Graphic Packaging Holding Company

Ladies and gentlemen, thank you for standing by and welcome to the Graphic Packaging Holding Company second quarter of 2020 earnings call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to Melanie Skigis, Vice President of Investor Relations. Thank you. Please go ahead, ma'am.

Good morning and welcome to Graphic Packaging Holding Company's conference call to discuss our second quarter 2020 results. Speaking on the call will be Mike Doss, the company's President and CEO, and Steve Scherger, Executive Vice President and CFO. To help you follow along with today's call, we will be referencing our second quarter earnings presentation, which can be accessed on the investor section of our website at www.graphicdkg.com. I would like to remind everyone that statements of our expectations, plans, estimates, and beliefs regarding future performance and events constitute forward-looking statements. Such statements are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the company's present expectations. Information regarding these risks and uncertainties is contained in the company's periodic filing for the Securities and Exchange Commission. Undue reliance should not be placed on forward-looking statements as such statements only as of the date on which they are made, and the company undertakes no obligation to update such statements except as required by law. Mike, I'll turn it over to you.

Thank you, Melanie. Good morning, and thank you for joining us on the call today. I'm pleased to be with you to discuss our excellent results we delivered in the second quarter of 2020. Before we focus on financial results, I'd like to take a few moments to update you on the initiatives to keep employees and partners safe. while continuing our essential operations supporting the food, beverage, consumer, and food service markets globally. Employees come first at graphic packaging. We continue to invest in added safety protocols, including plexiglass barriers on production lines, face masks for employees, temperature scanners, and enhanced cleaning and sanitation protocols designed specifically to prevent the spread of viruses, including influenza and COVID-19. While we have established and implemented safety protocols for our frontline employees, we have also executed technology solutions to enable our non-production employees to conduct their roles effectively from home. Workforce productivity and collaboration across our organization during these challenging times has exceeded my expectations. We have managed through the COVID-19 environment exceptionally well to date and have remained agile, approaching every day with a can-do attitude. Over the course of the last few months, we have often been recognized by customers for our flexibility, best-in-class service and support through these volatile times. We attribute the exemplary customer service our teams provide directly to the focus we place on the well-being of our employees. Our teams have continued to perform for our customers and have gone above and beyond to provide continuity of supply. I thank everyone at Graphic Packaging for their ongoing and tireless efforts. I would also like to take a moment to discuss a very important topic of graphic packaging, diversity and inclusion. We believe a diverse and inclusive working environment encourages creativity, innovation, and collaboration. It enhances our ability to serve global customers, and it is why it is vital that our global organization reflects the diversity of the communities in which we operate. While diversity and inclusion has been a longstanding practice, It is more important than ever that we listen to our 19,000 employees worldwide and have conversations necessary to ensure all the employees have a sense of place and inclusiveness as members of the graphic packaging team. We benefit as an organization from a truly collective and diverse viewpoint. I commend all our employees around the globe for their teamwork and the care and support everyone continues to provide to one another every day. Our organization is committed to driving positive change for employees, customers, and the communities in which we operate. Meaningful, sustainable change starts with listening, and we are encouraging the voices of many across the company, and specifically with our human resources teams globally, to ensure our words and actions are congruent with the values of the company. Turning now to our financials on slides five and six, I will walk through some of the highlights for the second quarter. Sales increased 4% year over year, while adjusted EBITDA of $260 million declined slightly from Q2 last year. Adjusted EBITDA was impacted by approximately $25 million in incremental planned maintenance downtime we incurred compared to the second quarter of 2019. It was largely offset by positive price, commodity input cost deflation, and strong productivity during the quarter. Overall execution was excellent. Net organic sales growth increased 1.5% compared to the second quarter of 2019. Positive at-home consumption trends and new product development initiatives more than offset the declines in our food service business. Net organic volume, as measured in tons, actually increased more than net organic sales dollars due to the market mix in the quarter that significantly impacted net organic tons sold on a favorable basis. We believe net organic