Sonoco Products Co (SON) 2021 Q2 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Second Quarter 2021 Sonoco Earnings Conference Call. (Operator Instructions) Please be advised that today's conference may be recorded. (Operator Instructions)

I'd now like to hand the conference over to Roger Schrum, Vice President of Investor Relations.

Thank you, Liz, and good morning, everyone, and welcome to Sonoco's Second Quarter Investor Conference Call. Joining me today are Howard Coker, President and Chief Executive Officer; Rodger Fuller, Executive Vice President; and Julie Albrecht, Vice President and Chief Financial Officer.

A news release reporting our financial results was issued before the market opened today and is available on the Investor Relations website at sonoco.com. In addition, we will be referencing a presentation on our second quarter results, which was also posted on our website this morning.

Before we go further, let me remind you that today's call and presentation contains a number of forward-looking statements based on current expectations, estimates and projections. These statements are not guarantees of future performance and are subject to certain risks and uncertainties. Therefore, actual results may differ materially.

Furthermore, today's presentation includes the use of non-GAAP financial measures, which management believes provides useful information to investors about the company's financial condition and results of operations. Further information about the company's use of non-GAAP financial measures, including definitions as well as reconciliations of those measures to the most closely related GAAP measure, is also available in the Investor Relations section of our website.

Now let me turn it over to Julie.

Thanks, Roger. I'll begin on Slide 3, where you see that earlier this morning, we reported a second quarter loss on a GAAP basis of $3.34 per share and base earnings of $0.84 per share, which is just shy of the midpoint of our guidance range of $0.82 to $0.88 per share. Despite strong volume growth in many of our businesses, our second quarter operational results were challenged by unparalleled raw material and other operating cost inflation that did outpace our significant price increases and solid productivity results across our portfolio.

In terms of the $4.18 difference between base and GAAP EPS, by far, the largest item was the $4.04 noncash charge related to the settlement of approximately $1.4 billion of U.S. pension liabilities, as our pension termination process substantially wrapped up in June. This charge was just below the estimates that we've been communicating for a while.

The next largest item also relates to a unique transaction in the second quarter. In May, we completed a tender offer for a portion of our 5.75% bond due in 2040 that resulted in a debt repayment of $63 million. This transaction also resulted in an after-tax loss on the early extinguishment of debt of $0.15 per share.

Next, you see our adjustments for normal nonoperating pension costs at $0.06 per share as well as $0.02 related to net favorable restructuring and asset impairments. The last item, all other, at $0.05 per share is mostly composed of a $0.03 foreign exchange hedge gain on our euro-denominated loan repayment and another $0.03 gain on a favorable foreign VAT refund plus interest.

So moving to our base income statement on Slide 4 and starting with the top line, you see that sales were $1.383 billion, up $138 million or 11% from the prior year period. I'll review more details about key sales drivers on the sales bridge in just a moment.

Gross profit was $263 million, $15 million above the prior year quarter. This performance resulted in a 19% gross profit as a percent of sales, which was 90 basis points below the second quarter of last year. SG&A expenses, net of other income, were $134 million, an increase of $13 million year-over-year. This increase was expected, and key drivers were higher expenses for normalized management incentives, increased group medical spend and higher costs for property insurance premiums and strategic IT activities, all this resulting in second quarter 2021 operating profit of $129 million. And I'll discuss the key drivers on the operating profit bridge in a few minutes.

Net interest expense of $17 million was $2 million lower than last year due to reduced debt balances and a more favorable mix of fixed and floating rate debt. Income tax expense of $30 million was $1 million higher than last year due to our higher pretax profits somewhat reduced by a modestly lower effective tax rate. Our current quarter's base effective tax rate was 26.4%. Moving down to net income. Our second quarter 2021 base earnings were $85 million compared to $80 million last year.

Now looking at the sales bridge on Slide 5, you see volume/mix was higher by $95 million or 7.6% for the company as a whole, with our industrial segment and All Other businesses seeing widespread recovery from the pandemic, somewhat reduced by lower volumes as expected in our consumer segment. Consumer Packaging volume was down $12 million or 2.1%, as our global rigid paper containers demand declined almost 6%. This was partially offset by solid growth in our plastics food businesses, which were up nearly 5% and modest recovery in our flexibles volumes, which was partially offset by an unfavorable mix of sales.

Moving to Industrial Paper Packaging. Volume/mix was up $65 million or over 14%, with a surge in post-COVID economic recovery across most of this business. Our global tubes and cores franchise rose over 13%, and global paper grew by nearly 4%. In addition, our cones and protective fiber businesses saw outstanding rebounds in demand.

And finally, our All Other group saw volume/mix growth of $42 million or 32% when excluding D&P, Display and Packaging, from 2020. This significant recovery was very broad across these businesses.

Now moving to price. You see that selling prices were higher year-over-year by $89 million as we increased prices to battle inflation globally. This was mostly driven by our industrial segment as we work to recover escalating OCC, freight and energy costs. We are proactively increasing prices in our consumer segment and All Other group. But timing of contractual price resets pushes some recovery of cost inflation into the third and fourth quarters.

Moving to acquisitions and divestitures. You see a top line negative impact of $80 million, which is driven by the recent divestitures of our Display and Packaging European and U.S. operations, partially offset by the Can Packaging acquisition completed in August of last year. And finally, the sales impact from foreign exchange and other was positive by $34 million, with the primary driver being foreign exchange translation associated with a weaker U.S. dollar year-over-year.

Moving to the operating profit bridge on Slide 6 and starting with volume/mix. Our higher sales volume of $95 million, combined with the impact of mix, had a positive impact on operating profit of $28 million.

Shifting to price/cost. I will remind you that this category includes the earnings benefit from higher selling prices as well as the impact of total inflation. In the second quarter, we had $26 million of unfavorable price/cost, with most of this impact falling in our Consumer Packaging segment. Within our consumer businesses, the inflation of resin pricing is much greater than expected and resulted in higher material cost of approximately $15 million in the second quarter. In our All Other business group, resin is also a key raw material, and this inflation drove almost $10 million of higher costs.

