our business, as you well know, that comes up for contractual renewal. And this year is no different in that regard. I wouldn't call it heavier than normal. Having said that, as I mentioned on our last call, our real focus is trying to drive those lags down to that 6-month timing. We need to get in a position where we can be getting a couple increases a year to recover inflation. And so that would be probably overweighting in terms of our commercial efforts, in terms of where our focus is versus cost model versus open market.

Your next question comes from the line of Mark Connelly from Stephens.

Just following up a bit on that. How sensitive is your price-mix assumption to fiber cost inflation? So if we saw OCC prices move back up, would that close to price-cost gap and recreate the problem? And I'm trying to get a sense of you've already made some changes to how these contracts are working, and they've been helpful. How much better could that situation be if you found yourself in that problem in '19 versus the lag that we saw in '17, '18?

Mark, it's Steve. I think just in terms of the mix between fiber, if you will, recycled versus virgin, et cetera, what we've assumed in the $85 million is some modest inflation across all of the fiber, both virgin and recycled fiber. As I mentioned, we're seeing some inflation in wood. If OCC were to accelerate, we would see that and we would, of course, appropriately take action as we have in the past. I think what you're seeing us do on the pricing front, though, is working to actually get ahead of the inflation so that we do recover beyond the current inflation given that we'd still have the shortfall that we've talked about quite extensively. Mark, the second question?

Yes. The second part was how much better -- you've made some significant progress going from 9 months to 8 months, but how much better could that be overall in 2019 if you get to where you want to be?

We're pushing very hard on the open contracts we have this year, Mark, and the ones we finished up last year to try to drive towards that 6-month timing that I mentioned. It's a key strategic commercial focus for us.

Okay. Helpful. So the follow-up question is your big productivity projects are done. Are there any new projects we should be looking out for in the next 12 to 18 months that might get announced? Or are we more likely to see a shift back in spending to M&A?

I think if you look at what we're doing right now and what we're excited about in 2019, is this is the year we really get to run the business. And you take a look at the investments we've made in our SBS platform, what we've done in West Monroe -- Monroe, I should say, and we're starting that facility up this year, it's a great opportunity for us to focus on commercial and operational excellence on our combined platform. That's really our focus here in 2019. In regards to M&A, we'll continue to look at those kind of opportunities as they come up. One of the things we have to look at there is comparing that against some of the other strategic priorities that we outlined here, and you saw us pivot in Q4 to buy more shares back given the intrinsic value of our stock and where it was trading at. And so we got the levers that we need to be able to do that and be able to be pretty responsive and adaptive to things as they occur. In terms of the M&A that we would look to do, Mark, I think you would expect us to focus more on SBS integration than other types of bolt-on acquisitions. We're pleased with the progress we've made. In 1 year, we're up to almost 40% now on the integration level. But as you recall, we laid a goal out there when we announced that deal on the combination that we wanted to be in a 70% to 80% range over a 3- to 5-year period. So we're down that journey, and that's really going to be our ongoing focus.

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

I just had a question on the relationship between the prices in the U.K. and SBS. Of course it's very clear, SBS has been higher. But with the proposed $50 a ton increase you guys have out there, that could put the U.K. at less than $60 a ton premium to SBS. Just wondering if you -- how you think about the sustainability of that longer term. Do you think that there will be opportunity or a need to increase SBS prices to get back into line with where we've been historically? Or do you expect or anticipate customers to maybe switch between CUK to SBS because of the lower price there?

Yes. Thanks, Brian, for that. Here's what I would tell you about our CUK, in particular. I mean, 80% of really the business that we run on that grade or so is really all driven by performance-based specifications that we've got established with our customers. As you know, it's got outstanding strength and tear characteristics. The sustainability profile of it is very good. People like the brown. You look that it's gotten -- global demand has been pretty good. We saw our global beer grow again last year, driven by some of the conversions off of shrink film and into fully enclosed in wraps. And so that part of our business continues to be very, very positive. And relative to the spread of SBS, we've kind of been the guys over the years that have converted SBS into CUK. If it makes sense for us to -- for whatever reasons with the customer to move some back into SBS where it makes sense, we can do that as well. So we've really got, with all 3 grades now in leading positions in all 3 grades, a lot of flexibility to service customer needs and really drive ongoing profitability. And that's how I would ask you to think about that.