sales growth in dollars is the best indicator of how we are performing versus our vision 2025 goals. Excluding the impact of price and foreign exchange, net organic sales growth for the first half of 2020 was 3% year over year, a strong start to achieving our long-term 100 to 200 basis Our paper board integration rate improved 200 basis points from 68% in 2019 to 70% for the year today. While Steve will talk in greater detail on quarterly financial results and our outlook for the year, I'm pleased to report we are reinstating full-year 2020 guidance today. After evaluating multiple scenarios as it relates to consumer demand and likely spending and consumption patterns in the second half of the year, we are reinstating our full-year adjusted EBITDA guidance in the range of $1.05 to $1.09 billion, representing a 4% growth year-over-year at the midpoint and adjusted cash flow guidance in the range of $200 to $275 million. The operating environment remained relatively healthy in the second quarter, particularly in the food, beverage, and consumer markets we served. Backlogs were five-plus weeks for CUK and CRB and four weeks for SPS. Operating rates for both CRB and SPS, as reported by the AF and PA, were 97%. Our estimated operating rate for our CUK continues to be very strong at 95-plus percent. We continue to closely monitor demand, specifically cup demand, for the food service markets. One of our paper machines in Texas into paper cups. Due to declines in paper cup demand, we have taken 14 days of market downtime so far in July on this paper machine. We intend to extend our planned maintenance downtime on the same line in September, adding 14 days of market downtime to the scheduled maintenance outage we have planned. We will continue to align our SPS supply with our forecasted recovery rate of the food service market. Currently, market downtime in our SPS cup paperboard production is expected to yield a reduction of 20,000 to 30,000 tons in the third quarter. In addition to taking the market downtime where needed, we have successfully transitioned and annualized 100,000 tons of integrated folding cartons from CUK to SPS paperboard. This has the dual benefit of meeting increased demand for our CUK beverage packaging and as well as leveraging our low-cost SPS mill platform. As a producer of all three paperboard substrates, CRB, CUK, and SPS, we are well-positioned to move products among the end-use markets to meet changing volume requirements by market when needed. Moving to slide 7, you can see the progress we made in 2019 and year-to-date in 2020 on the price-to-commodity input cost recovery. We remain committed to price offsetting commodity input costs over time and are pleased that we've been able to fully recover the dislocation that took place from 2016 to 2018. New product development continues with our customers even during these challenging times. PaperSeal Trace Solution is a product we are very excited about, and you'll see the details on slide 8. We began development a few years ago on the hermetically sealed paperboard tray that is well positioned to serve a wide range of food applications including proteins, cheeses, salads, fruits, and frozen foods. We formally introduced PaperSeal in 2019 and are making products for customers in Europe and Australia today. We expect to be commercial with customers in North America early in 2021. We are encouraged about this opportunity to move into new markets, including protein packaging, with our innovative paper-based tray solution. As we discussed in Vision 2025 last September and our Investor Day, we are well-positioned to capture sustainability-supported organic sales growth and to benefit from new product development for years to come. marketplace. While some COVID-related delays have been factored into the near-term outlook, multi-year sustainability-supported sales growth opportunities remain intact, and we continue to see a path to our 100 to 200 basis points net organic sales growth for the next several years. We are executing multiple beverage packaging installations in Europe that will support organic sales growth in 2021 and beyond. Notably, the first Keogh important customer. Our teams are also progressing on alternatives for polyethylene coated containers and cups, and we are confident in the development with customers today for conversions in 2021. Premiumization and custom structural packaging design are additional areas where we're seeing increased interest from customers as they look to differentiate their products in the marketplace with end-use consumer safety in mind. We are working closely with customers and continuously finding opportunities year of change and adaptation. Our teams had to quickly mobilize and operate under the realities of the COVID-19 pandemic. Our production employees were nimble and adjusted quickly to changing demand patterns. Importantly, they maintained our continuity of supply to our vital food, beverage, consumer, and food service markets amid uncertainties with the pandemic, logistics challenges, and an occasional severe weather event. We enter the second half of the year with the result to continue learning and improving from these events of this year and have confidence our teams will successfully manage the business during the current uncertain economic times. Steve, I'll hand the call over to you now for a more detailed discussion of our financial results.