In our industrial segment, we were chasing higher OCC pricing during the second quarter, but were slightly positive in price/cost due to sales price increases. As usual, there is a slide in the appendix that shows recent OCC price trends, and you'll see there that Southeast OCC official board market pricing started the quarter or came into the quarter in March at $90 per ton until market pressures caused the jump to $125 by June, resulting in an average of $107 per ton in the second quarter. This represents a $7 increase relative to the second quarter of last year, and importantly, a $20 sequential increase over this year's first quarter.

Next is the impact of productivity, which includes all results from our productivity actions, including manufacturing, procurement and fixed cost. You see that our total productivity was a solid $22 million year-over-year, with a favorable impact across all 3 segments. Our productivity actions remain a very important focus area across our business as we work to overcome inflation and protect our margins.

Moving to acquisitions and divestitures. The $6 million decrease in operating profit is the net impact from the Display and Packaging divestitures and the Can Packaging acquisition. And finally, the operating profit change in foreign exchange and other was unfavorable by $16 million with various moving pieces, but mostly within SG&A expenses.

Moving to the segment analysis on Slide 7. You see that Consumer Packaging sales were up over 4%, driven by higher selling prices, positive foreign exchange translation and the addition of Can Packaging, somewhat reduced by lower volumes as COVID eat-at-home behaviors have moderated from the pandemic-driven highs of last year. Consumer segment operating profit fell by 29%, driven by significantly unfavorable price/cost and the softer demand. Our consumer segment margin declined to 10% versus the second quarter of last year when the margin was a very strong 14.7%.

Our industrial segment sales grew by almost 34% due to year-over-year price increases, strong recovering demand as well as the impact from positive foreign exchange translation. Industrial's operating profit surged by 74%, driven by the significant global turnaround in demand and the associated leveraging impact on manufacturing productivity. The segment's earnings were also lifted by favorable price/cost and procurement productivity. Our industrial segment's operating profit was 9.5%, a strong 220 basis point increase when compared to 7.3% in the second quarter of last year.

And finally, All Other sales declined by nearly 19%, driven by the sale of our Display and Packaging businesses, but significantly offset by the great demand across the segment's businesses. Despite the sale of Display and Packaging, operating profit increased by 23% due to the strong demand and the associated positive impact on productivity. Operating margins improved to 6.2%, 210 basis points higher than the prior year's 4.1%. For the total company, sales were up 11% and operating profit improved by 1.6%, resulting in a company-wide operating profit margin of 9.3%.

Moving to cash flow on Slide 8. In the middle of this slide, you see that our year-to-date second quarter operating cash flow was $102 million compared with $282 million last year, a decrease of $180 million. The primary driver to these lower cash flows was our contribution in the second quarter of $133 million related to our pension, settlement and termination process. In addition, we consumed $19 million more dollars more cash in our net working capital balances, which was driven by both inflation and increased level of business activity. Overall, our management of net working capital remains very strong.

So back to the top of this slide, we had year-to-date GAAP net loss of $262 million compared to a profit of $135 million in the prior year period. Most of this decrease was the $406 million after-tax noncash settlement charge related to our pension termination process.

Moving down to our year-to-date CapEx spend. Our net spend was $93 million so far this year compared to $72 million for year-to-date at second quarter 2020. This $21 million increase is mostly due to spending on Project Horizon. We do expect our CapEx spend to ramp up over the balance of this year as we progress on Project Horizon and other important projects. Howard will be providing additional comments about Project Horizon in a few minutes.

So this takes us to free cash flow of $9 million compared with $210 million for the same period of last year, again, mostly driven by the pension termination process, increased working capital and higher CapEx spend. Finally, we paid cash dividends of $90 million year-to-date this year compared to $86 million for the same period last year.

On Slide 9, you see that our balance sheet and our liquidity position remain very strong and reflects several strategic actions executed during the second quarter. Our second quarter 2021 consolidated cash balance was $264 million, a $301 million decrease from year-end 2020. This decrease was driven by significant deployment of cash, which included the accelerated share repurchase of $150 million; the tender offer for our 2040 bonds which retired $63 million of principal; the repayment of our maturing $100 million -- $180 million euro-denominated debt; and finally, the $133 million of pension contributions. These cash usage were somewhat offset by the Display and Packaging U.S. gross proceeds of approximately $80 million and operating cash generated by our businesses.

Our consolidated debt at the end of the second quarter was approximately $1.6 billion, a decrease of $102 million from year-end. This decrease was driven by the debt repayments that I just mentioned, partially offset by our return to the commercial paper market.

Finally, on Slide 10. For your reference, we've included our quarterly earnings history for the last 2 years at the top. You can note that the now-divested Display and Packaging businesses contributed $0.08 and $0.09 of EPS in 2019 and 2020, respectively. But focusing on this year and our third quarter guidance, you see that our range for Q3 base EPS is $0.87 to $0.93 per share. As Howard will describe further in his comments, this guidance assumes continued solid demand for our products, but also continued inflation headwinds.

I'll highlight that our base earnings effective tax rate in the third quarter is estimated at approximately 21.5%. Embedded in this assumption are an approximate 26% tax rate on base earnings and the positive impact from a unique onetime $5.5 million release of a reserve for uncertain tax positions.

Specific to our expected full year effective tax rate, we continue to assume a rate of approximately 25%. This is unchanged since our original guidance in February and has always included the impact of this $5.5 million benefit. We were previously uncertain of the timing, but now have visibility for the third quarter.

You also see on this slide that we are not changing our full year base earnings per share guidance range of $3.60 -- I'm sorry, $3.50 to $3.60. And we're also not changing our full year free cash flow guidance of $270 million to $300 million, which does exclude the $133 million of pension contributions made in the second quarter to fund our U.S. pension liability settlement.

