GRAPHIC PACKAGING HOLDING COMPANY INTRODUCTION
This management's discussion and analysis of financial conditions and results of
operations is intended to provide investors with an understanding of the
Company's past performance, financial condition and prospects. The following
will be discussed and analyzed:
Ø Overview of Business
Ø Overview of 2020 Results
Ø Results of Operations
Ø Financial Condition, Liquidity and Capital Resources
Ø Critical Accounting Policies
Ø New Accounting Standards
Ø Business Outlook
OVERVIEW OF BUSINESS
The Company's objective is to strengthen its position as a leading provider of
paper-based packaging solutions. To achieve this objective, the Company offers
customers its paperboard, cartons, cups, lids, foodservice containers and
packaging machines, either as an integrated solution or separately. Cartons,
carriers and containers are designed to protect and hold products. Product
offerings include a variety of laminated, coated and printed packaging
structures that are produced from the Company's coated recycled board ("CRB"),
coated unbleached kraft ("CUK") and solid bleached sulfate ("SBS"). Innovative
designs and combinations of paperboard, films, foils, metallization,
holographics and embossing are customized to the individual needs of the
customers.
The Company is implementing strategies (i) to expand market share in its current
markets and to identify and penetrate new markets; (ii) to capitalize on the
Company's customer relationships, business competencies, and mills and folding
carton assets; (iii) to develop and market innovative, sustainable products and
applications that benefit from the consumer-led sustainability trends; and (iv)
to continue to reduce costs by focusing on operational improvements. The
Company's ability to fully implement its strategies and achieve its objectives
may be influenced by a variety of factors, many of which are beyond its control,
such as inflation of raw material and other costs, which the Company cannot
always pass through to its customers, and the effect of overcapacity in the
worldwide paperboard packaging industry.
Significant Factors That Impact
COVID-19 Pandemic. Many uncertainties remain regarding the current novel
coronavirus ("COVID-19") pandemic, including the anticipated duration of the
pandemic, and the extent of local and worldwide social, political, and economic
disruption it may cause. While the COVID-19 pandemic has not materially impacted
the Company's overall business, operations, or financial results to date, it may
have far-reaching impacts on many aspects of the Company's operations, including
impacts on customer and consumer behaviors, business and manufacturing
operations, inventory, accounts receivable, the Company's employees, and the
market generally. The Company will continue to assess the evolving impact of the
COVID-19 pandemic and intends to make adjustments to its business accordingly,
such as to balance the Company's supply with demand by adjusting mill
maintenance outages and taking downtime where appropriate such as the uncoated
SBS cupstock paper machine market downtime that the Company took in Q3 of 2020
to reflect reduced demand for paper from customers.
Impact of Inflation/Deflation. The Company's cost of sales consists primarily of
energy (including natural gas, fuel oil and electricity), pine and hardwood
fiber, chemicals, secondary fibers, purchased paperboard, aluminum foil, ink,
plastic films and resins, depreciation expense and labor. Costs increased in the
first nine months of 2020 by $9.1 million , compared to the first nine months of
2019. The higher costs in the nine months ended September 30, 2020 were due to
higher labor and benefit costs ($34.1 million ), secondary fiber cost ($15.1
million ), and freight ($3.2 million ) partially offset by decreases in wood
($26.8 million ), energy ($10.7 million ), external board ($3.8 million ) and other
costs, net ($2.0 million ).
Because the price of natural gas experiences significant volatility, the Company
has entered into contracts designed to manage risks associated with future
variability in cash flows caused by changes in the price of natural gas. The
Company has entered into natural gas swap contracts to hedge prices for a
portion of its expected usage for the remainder of 2020 and all of 2021 and
2022. Since negotiated sales contracts and the market largely determine the
pricing for its products, the Company is at times limited in its ability to
raise prices and pass through to its customers any inflationary or other cost
increases that the Company may incur.