Thanks, Mike, and good morning. Turning to slide nine in our sales performance waterfall, net sales in the second quarter increased 4% from the prior year to $1.6 billion, driven by acquisitions, net organic sales growth, and continued flow-through of positive pricing. Reported earnings for the quarter were 19 cents per diluted share, compared to 22 cents in the second quarter of 2019. Second quarter 2020 net income was negatively impacted by a net $21 million of special charges, nearly half of which was a one-time settlement accrual for a multi-employer pension plan. When adjusting for these charges, adjusted net income for the second quarter was $72 million, or 26 cents per diluted share, an increase of 8% compared to 24 cents per diluted share in the second quarter of 2019. Turning to slide 10, focused on our EBITDA waterfall. Second quarter 2020 adjusted EBITDA was $260 million. Adjusted EBITDA was positively impacted by $5 million of higher pricing, $15 million of net productivity improvement, $10 million in commodity input cost deflation, and $2 million of favorable foreign exchange. These benefits were offset by $2 million in unfavorable volume mix, $13 million in other inflation, primarily labor and benefits, and $25 million in planned maintenance outage expense incurred during the quarter. Turning to commodity input costs, we experienced a benign inflationary environment across most commodity categories with the exception of secondary fiber. OCC costs saw a dramatic move higher in the months of February through May and reverted lower in the months of June and July. As Mike mentioned, we are committed to price offsetting commodity input costs over time and we will continue to actively monitor the inflationary environment. On Flight 11, you will see the decisive actions we are taking to position our business for success in both the current and long-term business environment. We are optimizing our network of mills and converting facilities and integrating acquisitions with the goal of increasing paperboard integration rates, expanding market participation, and driving profitability and cash flow. The closures we announced last quarter have been successfully completed. The integration of the GRIF assets has exceeded our expectations to date. Energy achievement is on track, including rationalization of two converting facilities into lower-cost locations. The Kalamazoo project also remains on time and on budget and is expected to yield $100 million in annualized EBITDA improvements in the 2022 to 2023 timeframes. Moving to liquidity and our balance sheet. We have total available liquidity of $1.4 billion. Our balance sheet remains strong. We ended the quarter with $3.4 billion of net debt, reflecting an increase of $54 million during the quarter. Net leverage was 3.26 times at the end of the second quarter, compared to 3.18 times at the end of the first quarter. We expect to be within our 2.5 to 3 times targeted range, as we exit 2020. Moving to a discussion on our return of capital to stakeholders. Given recent volatility and the dislocation in our stock price relative to our view of the long-term intrinsic value of the company, we continued to repurchase shares in the second quarter of 2020. We repurchased $38 million of common shares at an average price of $12.59 per share. bringing our total open market shares repurchased in the first half of 2020 to $157 million. In addition to the capital return to stakeholders, we also continue to invest in the business. Capital expenditures in Q2 were $154 million and include progress on our $600 million strategic CRB platform investment in Kalamazoo. Turning now to our partnership with International Paper, You can see on slide 12 an illustration of the optionality we have when monetizing international papers partnership units. While we do not have anything to report to you today relative to ongoing monetization, you can see in this hypothetical calculation the non-dilutive nature of a conversion if we were to utilize GPK stock as part of a monetization, and that we have significant flexibility in how we create value for stockholders. Before turning to our outlook, one housekeeping item. Our existing shelf registration statement expires later this month, and consistent with past practices, we will file a new one in the normal course this quarter. Turning now to a discussion of the current business environment on our outlook. We were pleased with our performance in the second quarter. Our team continued to execute well to meet the changing demand needs of our customers. Given sustained patterns of at-home consumption, solid first half financial results, and assumed gradual pickup in our food service business, we are reinstating full year guidance. Adjusted EBITDA for 2020 is projected to be in the range of $1.05 to $1.09 billion. Adjusted cash flow for the year is projected to be in the range of $200 to $275 million. On Flight 13, you will find updates to the components of our guidance for the full year. Thanks for your time today, and I'll turn the call back to Mike. Mike?

In closing, the first half of 2020 has been eventful, but as the results reflect, we have met the increased demand needs of our customers and have successfully overcome challenges presented by the global pandemic. Net sales and adjusted EBITDA are both up 5% in the first half of the year versus the same period one year ago. We are operating the business from a position of financial strength We have reinstated our annual guidance that includes adjusted EBITDA growth and healthy cash flow for the year, maintained our dividend and share repurchase programs, all while continuing to invest for the long-term growth and achievement of our Vision 2025 goals. Thank you again for your interest in graphic packaging, and I'll now turn the call back over to the operator to begin Q&A.

As a reminder, if you would like to ask a question, you may do so by pressing star, then the number one on your telephone keypad. Again, that is star one if you would like to ask a question. We'll pause for just a moment to compile the Q&A roster. Your first question is from Mark Wilde of Bank of Montreal.

Good morning, Mike. Good morning, Steve. Hi, Mark. Good morning, Mark.