So this concludes my review of our second quarter results and our outlook for the third quarter and full year. So I'll turn it over to Howard.

Thank you, Julie, and good morning, everyone. Let me provide you with my thoughts on our second quarter performance. I'll also give you a brief update on Project Horizon and our new sustainability commitments. I'll close with what we see entering the second half of the year.

Our balanced portfolio of consumer and industrial businesses did well in the second quarter, as we were well within our guidance range despite unprecedented inflation and some lingering effects of COVID-19, where there remain lockdowns in parts of Asia, Europe and Latin America as well as hotspots here in North America. Our industrial segment and All Other group of businesses experienced double-digit volume growth during the second quarter, with demand returning to near pandemic levels. As we anticipated, consumer volumes normalized from the pantry-stocking record set during the second quarter of last year, although demand remains above prepandemic levels. As Julie mentioned, our biggest challenge in the second quarter and, frankly, the rest of 2021 is battling significant raw material and nonmaterial inflation.

In our consumer business, we have seen some resin prices nearly double from last year's level, while film, metals, paper, packaging and freight are up mid-single to double digits. Old corrugated containers, our largest raw material, have moved up from $85 a ton in January to $145 a ton in July. We now expect our external expenses, excluding OCC and label, to rise an additional 2.5% over our prior estimate made just last quarter. This means that our cost globally will increase approximately 8%. In addition, as Julie noted, we've seen S&A expenses increase due to higher property insurance, more normal medical and incentive costs and additional [PT] costs.

Having said that, I'm extremely proud of how our global team has worked to pull all levers to cover these costs, including driving productivity, controlling expenses and implementing necessary price increases to fully recover all commodities and other cost increases. The fundamentals of our business are in good shape. Volume, productivity, working capital, cash management, all are exceeding expectation. Inflation is the issue.

Now let me switch gears and give you a brief update on Project Horizon, the $115 million conversion of our #10 corrugated medium machine to a state-of-the-art, uncoated recycled board machine with approximately 180,000 tons of annual capacity. We now expect the conversion to be completed by the end of the second quarter of 2022, and there are a number of significant construction projects underway that will modernize the infrastructure of the entire complex and allow for more efficient handling of raw materials and finished goods.

A key element of Project Horizon is construction of a new stock prep system to provide approximately 650 tons per day of recycled fiber to the rebuilt #10 machine and other Hartsville cylinder machines. The new stock prep system will allow for increased consumption of lower-cost mixed paper along with OCC. We expect this system to be operational by the end of October. As previously announced, we expect to exit the corrugated media market by early 2022 to allow time for the conversion. And our strategy is to keep our URB capacity neutral at approximately 1.2 million tons.

As a result, we recently announced that we expect to permanently shut down our Hartsville #1 and #9 machines, which will reduce annual capacity by approximately 70,000 tons. The exact timing of these closures will depend on market conditions as well as the start-up of the converted #10 machine. As a reminder, last year, we permanently shut down a 30,000 ton per year machine in Hartsville and our 95,000 ton per year Trent Valley, Ontario paper mill, which -- that particular machine produced both recycled linerboard and URB. Project Horizon is expected to drive approximately $30 million in annual cost savings by 2023, ensure the long-term viability of the Hartsville paper mill complex and place our U.S. and Canada mill system into the top quartile of performance from a cost perspective.

More and more investors are asking us about sustainability, so I thought I would provide some updates regarding new commitments we have made to reduce our environmental footprint. I think we can all agree that packaging plays a fundamental role in providing sustainable, safe and hygienic delivery systems for food, medicines and other essential products around the world. As a top recycler in the U.S. and the global leader in the production of recycled paperboard along with providing a diverse mix of consumer, industrial, health care and protective packaging, we believe it is our responsibility to address environmental challenges such as climate change based on data-driven scientific criteria. While we have reduced our normalized greenhouse gas emissions by approximately 25% since 2009, we're committed to doing more.

After much research and planning, we have set ambitious new targets to reduce our global greenhouse gas emissions in line with the Paris Climate Agreement to limit global temperatures to warming to well below 2 degrees C above pre-industrial levels. Specifically, we've committed to reduce absolute scope 1 and 2 greenhouse gas emissions by 25% by 2030 from a base -- 2020 baseline. We have also committed to reduce absolute scope 3 greenhouse gas emissions by 13.5%.

In addition, we're actively studying necessary operational changes, technology developments and market changes that would be required to achieve net 0 greenhouse gas emissions by 2050. I'm pleased that our targets have been reviewed and validated by the Science Based Target initiative. To drive compliance of our goals, we'll begin incorporating our sustainability and environmental metrics into each of our business units' plans and management's incentives.

To help our customers achieve their sustainability targets, we continue to expand our EnviroSense line of more sustainable packaging that incorporates increased recycled content and improve recyclability. EnviroSense is represented across our portfolio from rigid plastics to flexibles to our iconic paper containers. In fact, we're working with customers in Europe to transition their products into our EnviroCan paper containers today. We expect this trend to continue.

We'll be providing more detailed information on all our environmental, social and governance activities, both from a commercial and corporate perspective, next week when we publish our annual corporate responsibility report. We hope you'll take some time to download and better understand our commitments to our purpose, our people and our planet, which happens to be the title of our new report.

Let me close by going over some of the things we're seeing heading into the second half of the year. It's said that the only thing we know about the future is that it's going to be different. Clearly, what we were expecting just 6 months ago around inflation is different than what we're seeing now. As we enter the third quarter, we remain confident that our business will continue to benefit from the post-pandemic economic recovery.

In our consumer-related businesses, we expect volumes to remain a book prepandemic levels despite more normalized demand for food packaging as consumers moderate their at-home eating patterns. However, we also expect certain COVID-impact markets such as confectionery, food service and even construction products should continue to benefit. We also expect further recovery in our industrial markets as illustrated by the historically high backlogs for our paperboard globally and demand for global tubes, cores and cones which are strengthening to prepandemic levels.

