Greif, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Greif, Inc. Q1 2020 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you'll need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to Matt Eichmann. Thank you. Please go ahead.

Thank you, Denise, and good morning, everyone. Welcome to Grice First Quarter Fiscal 2020 Earnings Conference Call. On the call today are Pete Watson, Grice President and Chief Executive Officer, and Larry Hilsheimer, Grice Chief Financial Officer. Pete and Larry are available to answer questions at the end of today's call. In accordance with regulation fair disclosure, we encourage you to ask questions regarding issues you consider material and because we are prohibited from discussing significant non-public items with you on an individual basis. Please limit yourself to one question and one follow-up question before returning to the queue. Please turn to slide two. As a reminder, during today's call, we will make forward-looking statements involving plans, expectations, and beliefs related to future events. Actual results could differ materially from those discussed. Additionally, we will be referencing certain non-GAAP financial measures, and reconciliation to the most directly comparable GAAP metrics can be found in the appendix of today's presentation. And now, I turn the presentation over to Pete on slide three.

Thank you, Matt, and good morning, everyone. We continue to make strong progress across all of our strategic priorities. From a financial performance standpoint, our first quarter adjusted EBITDA and adjusted free cash flow both improved versus the prior year quarter. We also recorded our 11th consecutive quarter of customer satisfaction index score improvement and received recognition from several third-party organizations for our strong sustainability performance. Finally, we announced today that we agreed to sell our consumer packaging group business to Graphic Packaging for $85 million in cash. We continue to experience challenging industrial markets across our portfolio, and the overall demand environment remains soft. Conditions in several important regions and RIPs improved over the last several months, especially versus the prior year quarter, but it's premature to tell whether those trends are sustainable. Care Star performed better than internal expectations, and our global intermediate bulk container volumes are growing double digits in line with our strategy. I'd like to now review our performance by segment, and if you could please turn to slide four. The Ridge industrial packaging and services segment delivered a strong first quarter, benefiting from better demand in key markets, favorable raw material costs, and strong cost control. Our global IBC volumes grew by 23.5% versus the prior year quarter, partially due to our strategic investments that include the total acquisition, an IBC reconditioner in Europe, and new IBC projects delivering positive results in Houston, Texas, and Russia. Overall, global steel drum vines declined by 1.7% versus the prior year quarter. Steel drum demand in EMEA, which is our largest steel drum region, grew by nearly 3% as customers reported a more stable outlook and we achieved new customer growth. Steel drum volumes in the Middle East and North Africa also grew by roughly 7% thanks to solid chemical and lube demand, and by roughly 1% in Eastern Europe. Steel drum volume in the U.S. remained soft, especially in the trade-sensitive Gulf Coast, while volumes in Southeast Asia were negatively impacted by competition and by price margin decisions. China, on the same store, steel drum volumes were up low single digits versus the prior year quarter. RIP's first quarter sales were roughly $25 million lower versus the prior year quarter on a currency neutral basis due to lower volumes and lower average selling prices tied to contractual adjustments related to raw material price declines, partially offset by strategic pricing decisions. RIP's first quarter adjusted EBITDA rose by roughly $14 million versus the prior year quarter due to lower cost raw materials and aggressive back office cost reduction activities, partially offset by the impact of lower sales. Our Q1 2019 adjusted EBITDA was adversely impacted by a $1.5 million