Okay. And just a follow-up question on the performance for the year. It was -- I think if you take out the integration benefits from the SBS assets, performance was only up $42 million or so this year. It looks like next year, you're gunning for base to be up maybe $60 million in the contribution. I think it's a little bit lower than kind of where it had been the last couple of years. I think maybe that but -- some of the performance issues at Augusta might have factored in there a little bit. But just wondering sort of this year if you look back on it, where will there -- might have there been some shortfalls on that performance line. And if you think about 2019 or beyond, opportunities to take that back up again?

Brian, it's Steve. With regards to the $42 million that you're referencing in what we call core productivity, we -- if you look underneath that number, we operated at about a $60 million clip for productivity. There were 2 headwinds in that $42 million. One, as we've talked earlier in the year, we did incur more costs than we anticipated to start up the West Coast supply chain associated with the Santa Clara mill shutdown that probably cost us $5 million to $10 million. That was a headwind in the first half of last year. That has now stood up. We feel very good about that supply chain, what's been stood up there, but we did it in the face of, if you'll recall, a running freight inflationary environment last year when we kicked that off. And then year-over-year 2017 to '18, we had a very difficult and poor incentive compensation year in 2017. It's below expectations again in '18, but that was actually a headwind from 2017 to '18 that kind of tapped that number down relative. So there's some incentive payments long term specifically that drove a headwind in that $42 million. So it was incentives in Santa Clara, our confidence in the $60 million run rate is high, hence the $60 million we talked about earlier for 2019.

Your next question comes from the line of Ghansham Panjabi from Baird.

This is actually Matt Krueger sitting in for Ghansham. Given that you now have a full year of SBS asset contributions and you could potentially benefit from some sustainability focused substrate shifts, can you talk a bit about the underlying volume outlook for -- baked into your guidance and then the reasoning behind this assumption? I guess I'm just trying to get a sense for if we could see any sort of volume benefit from substrate conversion or the inclusion of the foodservice assets that are growing nicely?

Yes. I think if you take a look at how we performed in Q4, our overall volumes were up 0.5%. As we've kicked off the new year here in January, that is consistent with what we saw in Q4. And the overall demand profile has held up pretty well in the face of our pricing actions. And so that's really what we're looking at here in 2019 as we start the year and how we built our plan. As you now, Matt, as we've talked about this before, we plan for flat volumes and work really hard on new product development to be able to beat that. We did in Q4. We're seeing gains, as we've talked about, particularly on the foodservice side of the business around the perimeter of the store, cup conversions out of polystyrene foam, CPET trays that are being replaced with paperboard trays and also some of the conversions that we've seen in Europe out of shrink film into our fully enclosed in wraps. So that's pretty much the momentum we've got and how we built this operating plan for 2019.

Great, that's helpful. And then switching gears a little bit to the cash flow side of things. Where does working capital come in for 2018 on a full year basis? And can you talk about some of the projects that drove that performance? And then looking ahead, what do you expect from 2019? And what sort of efforts do you have underway there?

Yes, Matt. It's Steve. I mean, overall, we didn't have any what I'd characterize as material movement in working capital once you look at it on a post-acquired basis, the numbers we chatted about, for example, the $1 billion on inventory and the like. Our SBS platform ended roughly where it began. We built some inventory but came back down pretty neutral. The rest of working capital did not have what I'd characterize as any significant movement. What is important in the guide, we've assumed neutral again for working capital. As Mike mentioned earlier, that is an area of emphasis for us in terms of looking for opportunities to improve the overall return profile of the company by driving cash flow, particularly out of inventory. That's an initiative for us that we're very focused on this year. We haven't provided it in the cash flow as a net positive for us, but the overall guide that's in the cash flow is working capital neutral.

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

I'm going to follow up on Matt's question. So the volume comes in flat in your guidance and you're just saying you might perform a little bit better than that. I just wanted to confirm that.

Yes. I think right now, the way we built our plan for 2019, our volume assumption is flat and you see that really on the waterfall.

Okay. And in the substrates, just can you just walk us through just, first, are you seeing an uptick in conversation with your customers? And just kind of the mechanics or timing if some of your customers want to shift more aggressively into some of the products you offer that they would need to do and your response?