Our biggest challenge will continue to be managing and recovering escalating raw materials and nonmaterial inflation. We believe prices for most resins are nearing a peak, and prices could begin to ease into the fourth quarter. Recovered paper prices on the other hand may still rise this quarter due to strong domestic demand. That said, we still believe OCC prices will follow historic patterns and likely decline in the fourth quarter as collections improve and demand should slow.

We're currently behind the price/cost curve in several of our businesses. However, price recovery mechanisms, including announced price increases, should allow us to fully recover these costs over time. We believe Sonoco is well positioned given our resiliency over the last year and improving trends in our primary-served markets. Our strong financial position supports our value creation strategy to invest in ourselves to drive growth and margin improvement while consistently returning cash to shareholders.

Now with that, operator, we would be pleased to review any questions.

(Operator Instructions) Our first question comes from George Staphos with Bank of America.

Just a quick question maybe to start for the third quarter, Howard and Julie. Could you give us your rough approximation of what you think price/cost will be either in millions of dollars or just from an EPS standpoint? And related to that, just for comparison purpose, I think you said the net Display and Packaging divestiture -- divested businesses were something around $0.08 or $0.09 a quarter, if I heard you correctly. Would that be fair as an adjustment factor we should look at for the third quarter as well? Or let me know what should be the case there. So that's the start.

Yes, I think you're right on the D&P side. But based on specificity, I will pass on to Julie.

Thanks, Howard. So yes, you're right. The divestiture of D&P, with a little bit of offset from the Can Packaging acquisition, so call it all of our M&A there, is about $0.08 of kind of, call it, a headwind, a pullout from Q3 of last year. And from a price/cost perspective, I'd say we are expecting that to continue to be slightly negative in the third quarter as we -- obviously, and Howard and Rodger can provide more color. Obviously, a lot of dynamics going around contract reset, timing around price increases as well as just open market price increases. But I think nonetheless, with the inflation, we continue to expect still slightly negative year-over-year.

Okay. But that implies that you'll see some fairly good improvement sequentially in price/cost 2Q to 3Q. And should we assume that both industrial and consumer are slightly negative on price/cost? Or can industrial keep its net positive as it was in 2Q on a price/cost basis in 3Q?

Yes. We are expecting industrial to stay slightly positive price/cost, although, I mean, there's -- and it could be neutral, again, to OCC headwinds. Rodger and Howard can talk a little bit more about that. Obviously, kind of uncertain there but upward price increases. And so it's -- I think puts and takes, quite frankly, across the segment, it really is going to depend on the continued inflation in resins and OCC especially. But I don't know if, Rodger, you want to add any more color on that?

On the consumer side, George, as you would expect, fairly significant price increases going through in July. Most of our major CPGs in the consumer business, we have quarterly price change mechanisms where we recover the resin 3 months in arrears. So for instance, in July, we're implementing March, April, May increases. We calculate in June. We put that in force in July. So we saw more increases in June and July.

So we will still see some negative price/cost in consumer around resin. In the third quarter, we expect to start catching that up. We will catch that up in the fourth quarter.

Okay. My last one and I'll turn it over. Can you reflect on what you've learned about your consumer packaging businesses and kind of the top 2 or 3 ones as we look out the next several years, right. Paper cans, composite cans at a surge, and now they're normalizing. Obviously, there's a lot of margin in that business. Flexibles has remained somewhat pressured from a volume standpoint, although a lot of that is the convenience angle and confectionery. And you're seeing growth in consumer.

What do you think is the right growth outlook for those businesses looking out the next couple of years? And how much do you think the consumer has maybe readopted? What increment to growth normalized do you think you've gained in that business relative to what would have been the case pre-COVID?

Thanks, George. I'm not going to try to forecast the exact percentage, but just talking generally, if you talk about our paper can business, as we noted, volumes are ahead of 2019 levels. We do think there's been continued adoption here in North America in some of the categories. What's really exciting at this point in time is what we're seeing on an international perspective, the anti -- let's just call it, sustainability efforts.

We're just -- where our funnel is continuing to build and drop through in terms of folks wanting to switch over to a paper container from another substrate. And it really is an exciting opportunity. If we look at, on the can side with Asia, we've seen double-digit growth just quarter over quarter over quarter for a number of years now, and we expect that to continue as well.

Flexibles, trays, the plastic tray business, we're really happy with how that business -- specifically flexibles is being managed right now. Relatively flat in the quarter, but we saw really good productivity throughout the business. We're going to see pickup. I think as we head into the future where we saw softness in confectionery, other convenience and holiday-related products, it was actually a bit of a drag on that business. So we expect that to be on a positive slant as we move forward.

And I noted quickly about our plastic food frozen sector, that's the one that's really interesting that it's actually -- the volume has actually tracked ahead of last year during the pantry stock. And I think that one's carrying probably more long-term new consumer activity than any other. And the work from home, that will settle down, but there will be more people working from home than ever. And I think that just -- because these consumers have been driven to the market to pantry stock, and they're finding the product is good. They'll be working from home. They'll be grabbing frozen meals out of their freezers. So really feel very, very bullish about the consumer sector in totality, not through just the end of this year, but into the future.

Our next question comes from Josh Spector with UBS.

Maybe just a follow-up on some of the sequential bridging. I guess if I listen to what you're saying about volumes being consistently strong, you're talking about things getting better. You're getting pricing in the second half. But your updated guidance kind of implies flattish operating income in 3Q and maybe similar for 4Q. So what are the incremental negative factors in the second half which hold back you from perhaps lifting guidance versus prior expectations?

Josh, really, it's just the continuation and lag of recovery of this hyperinflation period that we're in right now. I think Rodger did a good job in explaining particularly resin. I mean that's the one that has escalated the most. We have solid recovery mechanisms. It's just timing. And I think as Rodger pointed out, that it's, on average, we get 3 months in arrears with the fourth month or the month prior to the quarter is the calculation month.