Commitment to Cost Reduction. In light of continuing margin pressure throughout
the packaging industry, the Company has programs in place that are designed to
reduce costs, improve productivity and increase profitability. The Company
utilizes a global continuous improvement initiative that uses statistical
process control to help design and manage many types of activities, including
production and maintenance. This includes a Six Sigma process focused on
reducing variable and fixed manufacturing and administrative costs.
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The Company has expanded the continuous improvement initiative to include the deployment of Lean Sigma principles into manufacturing and supply chain services.
The Company's ability to continue to successfully implement its business strategies and to realize anticipated savings and operating efficiencies is subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company's control. If the Company cannot successfully implement the strategic cost reductions or other cost savings plans, it may not be able to continue to compete successfully against other manufacturers. In addition, any failure to generate the anticipated efficiencies and savings could adversely affect the Company's financial results. Competition and Market Factors. As some products can be packaged in different types of materials, the Company's sales are affected by competition from other manufacturers' CRB, CUK, SBS, folding box board, and recycled clay-coated news. Additional substitute products also include plastic, shrink film and corrugated containers. In addition, while the Company has long-term relationships with many of its customers, the underlying contracts may be re-bid or renegotiated from time to time, and the Company may not be successful in renewing on favorable terms or at all. The Company works to maintain market share through efficiency, product innovation and strategic sourcing to its customers; however, pricing and other competitive pressures may occasionally result in the loss of a customer relationship. In addition, the Company's sales historically are driven by consumer buying habits in the markets its customers serve. Changes in consumer dietary habits and preferences, increases in the costs of living, unemployment rates, access to credit markets, as well as other macroeconomic factors, may negatively affect consumer spending behavior. New product introductions and promotional activity by the Company's customers and the Company's introduction of new packaging products also impact its sales. Debt Obligations. The Company had an aggregate principal amount of$3,713.9 million of outstanding debt obligations as ofSeptember 30, 2020 . This debt has consequences for the Company, as it requires a portion of cash flow from operations to be used for the payment of principal and interest, exposes the Company to the risk of increased interest rates and may restrict the Company's ability to obtain additional financing. Covenants in the Company's Amended and Restated Credit Agreement, the Term Loan Credit Agreement and Indentures may, among other things, restrict the ability of the Company to dispose of assets, incur guarantee obligations, prepay other indebtedness, repurchase stock, pay dividends, make other restricted payments and make acquisitions or other investments. The Amended and Restated Credit Agreement and the Term Loan Credit Agreement also require compliance with a maximum consolidated leverage ratio and a minimum consolidated interest coverage ratio. The Company's ability to comply in future periods with the financial covenants will depend on its ongoing financial and operating performance, which in turn will be subject to many other factors, many of which are beyond the Company's control. See "Covenant Restrictions" in "Financial Condition, Liquidity and Capital Resources" for additional information regarding the Company's debt obligations. The debt and the restrictions under the Amended and Restated Credit Agreement, the Term Loan Credit Agreement and the Indentures could limit the Company's flexibility to respond to changing market conditions and competitive pressures. The outstanding debt obligations and the restrictions may also leave the Company more vulnerable to a downturn in general economic conditions or its business, or unable to carry out capital expenditures that are necessary or important to its growth strategy and productivity improvement programs.
OVERVIEW OF THIRD QUARTER 2020 RESULTS
This management's discussion and analysis contains an analysis ofNet Sales , Income from Operations and other information relevant to an understanding of the Company's results of operations. On a Consolidated basis: •Net Sales for the three months endedSeptember 30, 2020 , increased$116.1 million or 7.3% to$1,697.7 million from$1,581.6 million for the three months endedSeptember 30, 2019 , due to organic sales growth, the Greif, Quad and Artistic acquisitions and favorable foreign currency exchange rates, partially offset by lower selling prices and lower open market volume of our paperboard. •Income from Operations for the three months endedSeptember 30, 2020 decreased$3.6 million or 2.9% to$119.1 million from$122.7 million for the three months endedSeptember 30, 2019 . Decreases due to higher labor and benefit costs, higher levels of market downtime at the uncoated SBS cupstock paper machine, lower selling prices and higher depreciation and amortization were offset by cost savings through continuous improvement and other programs, higher volumes, commodity deflation, and favorable foreign currency exchange rates.