Yes. I think, Debbie, just to build on the comment that I was making, I mean, we're seeing a lot of new product development activity, particularly on the foodservice side of the business in conversions out of some of the products I talked about, CPET trays and shrinkwrap film into paper-based solutions that we provide. And so that's the biggest source of growth that we see. We drive it through our new product development initiatives. And as we were able to do in Q4, we saw 0.5% increase, and we're excited about the momentum we've got in 2019 as we enter the year here on those types of initiatives. And if we continue to make progress there, that would be above what we built our plan for. But right now, we've got an assumption there of relatively flat volume.

Okay. I guess what I'm also trying to understand is if there's like a switching cost. Or what are some of the barriers for your customers to more aggressively move out of plastic substrates into some of your product offerings? Is it cost?

Yes. I mean, the paper solutions, in general, as a general rule, are more expensive than plastic. So this comes down to a decision they're making around sustainability or the image of their products or how they want to position their brands. And you, like we, see the announcements that have been coming out around goals and targets that our major customers are putting out there relative to getting out of single-use plastics. And in some cases, paper provides an opportunity for them to be able to do that, and that's where we're placing our new product development activities.

And Deb, it's Steve. It also -- to your question for our customers, it does take time for them to execute on that. As Mike said, they have to make a decision to invest more, in essence, in their raw material, a cup or a plate or a folding carton. But also then they have to work through the transition time of actually bringing the product into the marketplace. And sometimes, that means either they may have to buy equipment, machinery to do the packaging or we may be investing with them. So it's a bit of a -- there is a timeline there that can be measured in 6, 12, 18 months depending upon the complexity of the conversion, Dunkin' Donuts being a good example. That's a multiyear transition. So we see a lot of activity, but the transitions themselves kind of come when they come and when the customers can, in fact, make the investment themselves as well.

Okay. That's helpful. And just one last quick one. On your Q1 guide, could you tell us what you've embedded in there for your price-cost assumption? And any other big levers that Mike called out?

Yes. Just at a high level on the -- we'll be price-cost positive in Q1. Pricing will be in the low -- probably low $30 million range in terms of as you look at the pricing, so a good start to the year on pricing. And we would expect under that scenario to be modestly price-cost positive, consistent with the overall guidance for the year.

Your next question comes from the line of Adam Josephson from KeyBanc.

Just one on your commodity cost inflation guidance. You're guiding to 4% inflation this year compared to 5% last year. Obviously, last year was a heavy inflation year. We're all seeing signs of a slowing global economy. Could you just give us a little more detail about what assumptions you're making in terms of percentage increases in those cost baskets and whether you think that guidance is perhaps on a conservative side or kind of more realistic than conservative?

Yes, Adam, it's Steve. I mean, we believe it's the appropriate assumption for the business based upon all of the negotiations that we've had with our suppliers as well as just the view into the marketplace. You certainly recognize, too, that there could be movements, obviously, given the economy. But if you stand back from the $85 million, we've got pretty good line of sight that there's $20 million to $25 million of inflation on freight and logistics. Not off of last year's 10% increase, but probably into that 4% zone is where it's heading. We know we're going to have external paper inflation in the $20-plus million range. Those are done. We pass those increases through to our customers, but that's going to happen. And we're seeing very real inflation on virgin fiber, particularly hardwoods, in the South. This is a very difficult time right now just given the weather, and we saw, for example, $14 million of wood inflation last year, and we're seeing that continue into the first quarter. So our line of sight to that first $60 million, $65 million of inflation for this year is high. The rest of it will come from modest inflation net from chemicals and energy, secondary fiber, for example. So we've got very strong line of sight to probably that first $60 million, $65 million. The rest was -- is obviously to be determined, but we feel $85 million is the right assumption for the business.

That helps a lot, Steve. And just back to Brian's question for a moment about the CUK, SBS price gap. I just want to try to better understand your answer. So historically, there's been a clear tight price gap between the 2, and SBS has almost always been higher and now that's flipped. And it's about to flip even further potentially. Would you have us think about -- should we think about SBS staying a higher price grade over time? Or should we think about CUK being higher? I'm just trying to, again, understand. Do you think the historical relationship between the 2 grades still holds? Or is it kind of out the window from your vantage point?