So as we look at Q2, inflation that we saw in June is going to carry into Q3, and we still are expecting to see inflation in early Q3, with that moderating as we -- in that quarter and go into Q4. And that's how we're expecting things to play out.

So just so I understand, the GAAP doesn't get any better sequentially. It still remains similar to what it was in 2Q and 3Q because of that catch-up.

Yes, that's exactly the point.

Okay. No, I appreciate that. And just one other question just on the rigid plastics side. We're reading more about some challenging growing conditions for certain fruit, vegetables and specialty crops in the West Coast of North America specifically. Is that something that you are seeing have an impact on your rigid plastics demand or could have an impact? And is anything from that perspective baked into your guidance for the second half?

Josh, this is Rodger. We are seeing some impact on the crops, primarily in the Northwest of the United States. We built that headwind into our sales forecast for the second half of the year. Same story there. [PT], up -- since the first of the year, is up 30%-ish, so we're moving prices in that business as well. But any headwinds from weather, fires and all that, we have built that into our forecast. But the answer is yes, for some specific crops in the Northwest, we have seen some impact.

Our next question comes from Mark Wilde with Bank of Montreal.

I wanted just to start out, you've done a good job of kind of walking us through some of the lags there in consumer plastic packaging. Anything you can do to help us with just the cadence of kind of price/cost catch up in other parts of the portfolio?

I'd turn it over to Rodger. But what I would say, the headline here is related to resin. And when you see other parts of the portfolio, if you look across, where you see that resin influence really hit us hard in the All Other category, which is effectively a resin-based business and, of course, as we've just said on the consumer side. But Rodger, any further thoughts?

No, I think that's right. If you look at the other -- freight inflation, packaging, you name it, Mark. As you know, they're all escalating faster than expected. We're out on a regular basis with increases in those areas outside of our normal price change mechanism, so that's happening. I'm sure it will come on to OCC in our industrial side in a minute.

But as you're aware, we've announced our fourth $50 increase for URB, which went into effect July 15. That went well. We filed with a 6% to 7% tubing core increase, which has gone well. So we're trying to stay out in front of industrial, and that's part of the reason we announced that when we did. We're expecting more headwinds in OCC in the second quarter, with an upward bias to OCC prices throughout this quarter.

Okay. That's helpful. And is there any difference, Rodger, in sort of the -- both the order of magnitude of just cost increases on OCC in your European business versus North America? And also any timing difference between kind of North America, Europe and the other markets?

Well, Europe ran up faster. If you convert the European euro metric ton to U.S. short ton, they're up to about $175 a ton on average. But the team there has done a really nice job of staying out in the front of that. So I'd say their run-up has happened in front of the U.S. I'm not sure that tells us exactly where the U.S. is going, but that's the comparison. But again, our team has done a good job there of recovering so far.

Okay. The other question I have is, I guess, probably for Julie. And I'm just curious, if I heard you correctly, it sounds like you're going to stop medium production at Hartsville at the end of the fourth quarter, but the ramp-up on the URB is not until the end of the second quarter next year. And just kind of looking at the corrugating medium market this year, I'd assume that, that machine has to be quite profitable this year. So I'm just curious if you can give us any help as we think about next year, the move into next year. And what the earnings impact of the phaseout of corrugating medium and the ramp-up of URB, what that may be on a year-over-year basis?

Yes. Good question, Mark. In fact, it's probably going to go down latter part of the first quarter of next year and will be down for 6 to 7 weeks as we make that conversion. We're not at a point at this point in time where we're -- we have even sat down and looked at the overall impact and how that -- what would be reflected in our 2022 assumptions. So it will be coming, but it won't be a -- it won't be this year. It will be latter part of the first quarter and into the second quarter of next year.

Could you -- and Howard, without trying to lead you too far on this. But would it be reasonable to assume that you might take a little bit of an earnings hit in '22 just because you're going to give up very profitable medium production this year, and you're going to have a, not only a period where the machine is not running, but you're going to have kind of a start-up curve after the rebuild?

Sure. That's a fair assumption, but you got -- I guess where I'm coming from, we'll have to see what the entire corporate roll up looks like and how meaning and material that is going to be. But any time, yes, you're starting up a new process, a new plant, new equipment, you've got to walk through that.

Okay. Last one real quickly for me. How is the Halloween season looking in the flexible packaging business?

Actually, you need to get your trick-or-treating stuff ready because the CPGs are acting as business as normal.

Our next question comes from Ghansham Panjabi with Baird.

This is actually Matt Krueger sitting in for Ghansham. So I was hoping that we could touch on volumes for the back half of the year. So what are your embedded volume assumptions on a segment basis for the second half of 2021? And what type of underlying market environment are you kind of projecting within these assumptions? If you could provide any detail by region or by product line on a kind of a major product basis, that would be really helpful.

To kind of share with you from a macro perspective, it might help to talk about where we thought we were going to be this year, which is about 2% for the year. And we've seen Q1 up 4%, Q2 is up 8%. And our forecast now for Q3 is just over 5%, with the bulk of that -- well, our consumer side, slightly up 1% to 1.5%. The industrial side continuing to trend upward, 7.5% to 8% or so. And the All Other category showing the biggest ramp up in this particular quarter to about 12%. I don't know if we're prepared to really talk about each individual business within the sectors, but we do expect to see volume to be very positive going forward.

Great. That's helpful. And then I guess I just wanted to touch on -- maybe see if you could talk about how inventory levels are trending across the various end markets in which you play. Have you incurred any incremental cost-to-service customers in an out-of-pattern manner from a freight or supply perspective? And have you had any challenges in gaining access to raw materials in any specific markets or instances?