correction adjustment that was previously disclosed related to a divestiture. We continue to assume that RIP's steel drum volume would be roughly flat to fiscal 2019 with IBC volume growth in the low double digits. While pleased with the demand uptick we saw in EMEA, we expect economic growth in Europe to remain subdued overall and vary by country. I'd like you to please turn to slide five. The Flexible Products and Service segment experienced a challenging first quarter was negatively impacted by weak demand in Western Europe and by a delayed fertilizer season due to weather, which is not expected to be fully recovered. First quarter segment sales were roughly 16% lower than the prior year quarter and 15% lower on a currency neutral basis. Weak finds were the main driver to lower sales. First quarter adjusted EBITDA fell by roughly $4 million versus the prior year due to lower volumes, only partially offset by lower SG&A expense. We are reducing our variable cost structure in light of weaker volumes, executing on SG&A and other cost savings opportunities. And please keep in mind that FPS is a 50-50 joint venture, so the bottom line impact from soft end markets is small. Before transitioning to paper patching, I'd like to say a few words on the impact of the coronavirus. We have over 900 Greif colleagues in China working in both our rigid and flexible packaging segments. China accounts for roughly 3% of our overall annual and consolidated revenue, and all of our plants were operational as of February 17th. To our knowledge today, none of our colleagues have contracted the virus, and we have extensive precautions in place to safeguard their health and well-being. While we've incorporated a minor coronavirus drag into our guidance of 1.5 million, it is way too early to assess the ultimate impact the virus may have on global macroeconomic conditions and to our global customers. I'd ask that you turn to slide six, please. Paper packaging's first quarter sales grew by $256 million versus the prior year quarter due to Kerastar's contribution partially offset by lower published prices in our container board business. Biomes were negatively impacted primarily by 21,000 tons of container board economic downtime and by softer demand from integrated customers in our legacy business. Paper packaging's first quarter adjusted dividend rose by roughly 68% versus the prior year. Caristar outperformed our internal expectations during the quarter, which is a seasonal slower period for them. Looking ahead, we incorporated January's published $10-ton liner board and $15-ton medium declines, as well as February's $30-ton box board price decline into our guidance range. Finally, we agreed to sell our consumer packaging group business consisting of seven folding carton facilities to graphic packaging for $85 million. This sale excludes the three CRB mills acquired in the CareStar acquisition, in which we have multi-year supply agreements in place. Given our industrial focus, we are not the rightful owner of the consumer packaging group business. This divestiture helps us delever our balance sheet, optimize our capital allocation plans, and refocuses our business on our core industrial franchise and strategic growth priorities. We expect the divestiture to close by March 31st, and I'd like to thank our CPG colleagues for their contribution to Greif for the past 12 months. Their sincere commitment to safety and the customer service excellence will serve them well in the future. We wish them nothing but the best in the transition ahead. If you could please turn to slide seven. We own the CareStar business now for just over a year and continue to be very pleased. The business has enhanced our overall margins and anticipated synergies have been revised by more than 55% higher since the deal closing. Most importantly, we have a 99% colleague retention rate through a strong cultural fit and alignment, which is a large driver to the success of our integration. We continue to expect to achieve run rate synergies of at least $70 million by the end of fiscal 2022. And there is no material impact or synergy estimates from the Consumer Paction Group divestiture. I'd like to now turn over the presentation to our Chief Financial Officer, Larry Hilshimer.