I wouldn't say it's out the window, Adam, but I'd say that it's definitely converging a little bit on those 2. I mean, the demand for CUK on a global basis is really, really good. And as you know, the 1.5 million tons that we manufacture, when we shut down Santa Clara, we transferred 65,000 of those tons into that mill system. And so operating rates are very high, it's in demand, consumers like it, it's got that brown look, that great sustainability feel. And I think right now, we're seeing ongoing support for that, and we expect that will be the case here as we go into 2019.

Your next question comes from the line of Arun Viswanathan from RBC.

Just maybe I can ask this a different way. I just want to understand the confidence level around the $1.5 billion. The last couple of years, you've had significant inflation. Could you remind us where you are behind on the price-cost side? If I remember correctly, it was around $300 million. And this -- the '19 price-cost should take you to about a $100 million hole. I'm just surprised the industry hasn't been able to push more pricing just given the rationalization and the high operating rates. I mean, is there a possibility that we could see more price actions across all 3 grades that would allow you to narrow that gap in 2020?

Yes, Arun, it's Steve. We certainly wouldn't want to speculate on future price actions, but what you have seen us do is through a very significant number of price actions that we did execute on 2018, we've put ourselves in a position to be price-cost positive in 2019. If you assume 2019 is positive $25 million, you're correct. There's still another $100 million, plus or minus, gap that we need to close to return the business to the profitability and margin levels that we have aspired to and relative to the kind of return profile that we want to see for the business. So we certainly recognize there is more to do to recover fully on our long-term commitment to price offsetting inflation over time.

And I think the only thing that I would add to that, Arun, to your question around being aggressive, I mean, in the last 12 months, there's been now 8 price increases on these 3 substrates that have been announced, and 7 of those have been -- have some form of recognition. And then we've got the CUK one out there now. And so I think in terms of graphic, we've been very aggressive to try to close that gap and recover the inflation that we're seeing flow through the business.

And is there any concern that if freight or if any of these other kind of pullback that you'd have to kind of forfeit some of that achieved pricing? Or is it kind of a tight enough environment that you could hold on to that?

I'll just point to, again, our overall volumes have held up well, operating rates are high and the pricing that we're pushing through is contractually driven, with the exception of a small amount of open market tonnage. So it tends to be pretty sticky.

Okay. And then just as a quick follow-up. On your uses of cash, obviously, the buyback is encouraging. And I imagine you would be opportunistic there. Maybe you could also elaborate on the M&A pipeline. What's your preference for size of deals and locations? And do you expect to continue that activity? And should we expect more deals consummated in 2019?

Certainly, there remains a focus for us from a strategic capital allocation pillar. That's unchanged. Having said that, we'd have to take a look at what multiples have done in the space. And obviously, in the overall packaging space, those have come down a little bit. And we're going to be pretty diligent in terms of what we do as you've seen us do historically here, where we've been pretty focused on what makes sense for us to overly go after. And in terms of the markets that we're looking at, North America and Europe tend to be the 2 biggest ones that we would go for. That's where we have the biggest positions already, as you know. And specifically, to sharpen that point a little bit, as I mentioned earlier, we would love to drive SBS integration opportunities first just given our strategic priorities. So hopefully that helps you a little bit.

Your next question comes from the line of Steve Chercover with Davidson.

First question. I appreciate the color that you gave us on the strategy to repurchase shares. I'm just wondering if the recent activity has any impact on your ability to repurchase the IP shares once the last one expires.

No, Steve. It's Steve. It certainly doesn't. Our balance sheet remains in a very good place. We're very pleased with our cash flow generation. We're still at under 3x levered. And if you look at the cash flow generation that we'll be capable of over the next 12 to 24 months, we're still very well positioned to successfully repurchase that partnership if IP were to choose to begin that process roughly a year from now. So we have that certainly in mind overall from a capital allocation perspective, but we feel good about where the balance sheet is and our cash flow generation and our ability to execute on that at the right time.

Terrific. And as a follow-up, it's along the line of Debbie's questions. Nestlé, a big customer of yours, is really making the push for sustainability. They're going to get the Nestlés Quick out of plastic into paper. Do you guys have any aseptic capabilities? Or would you go there?

Yes, thanks, Steve. So I'm not going to talk about individual customer specifications. The one you mentioned, the customer you mentioned and there's multiple others out there that I have talked about, again, single-use plastics and trying to find alternative supply, various timing that they laid out in terms of their objectives. But we do make some paperboard that could wind up in an aseptic package per se. We don't actually convert an aseptic type package at Graphic.