Yes, Matt. Yes to all of the above. Inventories are tight. That -- particularly in the mill system where it's driving more changeovers, which does impact productivity. But then again, across the company, very pleased with how we've managed productivity, but it certainly has been a very dynamic situation for us. On an income and a raw material perspective, yes, it's tight. We're managing literally -- particularly resin based, and that's resins, that's adhesive. We're having to manage that almost on a -- well, we are, not almost, daily, if not a 7-day-a-week type situation.

Outbound freight, similarly, we're working weekends to make sure that we've got trucks that can come in and make the shipments that we've committed to, to our customers. So it is a very interesting, dynamic situation right now. But again, I can't tell you how pleased I am with how well our team is managing through this.

Understood. Understood. That's very helpful. Just one follow-up and then I'll drop off. Is there any time line for normalization there that you could feel is reasonable? Or is it just kind of a day-to-day assessment?

It's a macro issue. It's not a Sonoco issue. It's throughout North America. We're managing it on a day-by-day basis. I really couldn't forecast out what we're seeing. These type of costs and the issues that we're facing are going to continue for some time to come. Our biggest lever that we're going to be able to pull with all of the headwinds that we're facing is getting this material cost recovery from our customers and just managing the rest of it the best we can.

Our next question comes from Adam Josephson with KeyBanc.

Howard or Rodger, can you just -- on resin and OCC, just a little more clarification, if you don't mind. So as of last quarter, I think you were expecting 10% resin cost inflation for the year. I would be interested in knowing what that expectation is now. On OCC, I think the last call, you were thinking OCC would go up to 120% by June, and you nailed it. And it went up by another 20% in July.

And I think Julie or Rodger said you expect further upward pressure. Can you just put a little more meat on that bone? And then lastly, on freight. Just can you remind me what your expectations were for the year-end are now?

Adam, it's Roger. I'll give it a shot. And then Howard or Julie can add to this. But yes, on resin, if you look at what we're expecting now for the calendar year of 2021 -- and this is expecting some moderation and potentially slight reduction. At the end of the year, we're expecting a 30% increase for the year.

As you know, I mean, if you go year-over-year, in many cases, as I think as Julie said, resins have doubled, polypropylene is up 140%. So we buy a basket of resins. We buy about 120 million pounds a quarter. Over half of that's PE-based, about 30% is polypropylene, and then a bunch of all others. So we're looking at a 30% increase now. But again -- and that's assuming we get moderation in the back of the year of 2021.

OCC, as you know, has already moved to $140, 1...

45.

$145 in the month of July. And what I said earlier is there's an upward bias. The container mills are still pulling very heavily. We're seeing premiums in the marketplace. So at this point, I wouldn't tell you exactly what it's going to do in the coming months, but there is an upward bias, and that's the way we're looking at it today.

On freight, I believe we said 6% to 7% for the year. And then in the first quarter, we're now at 9% to 10%, which is not that significant a move. But the comments Howard made, for me, are even more important. It's the availability of trucks and trailers and drivers and the added cost of changing schedules that that's been a bigger headwind for us. But that's more color. If you need more, we can answer them.

No. And just one follow-up on the cost issue, which is I think you mentioned in Europe, OCC is up, the U.S. equivalent of $175. I forget over what time frame you were talking about. But in the U.S., year-to-date, Southeast prices are up 60, I believe. So are you would that lead you to think there's a lot more to go in the U.S.? Or how are you thinking about that relationship between Europe and the U.S. in terms of the year-to-date inflation?

Yes. I'll just say in the equivalent price of what we're paying today in Europe in U.S. short tons would be $175 a ton.

Oh, I'm sorry.

Yes. So that was the point. So -- and again, I'm not saying we're going to go to $175 million, but that just shows you the demand globally. And again, containerboard mills are pulling heavily, so we do see upward bias in the quarter.

Yes. And Adam, I'm not so sure you can totally create a correlation between the Europe situation in the U.S. to make an assumption at whatever levels they are we may be heading to. I don't think we've seen that historically. It's basically independent market and market dynamics.

Yes. And on demand by region, can you just talk about what you're seeing? Obviously, U.S., Brazil have been exceptionally strong all year. Europe has gotten better. China is getting worse, depending on what you read, markedly worse. So can you just talk about what you're seeing by region? What you think is going on in China? Obviously, Southeast Asia is having COVID problems. China is having other problems. Just what you're seeing by region and your expectations along those lines as embedded in your guidance?

Yes. And I think you covered it pretty well, actually. I'm -- if you look at Latin America on the industrial side, very strong. Same dynamics we're seeing here, order backlogs, et cetera, in our mill system. South America, as you noted, same. Our consumer business in South America is also very strong.

Just as a footnote, I mean, we're actually having to -- and this is part of the challenges here in North America in terms of mill capacity. But we're actually shipping board out of the U.S. to supplement our mills in South America. So really -- in fact -- and it's rolling to the bottom line as well. The South American business has performing exceptional on both sides, industrial and consumer.

You talked about Europe. Europe is somewhat similar to here, very, very strong. Our mills are full. Demand on the tube and core side is where we would hope it would be. On the consumer side, which is mostly our paper can business, I made comments earlier to George's question that very, very solid current demand and pending new orders.

Asia, as we look at -- it's relatively small for us in the full scheme. From COVID a year ago to today, we're extremely pleased with the turnaround. I think our cone business, as example, is about 97% of 2019. That was dropping from about 40% this time last year. So we're still somewhat enjoying the recovery. But no doubt about it, we're seeing that we expect, once things settle down, that there's going to be more pressure as it relates to just the overall macroeconomic conditions in China.

And I guess, lastly, I'd just point to Southeast Asia. COVID is a real issue for us. It's showing in Indonesia where we have our fairly large paper complex. But probably the biggest hit has been our consumer business, where we've got our largest Asian paper can facility that has been down for weeks now due to government mandates and new lockdowns, and that continues. This is the first quarter that I can remember, I noted earlier, when we're seeing double digits. Just quarter after quarter in Asia was actually flat because of that reason, that we had a major complex down for the period.