Thank you, Pete. Good morning, everyone. Please turn to slide 8 to review our quarterly financial performance. Before I get into the quarter's details, allow me to add to what Pete stated earlier about the CPG divestiture. We are very excited about the transaction announced this morning with Graphic Packaging. We view this as a win-win deal. It is consistent with the strategies of each organization and has unique benefits to each side. For us, when we acquired Caristar, we did so on the basis of a run rate EBITDA of $220 million. The business we just sold contributed no EBITDA in that $220 million run rate, nor were there any estimated synergies attributable to that operation. I want to wish our CPG colleagues the best of luck and thank them for their work at Greif over the last year. On to first quarter specifics. Overall, Greif generated very solid results in a challenged industrial economy. First quarter net sales, excluding the impact of foreign exchange, rose by nearly 25% versus the prior year quarter due to Caristar's contribution and strategic pricing decisions in RIPs. partially offset by demand softness and lower PAM-driven pricing in RIPs, weak FPS volumes. Legacy PPS also experienced softer demand and lower year-over-year published container board pricing. First quarter adjusted EBITDA grew by roughly 39% versus the prior year quarter, primarily due to CareStar's contribution and the improvement in RIPs, partially offset by lower EBITDA in our legacy paper business and weak demand in FPS. Below the operating profit line, interest expense rose as anticipated by roughly $20 million, while other expense was essentially flat the prior year. First quarter Class A adjusted earnings per share was roughly flat to the prior year quarter at $0.64 per share due to higher year-over-year depreciation and interest expense offsetting the Caristar acquisition driven lift to earnings. Our first quarter non-GAAP tax rate was 24.3%, and benefited from a $2 million resolution of an open item with tax authorities. We expect our non-GAAP rate to range between 27% and 31% in fiscal 2020. Finally, first quarter adjusted free cash flow improved by $22 million versus the prior year quarter to a use of roughly $13 million as a result of increased EBITDA and improved working capital management despite increased capital expenditures. Please turn to slide 9 to review our fiscal 2020 guidance and key modeling assumptions. We now expect to generate between $3.55 and $3.91 in adjusted Class A earnings per share in fiscal 2020. We've kept the guidance range deliberately wide given continued macroeconomic uncertainty and the still unquantifiable impact of the coronavirus on our global operations. To bridge to our new fiscal year 2020 midpoint of $3.73 per share from what we previously provided, please start with our original $3.88 per share midpoint shared at Q4. From there, we anticipate a $0.09 per share headwind from softer economic conditions and mixed erosion in PPS for the remainder of the year, partly offset by OPEX improvements in RIPs and several key raw material sourcing winds. We also assume a $0.09 per share headwind from the price-cost squeeze in paperboard that includes the $30 reduction in box board prices published last week, only partially offset by slightly lower fiscal OCC expectations. Offsetting those headwinds is a $0.02 per share lift from slightly lower fiscal year interest expense as a result of a farm credit system rebate. and our belief that our fiscal year non-GAAP tax rate will trend toward the lower end of our 27% to 31% range. We now forecast our 2020 adjusted free cash flow of between $265 and $305 million as lower anticipated EBITDA is more than offset by improved working capital and lower cash taxes. We continue to expect capital expenditures of between $160 and $180 million excluding integration CapEx, and anticipate working capital to be a cash source of between $0 and $20 million, primarily due to lower sales and working capital optimization programs. Turning to capital priorities on slide 10, our capital allocation priorities include funding organic CapEx, de-levering our balance sheet, maintaining steady dividends, and pursuing our strategic growth priorities in IBCs, IBC reconditioning, and container board integration. At quarter end, our compliance leverage ratio stood at roughly 3.7. We remain well within our stated covenants and expect to be back within our targeted leverage ratio raised by 2023. Our industry-leading dividend yields more than 4% today and offers investors a steady source of income to augment market returns. With that, I'll turn the call back to Pete for his closing comments before our Q&A.