Your next question comes from the line of Daniel Rizzo of Jefferies.

You mentioned that cost -- it's expensive to switch to paper versus plastic. I was wondering if that still holds true for recycled plastic that these companies are now pushing towards. I can understand that single-use and commoditized plastic is a lot cheaper. But as they go to a higher substrates for them, is it just a little bit more, I don't know, the same? Or is it a little bit more equal?

Yes, Dan, it's Steve. Generally speaking, when we see a conversion in our business, it's from a polystyrene cup to a paper-based cup. Or it's from a wrap -- a plastic wrap into a paperboard solution. Generally, where we participate, which is not in single-use at all, but where we participate tends to be they're moving to a slightly higher-cost solution.

And if you think about it, Dan, just to put a bit little bit more on that, those tend to be on the plastic side. Recycled or virgin tend to be pretty thin gauged. Paperboard's got more material there, but it's also much more sustainable.

Okay. And then just one other question. With your freight costs and how they've been fluctuating, are you locked in? Like, is there like a yearly contract or is it just based on stock price?

No, we play in both those arenas, but the majority of our freight is under contract and it tends to be 1-year contracts that we would negotiate.

Your next question comes from the line of Mark Weintraub of Seaport Global.

Two questions. One, a quick one, small technical one. DD&A was about $10 million lower in the fourth quarter than it had been running. Anything in particular to account for that?

Yes, it's Steve. We were just working through our final purchase accounting work associated with IP, and it was an adjustment to bring it in line and through our -- the full year mix between depreciation and amortization, goodwill. So that was all associated with getting final on the purchase accounting for the International Paper -- the SBS and foodservice assets.

Got it. And then bigger picture. So last quarter, you talked about $100 million of visibility on pricing. You gave $110 million. Obviously, we had the coated recycled board increase in December probably playing a role. And then bigger picture, though, there seems to be 2 issues with what's happened the last couple of years. One is the timing, and it takes a while for the pricing and the cost inflation to catch up. And then there does also seem to have been this systemic slippage on contract renewals. And so the timing part can take care of itself, and you're taking actions to improve that. On the systemic slippage, are there actions that you have underway that can help to mitigate that? And/or how important is the inflationary environment? And if we're in a lower inflationary environment, then that actually can start turning to your favor and you can start making up ground, whereas in a higher inflationary environment, it was working against you.

Yes, Mark. So I'll take that. I mean -- and your point around timing is spot on. Obviously, you know what we're trying to do there. I talked about it earlier in the call. In regards to some of the leakage or slippage, as you talked about, this is a highly competitive industry. It's been that way. We compete for the business on an ongoing basis. As I mentioned, we've always got every year some portion of our business that comes up for contractual renewal. We've been able to navigate those fees. And in total, over this 2-year period now, we'll drive $190 million of pricing, which is significant to those customers. We're looking at the rules of engagement on all different aspects of our commercial activities, down through freight, down through order quantities, down through inventory holding requirements to make sure that we're improving our overall pricing position. And we're investing at Graphic to put additional resources in that part of our business to make sure that we're being very aggressive along those lines. So that's how I think, again, I would have you think about that. And that remains, as I mentioned, in 2019, our commercial activities, our key strategic focus for us. And to your point, if inflation did abate, that would inure to our benefit. But we're not planning on that. Steve gave you the guidance there. We gave you the buckets that we talked you through there, and we expect to see $85 million of inflation this year.

Your next question today comes from the line of Edlain Rodriguez of UBS.

Just one quick one on the volume and mix. The revenue side, it's been quite okay, but that hasn't been translated into, like, positive EBITDA contribution. Like is that something we should expect to improve going forward? Or is mix going to remain a headwind for you?

Yes. Thank you for that question. As you saw, we did see a little bit of mix erosion in 2018 as we saw some movement out of some of the big beer brands and some of the mix. It was a negative. As you kind of get from the earlier conversation on our guidance for the year, we're not assuming a net negative, if you will, on mix. Our overall volume, flat; mix should be relatively neutral. And when we look through the mix of business that is -- we believe will come through in the coming year, we don't expect that to be a negative.

And that does conclude our time for question-and-answers today. I'll now turn the call back to the presenters.

Thank you for joining us on our earnings call. We look forward to speaking with you again in April. Have a great day.

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