Our next question comes from Kyle White with Deutsche Bank.

I wanted to go to rigid paper containers and food packaging. Are you able to provide any kind of cadence or details on how volumes trended throughout the quarter on a month-to-month basis and into July here? Just trying to understand what impact you're seeing as markets reopen and the kind of at-home consumption trend we can see here a bit.

Yes. Not within the quarter. I think we noted that in total, we were down about 5%, but we were above where we were in 2019. Julie, I really don't have that data in front of me.

Yes, not as much from a monthly perspective. But I think basically, volume trends during the quarter were, I'd say, relatively steady. I don't think anything unusual on a month-to-month basis during the quarter. The -- as Howard just mentioned, I think maybe you're talking about global cans being down about 6%. And -- but again, it was a really tough comp.

Again, the plastics food business had a very solid, like, again, year-over-year growth after a very strong second quarter of 2020. And so that volume growth continues to be very solid. So -- but I'd say I don't think there's anything terribly unusual monthly during the second quarter.

Got it. And then going to All Other, what are you seeing or expecting in terms of the flu season this year for that business? And then what are you hearing from your customers in terms of how sustainable some of the vaccine demand will be going forward?

It's Rodger. Flu season, we're expecting a good flu season. We typically capture over half of that volume, $15 million to $20 million. One thing we are seeing is the domain customers are pulling earlier with some concerns about supply constraints as we get into the fall. So we saw some of that volume come in, in the second quarter. We'll see the balance in the third quarter. So we're expecting a normally pretty solid flu season.

From a COVID vaccine standpoint, it's playing out almost like we talked last quarter to the point of we see this turning into more of a vaccine-type similar to the flu season. As we get in now to booster shots, as we get into some of these shots for younger children, 5 to 11, what we're hearing from our customers it's going to turn into more of a standard ThermoSafe package or temperature control package. And we expect about a $15 million to $25 million impact on an annual basis for COVID vaccine. So really no change to the guidance from the last quarter.

Our next question comes from Salvator Tiano with Seaport Research Partners.

So firstly, can -- I know you mentioned the tough comps in rigid paper containers globally. But as we look at kind of the end market demand, can you tell us a little bit about the trends? Why are you seeing essentially the deviation with the rigid plastics specifically, even though both benefited from pantry loading?

So Sal, to make sure I understand your question, you're asking why plastics...

Essentially why plastics are outperforming the rigid paper containers this quarter.

Yes, I understand. I think it's just the nature of the products that we're serving, back to my earlier point with the frozen -- well, QSR opening up, the fastfoods have certainly been a benefit. But equally so is that truly the acceptance of the consumer of frozen meals that they -- some of the consumers were reintroduced for the first time, consumed through COVID, are continuing to go back and continue. So we're actually seeing the frozen side slightly up over the peak of last year.

If you look at the can business, a lot of that is related to snacks and other items, refrigerated dough. And we just saw a bit of a pullback here in North America. Again, Europe was in good shape, actually just slightly up. And then I've already talked to the scenario in Asia as it relates to the shutdown that we had there.

Okay. Great. I wonder if you can also elaborate a little bit on the margin differential between the 2. Because I think when we think about the $15 million negative price/cost for the Consumer Packaging business that you mentioned, that leaves a pretty steep operating income decline year-on-year given the just 2% volume. So I can -- I would imagine the rigid paper can have a much higher margin. Was that the reason for the, I guess, the decremental margins being so high?

Julie, yes.

It's interesting. The dynamics among -- between those kind of 2 -- or really several parts of our consumer business. You may -- got different dynamics in productivity and labor challenges as well as the different inflation, whether it's very resin-oriented in the plastic food business and flexibles versus other types of inflation being more prevalent in the cans business.

So I think there's no simple answer there, quite frankly. The dynamics around, again, the different raw materials across our consumer businesses, again, labor challenges. I mean we have a broad footprint across all these businesses. And depending on COVID impact, labor availability, et cetera, obviously impacts productivity. And so just lots of moving pieces that, really, we won't be able to now get into any more granularity about that with the dynamics of what's impacting the margins in the different key parts of our consumer segment.

Yes. I'd say, Sal, just in summary, the inflation that we're seeing is really, as we've said, in our resin-based businesses. And so we're getting hit really hard. Even though volumes are up on the plastic tray side, we're back to this whole price/cost and capturing that resin inflation.

Okay, perfect. And just quickly, can you provide a little bit more color on the inflation on the cost differential between what you're seeing in the Consumer Packaging business and the other businesses, the other segment, I guess? Because, obviously, a $10 million price/cost headwind for other, it's super substantial for such a small segment. So can you elaborate on the differential in terms of pass-throughs and resins that you use in the other segment versus Consumer Packaging?

It is exactly that. It's back to the resins. All Other is almost 100% resin-based businesses embedded in there. So it's just as simple as that really. That's what's driving that large number.

Our next question comes from Gabe Hajde with Wells Fargo Securities.

I was curious, there's been a lot of sort of exogenous factors influencing OCC, I'll say, over the past 18 months in terms of China's actions, obviously, the COVID impact and then what we're seeing right now in terms of, I think, mill operating rates and stuff like that. But I'm curious if there's anything that you would view as instructive in terms of kind of what the new normal might look like for OCC.

And really, the genesis or what's behind the question is, I'm looking at a list of 25 to 30 recycled pulp projects across the globe, and it seems like China kind of has reached the upper limit in terms of what they can maybe collect domestically. And obviously, we know they're not going to be importing OCC, but potentially, obviously, recycled pulp. So just curious if there's potential for OCC to remain, I don't know, above $100 a ton or something like that in the foreseeable future?

The potential is certainly there. And if it does, it's really about stability, right? Right now, we've seen, what, 9 consecutive months of increase in OCC. It eventually will reach its plateau and hopefully get back to a more normal type trending. If it's $100 it plateaus at, so be it. If it's $150, so be it. But we've caught up. Price has been passed through -- I mean cost has been passed through, and you're back in a normalized situation.