Hey, thank you, Larry, and please turn to slide 11. The Greif team delivered a solid first quarter despite a challenging macroeconomic environment. As we progress through fiscal 2020, we remain well-positioned to serve a variety of end markets through our industry-leading product portfolio and our commitment to customer service excellence. We're advancing lower-risk growth opportunities close to our core And the Caristar integration continues to track the plan. We appreciate your participation this morning, and operator, please open the lines for questions.

As a reminder, to ask a question, please press star, then the number one on your telephone keypad. To withdraw your question, press the pound key. Please limit yourself to one question and one follow-up, and rejoin the queue for any additional questions. Your first question comes from Gansham, Punjabi, with Baird. Your line is open.

Hi, good morning. This is actually Matt Krieger sitting in for Gonsham. How are you doing? Good, Matt.

How are you?

Good, good. So I was just hoping that we could get your updated thoughts on your volume expectations by segment for 2020, along with any details underlying the regional economic assumptions that coincide with that volume outlook, including any impact on the various regions from the coronavirus.

Yes, let me first, I'll talk about the coronavirus and the impact. So as we mentioned, none of our colleagues are infected that we know at this time. And anything we comment on regarding the coronavirus is what we know today. We really can't speculate on future impact. We expect, as we said, a million five impact from the coronavirus. due to mainly extended shutdowns in our Chinese operations. We're about 70% operating capacity today. And beyond China, our Italian operations have not been impacted by the coronavirus. We're operating all facilities at full capacity. From a broader supply chain, we have not had any adverse impact in Greif in our supply chain and our ability to meet our customer needs. We're not restrained in raw materials or parts supply across our entire global supply chain. But there's no question the virus will clearly have an impact on certain business segments and that interconnectivity to the global supply chain that we've already read and you've read about negative impacts to parts of the economy. In regards to our global customers, we are seeing some shift in production from China to other regions in their global footprint, but again, it's premature to make any concrete determinations on what that longer-term impact may be. I would tell you today we're really well-positioned to serve our global customers as they do that because we have a very wide and diverse manufacturing capabilities across the globe. In regard to volumes as we see it, for the balance of the year are going to start with RIP. So on a global basis, we expect our steel drum volumes to be roughly flat to fiscal 2019. We see the mayor region continues to be an improving story. It's more stabilized. And Brazil and the Middle East also are doing well. I think the offset of that is the slow industrial economic conditions in the U.S., And then we have uncertainty around what the long-term effect is going to be on the coronavirus in Asia. We expect our large plastic drum business to grow low single digits, which is consistent with what we've done in the past year, and we've had several strategic investments in the U.S. that aids that. And again, we're very happy with the growth in our IBC and IBC reconditioning vines, and we expect continue to grow low double digits in that global platform as it's a big strategic priority for us. Again, those 2020 assumptions do not include any broader impact of future coronavirus impact. When you look at paper packaging, we still see continued softer demand conditions, and we don't see any changes from what our current environment is for the balance of 2020.

That's definitely helpful, and I guess that leads me into my next question. I was hoping that you could outline the net impact from the 21,000 tons in container board economic downtime across your business during the first quarter, and then maybe provide some detail on what's baked into guidance for the remainder of the year in terms of downtime for that business.

Yeah, the 21,000 tons downtime is roughly, you know, $8.5 million of impact. In the remainder of the year's guidance, we've built in a range. As you've noticed, our range is fairly wide to consider potential impacts of the continued macroeconomic factors impacting all of our businesses right now, including our legacy paper business.

Okay, that's helpful. That's it for me. Thanks.

Your next question comes from Mark Wilde with Bank of America. Your line is open.

Thanks. Pete, I wonder if it's possible to talk a little bit more about sort of the volumes in RIPs, particularly if we kind of exclude the IBC business. And then within the IBC business, how much of that 23.5% is the result of the acquisition?

So the IBC question first, Mark, the 23.5% improvement, 10% of that roughly is as a result of the Tolu acquisition in Europe, the reconditioning. We're really pleased with that, and I think it's an aid to our platform as we grow that reconditioning business. When you take steel drum, if you just look from a region standpoint, EMEA continues to really have positive growth. We grew by 3% in the quarter. In North America, demand continued to be weak in the first quarter. We did see signs of improvement in January and February, but again, I think it's too premature to say whether that's a continuing trend. And just to give you perspective, because there's really no public comparison in the rigid business like we have in paper, but In North America in 2019, an industry association produces annual steel drum results, and the industry in North America was down 15% in 2019, and we're down significantly less than that. So it's a challenged substrate, mainly due to the trade conflicts and a large percentage of that volume resides in that Gulf Coast. If you look at Latin America, we had really good steel drum growth of about 7%, and that's really a result of improvements in our operations and manufacturing in Brazil. Our new leader there has done an excellent job of improving our operations so we can better serve our growing customer base there. And at APAC, as we've talked about, Our Chinese steel drum volumes, if you look at a same store basis, and if you remember, we closed a plant in Ningbo a year ago, we're up 5%. That's pre-coronavirus. That will change in February, obviously, because we had 10 to 18 days of extended downtime due to the shutdown. And the only other comment I'll make in Asia, in Southeast Asia, and predominantly Singapore, we're experiencing weaker demand because of weaker export markets, but there's been a really intensive competitive environment in Singapore. There's been some added capacity from new steel drum manufacturers that entered the market. So that's an overall view of the steel drum volume in REPS, Mark.

Okay, that's really helpful, Pete. I guess for my follow-on, I'm just curious about the coated recycled mills, which weren't part of the asset sales process. I think Larry mentioned that you have some multi-year contracts. Can you just give us a little perspective on the contracts and on sort of like how much of the volume from those three mills the contracts would cover and whether, you know, you would be precluded at this point from, you know, pursuing a sale of those mills with somebody else or maybe even, you know, rationalizing capacity at some point?