Acquisitions
•OnApril 1, 2020 , the Company acquired theConsumer Packaging Group business from Greif, Inc. ("Greif"), a leader in industrial packaging products and services. The acquisition included seven converting facilities acrossthe United States , which are included in theAmericas Paperboard Packaging reportable segment.
•On
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•OnAugust 1, 2019 , the Company acquired substantially all the assets ofArtistic Carton Company ("Artistic"), a diversified producer of folding cartons and CRB. The acquisition included two converting facilities located inAuburn, Indiana andElgin, Illinois (included in theAmericas Paperboard Packaging reportable segment) and one CRB paperboard mill located inWhite Pigeon, Michigan (included in the Paperboard Mills reportable segment).
Capital Allocations
•On
•OnJanuary 28, 2019 , the Company's board of directors authorized an additional share repurchase program to allow the Company to purchase up to$500 million of the Company's issued and outstanding shares of common stock through open market purchases, privately negotiated transactions and Rule 10b5-1 plans (the "2019 share repurchase program"). The previous$250 million share repurchase program was authorized onJanuary 10, 2017 (the "2017 share repurchase program"). During the first nine months of 2020, the Company repurchased 18,896,538 shares of its common stock at an average price of$13.31 , under the 2019 share repurchase program. During the nine months endedSeptember 30, 2019 , the Company repurchased 10,191,257 shares of its common stock at an average price of$12.55 , which completed the 2017 share repurchase program. As ofSeptember 30, 2020 , the Company has approximately$211 million available for additional repurchases under the 2019 share repurchase program. RESULTS OF OPERATIONS Three Months Ended Nine Months Ended September 30, September 30, In millions 2020 2019 2020 2019 Net Sales$ 1,697.7 $ 1,581.6 $ 4,907.8 $ 4,640.3 Income from Operations 119.1 122.7 393.9 401.1 Nonoperating Pension and Postretirement Benefit Income (Expense)$ 0.2 $ -$ (150.8) $ (0.1) Interest Expense, Net (32.0) (35.9) (96.4) (106.4) Income before Income Taxes and Equity Income of Unconsolidated Entity 87.3 86.8 146.7 294.6 Income Tax Expense (8.3) (16.9) (21.2) (60.9) Income before Equity Income of Unconsolidated Entity 79.0 69.9 125.5 233.7 Equity Income of Unconsolidated Entity 0.3 0.1 0.7 0.5 Net Income$ 79.3 $ 70.0 $ 126.2 $ 234.2
THIRD QUARTER 2020 COMPARED WITH THIRD QUARTER 2019
Net Sales Three Months Ended September 30, Percent In millions 2020 2019 Increase Change Consolidated$ 1,697.7 $ 1,581.6 $ 116.1 7.3 %
The components of the change in
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Three Months Ended September 30 ,
VariancesIn millions 2019 Price Volume/Mix Exchange Total 2020
Consolidated $ 1,581.6 $ (9.6) $ 118.8 $ 6.9 $ 116.1 $ 1,697.7
The Company's Net Sales for the three months ended September 30, 2020 increased
by $116.1 million or 7.3% to $1,697.7 million from $1,581.6 million for the
three months ended September 30, 2019 , due to Net Sales of $82.5 million from
the Greif, Artistic, and Quad acquisitions, organic sales growth including
conversions to our paperboard packaging solutions, and favorable foreign
currency exchange rates, primarily the British Pound, Euro, and Australian
dollar. These increases were partially offset by lower open market volume of our
paperboard, product mix, and lower selling prices. The lower selling prices are
primarily the result of market-related price declines in our CRB paperboard
packaging solutions in the converting business and price declines on open market
sales. Core converting volumes were up, primarily in global beverage, dry foods,
and frozen foods offset by declines in food service packaging including cups,
dairy products and cereal. The COVID-19 pandemic had a positive impact on
volumes in the quarter for food and beverage packaging offset by a reduction in
demand for some foodservice products.
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