What is really -- the issue today is just that. It's month after month after month. It's the chase. In terms of what -- how the global market is going to settle, really, really hard to say.

Okay. I'm just curious. I know it's difficult in terms of visibility, but I guess from some of the work that we've done, it appears as if your customers' inventories are starting to normalize, where before, it felt like they were living kind of hand-to-mouth a little bit. Any visibility there in terms of where customer inventories are at?

And then real quick on CapEx. I think you talked about incurring most of Project Horizon spend this year, call it, $100 million, such that $15 million would fall into next year. I know you're not giving guidance for next year. But directionally in that $200 million of CapEx for spend knowing what we know today?

That's what we've modeled out as an incremental, finishing up when we -- on our free cash flow guidance. I think you can go to the bridge that Julie provided that we're assuming that we will spend to that $300 million level. I can tell you that with the delays we've seen associated with COVID, et cetera, that could push out into next year.

It's too early right now for us to make that call. I think by the time we're together in October, we'll be able to really have pure visibility in terms of how much of this CapEx is going to fall into this year or maybe even bleed into next year. So on the other...

Let me take it. This is Rodger. On the customer side, as you said, on the food side, you're right. I think our customers are saying their inventories have stabilized, so we're not seeing anything there. Just like us, they're struggling with some raw materials, but I would say, on average, they're back to more normal levels.

Any customer that's dealing with like appliances and automotive, the chip shortage, we're seeing it. Although both -- in both cases, our sales to those customers were up, obviously, significantly over the second quarter last year. We could have sold more, and our customers could have sold more appliances. Appliances sales were up 23% year-over-year, but they could have been up higher.

Automotive sales, you all know the story there. So I think anything to do with housing or anything to do with chip, the chip shortage, I think our customers still have plenty of upside from a sales standpoint, which means upside to us.

Our next question comes from George Staphos with Bank of America.

Sorry to come in late here. I'll make it real quick. So could you, Howard, remind us, with Project Horizon, the cost of the projects has moved higher over time to the current level of, whatever, $115 million. How much of that is just inflation in the construction materials? How much of that is flexibility that perhaps you're building into the system. Maybe optionality that even though you're net neutral on capacity with all of the closures that may be if URB grows on a more secular basis, coming off some very strong growth that we're seeing now, that you'd have the flexibility to hit that demand if that happens. And then the second question I had, just what preparation, if anything at all other than trying to get pricing up, are you doing in advance of hurricane season, which always brings a little bit of volatility to resin?

Thanks, George. Yes, we did increase the original capital of Horizon, but that was really built on the back of incremental opportunity that the team had identified as we -- after completion of the first capital submission. And so the incremental $30 million that brought it up to that $115 million range, was where -- a very justifiable and a good return opportunity presented itself to basically redo not just the paper machine, but the complex in terms of raw material flow, outside warehousing.

So when you come to the campus next, you'll see a new 120,000-foot warehouse. You'll see how the flow of OCC now does -- is appropriate to the back end of the machines. So that's where that incremental amount came from. And it was again justified on the savings we would achieve by spending that.

The second question was around the demand profile. As I noted in my comments, we've announced the close of a couple of machines, but that's all pending on market conditions. So we'll see what things look like. Hopefully, the demand that we're seeing today will continue, and that may lead us to continue operations versus bringing down machines. But the closure timing that I shared with you earlier today is just our communication to our internal team, giving them an annual notice so that we can make appropriate -- our employees can make the appropriate choices.

But it could be. Hopefully, we're saying we're going to -- we've got the new machine going and the other ones are full, too. And we're going to keep that situation for whatever time period that goes.

Hurricane prep, look, we've talked a lot about -- and for us, hurricane prep is not an operational issue, but more of a supply chain issue. We should all be concerned about that, yes. Inventories, as Rodger spoke to, are low. Supply chains are being managed on a day-to-day basis. So you're not seeing within the Gulf Coast supply chain the normal prebuild of materials in anticipation of such an event. So it's something that we should all be concerned about, but we'll let -- see what mother nature brings us there.

Our next question comes from Adam Josephson with KeyBanc.

Just really quickly. On that hurricane issue, just to be clear, are you -- I know it's impossible to forecast hurricanes, but what, if any, supply chain disruptions are you expecting in your updated full year resin cost forecast?

And then in terms of your OCC assumptions, I think you're expecting OCC prices to go down in the fourth quarter as collections improve and demand slows. But obviously, with e-commerce, box demand has been exceptionally strong in recent fourth quarter. So I'm just wondering why you would expect demand to slow and, therefore, OCC prices to go down seasonally in the fourth quarter?

Adam, this is nothing new. We have never really built in any type of forecast of what could happen if we have a hurricane. But forever, we've always managed to maintain stock in the event that our suppliers go down for a week, or whatever period of time they may go down, to ensure that we have raw materials to continue to operate. My only point here, and it's something I could never -- I just cannot forecast. We'll figure a way. We always do.

But we, and I assume others, including our suppliers who typically push material out ahead of the season, that's not happening this year. So there's no way to forecast what the ultimate impact of that would be.

With OCC, Rodger, you may want to talk about -- I think you spoke with [Dana] this morning, but we're just following the traditional seasonal trends. I will say one thing and whether it will carry through the fourth quarter, I don't know. But we have seen that exports are starting to drop as prices have risen. As we're seeing India and others starting to pull further back out of the market, that's creating more supply within North America. As you know, it's a very complicated, dynamic market, but that is our expectation at this point in time, that we should see things start to moderate, to come down.

No. Showing no further questions in queue at this time.

Well, thank you, Liz, and thank you, everyone, for joining us today. And again, if you -- we certainly appreciate your interest in the company. And as always, if you have further questions, please don't hesitate to contact us and be glad to talk further. Thanks for the call today.