Yeah, so as we talked about, we have – long-term agreements in place for those three mills. And our integration, when we owned the consumer packaging business, was about 40%. So that 40% is covered under long-term supply agreements. But we also feel really, really positive because at sale, these assets allow us to be a non-conflict channel partner to the folding cart industry, both to independent and integrated partners. And so we feel comfortable with that. In regard to what we may do in the future, we have no concrete plan, so we intend to run those mills. We feel very comfortable with the long-term agreements in place. And I think, again, to comment, we were not the rightful owner of those assets in the folding carton industry, and Graphic certainly is, and allows us to focus our capital allocations on our industrial franchise, and we grow our integration, vertical integration, our paper packaging business, as well as grower IBC and IBC reconditioning business.

And, Mark, just a follow-on, although we don't have any current plans, you asked whether we have any restrictions on selling those mills, and the answer is no.

Okay. Thanks, Larry.

Your next question comes from Adam Josephson with KeyBank Capital Markets. Your line is open.

Pete, Larry, Matt, good morning.

Hey, Adam, how are you?

I'm fine. How are you, Pete?

Good.

Thanks for asking. Larry, just one on the cash flow guidance. You mentioned working cap is better. Is that because of lower volume expectations or lower raw material cost expectations? And then with respect to the lower cash taxes, is that just simply a function of your profit forecast going down, or is there something else going on there?

Yeah, good questions. Adam, let me give you a high-level, just a walk first, and then I'll answer your questions specifically. So we had a midpoint guidance of 265. We would drop it by about $13 million relative to operations, increase $3 million because of CapEx that related to those CPG plants we just disposed of, pick up about $19 or so roughly on working capital. taxes is about 11 and a half, and interest expense and other things about roughly just short of a million. So that walks you from 265 to 285. On the OWC, it is a combination of, yeah, when you're projecting lower sales, you need to carry lower working capital. Obviously, disposing the CPG plants eliminates the need for carrying working capital there. But It also is kudos goes to our teams. We have had a focused effort, as we've talked about for years, of really being better on managing our working capital. And we continue to see improvements in that, and we forecast more improvements through the remainder of the year. So you have really good efforts going on across the board in that space. In the taxes, again, it's a situation of our tax group doing an outstanding job of some effective tax planning that is going to allow us to reduce our out-of-pocket cash tax payments this year. It's as simple as that, and there is also obviously a component that to the extent operating income drops, your taxes drop as well, but it's also some effective tax planning. Okay.

Thanks, Larry. And just one on your OCC, updated OCC forecast. So when you gave it in December, I believe it was, OCC was pretty much at rock bottom levels. And it's inched up since then. And it's reportedly up a fair bit in February. Yet you guys fairly significantly reduced your OCC forecast for the year. And if memory serves, you previously were thinking it would be flattish in the first two quarters and then there would be a spike. in the second half, and so we've been going up a bit in the first half, so I'm a bit confused as to why you would sharply cut your full-year OCC price forecast now in light of the fact that OCC is actually going up right now. So I'm hoping you can just kind of help me understand that.

Sure. You know, as we've gotten further in the market and worked with Greg Crotterill and his team and our RFG group, We believe we have a much higher confidence level relative to the remainder of the year, and we had it trending up pretty dramatically at the beginning of the year, but we had a range of alternatives in our very wide range of guidance earlier in the year, Adam, there were some of us who felt more confident that the OCC costs would not be going up toward the end of the year. It was influenced by some external forecasts as well. So, you know, we had it going up to $72 in the third quarter. We do not feel that's in the cards. And so what we've got is $42 or so in Q2, $32 to $47 in our range in Q3 and in Q4. So it brings it to an average for the year of 39 per ton in the midpoint. Thank you.

Again, to ask a question, please press star 1 on your telephone keypad. Your next question comes from Steve. It's your cover with Davidson. Your line is open.

Thanks. Good morning, everyone. Hey, Steve. So hopefully I haven't missed this somehow, but... With respect to the guidance and the CareStar consumer packaging, first of all, the free cash flow has got nothing to do with the $85 million. That's carved out. Correct. That's correct. Good answer. That's what I thought. And then you said that there's no EBITDA contribution from the seven folding cart and facilities. So I guess