I wondered if you can just give us some sense of kind of activity levels in July by kind of business lines, what you're seeing in kind of food, beverage, consumer versus what you're seeing in kind of food services. We've moved through July here. And also maybe a little more color on just the point between kind of organic sales and organic volume.

Okay, why don't I take the first part of that, Steve, and then you can handle the second. So, Mark, the way I'd characterize it, if we look at the second quarter, we would say that our food and beverage business was up roughly kind of 6%. That began, as you know, at about 77% of our portfolio. And the food service business was actually down about 20%. As we look at what we are seeing here in July and what we essentially expect for Q3, We see that range on the food and beverage probably being somewhere between 5 to 8, based on the various verticals that we operate in, and food service probably being somewhere in the neighborhood of 15 to 20. So it's improved a little bit, but not materially, as you'd expect, given all the information that's been out on the news around some of the challenges. over the volume in your sales.

Yeah, thanks, Mike. Good morning. Just with regards to organic sales growth, the 150 basis point of growth that we saw, that's a top line number, and we felt that it was the right and actually conservative approach to how we look through our business. Given the mix change that we're experiencing, if you actually step back and look at it on a tons basis, our organic volume tonnage, our integrated tonnage, was actually up 6% in the quarter, so quite material. But there's a pretty significant mix change that's happening inside of there. Just to kind of put it into context, our traditional food and beverage folding cartons, like a beverage package, would be $1,500 plus per ton on average. Whereas a food service on balance product, a cup that includes a lid, for example, might be in the $4,000 per ton range. So we wanted to step back from the results and stare through the top line consistent with our Vision 2025 expectations. And we're very pleased that the net result is a 1.5% growth in the quarter, 3% year to date on a top line organic sales basis. Integrated organic tons are actually higher than that. But as Mike was just saying, as we see some return to the food service volume, that kind of natural give and take of those two changes in mix will start to level play and fuel over time. So we're very pleased with the 1.5% and the 3% year-to-date in terms of the actual top line. Okay. And then I want to just make sure I understand what you said about – SPS downtime. I think I heard you say you took 14 days in July at Texarkana on one machine and that you're going to take another 14 days along with a maintenance outage in September. Is that correct?

You got that right, Mark. And so if you put that together, the incremental market downtime is somewhere between 25,000 and 30,000 tons that occur in Q3. And that's lining our supply with our demand, as we talked about. And that's on top of the planned outage where we're putting a new head box on that machine that was already planned. And that's all in the month of September.

Okay. And is there any way, Mike, to just take some of that – food service-oriented SBS volume and just move it to other businesses? I mean, it would seem with that second quarter operating rate of 97% that you noted from the AF and PA that, you know, SBS supply would be pretty tight right now and that maybe you could just, you know, swing volume on that machine.

Well, you know, that's an uncoated machine, you know, the cup machine itself. But you're, in fact, actually correct with what we've done in the second quarter. As you heard in my prepared comments, we talk about 100,000 tons run rate of, you know, CUK business and put it in SPS. Our teams did an exceptional job of, you know, making that transition very, very fast in order to service customers and capture the growth. in terms of those strong operating rates on the base SPS businesses, the fact we've made that shift. And as you know, we're pretty uniquely positioned to be able to do that, being the manufacturer of all three grades. And that factors into our integration work that Steve also mentioned about. And it's being tested in a pretty big mix change, which I think shows our resiliency of the end markets that we participate in and how our customers are performing through what most would consider a pretty big disruption. Okay.

Well, last one for me. I'm just curious. Are COVID-related restrictions on things like travel, like sending technicians over to install lines for Coke and other beverage companies in Europe, is that – slowing down sort of, you know, one element of your organic growth this year? It is, Mark.

I mean, we've lost a quarter or two, as we alluded to on our first call, and that continues to be the case. We've gotten pretty good at, you know, being able to do things via Zoom and FaceTime and that, but there are some things that just have to be done by our technicians. And what I would point to, and I had that in my prepared comments too, is that we've got our really our first line in Europe that will be operational here towards the end of Q3 and into Q4. We expect that to continue to accelerate as we go into 2021. The interest for that particular specification, Keoklip, continues to be incredibly strong. It's really an issue about getting the machines installed and operational, and we expect we'll have this delay, but there's no loss of interest. As a matter of fact, I would argue it's building.

Yeah, Mark, this is Stephen. that the delays that Mike referenced are kind of timing delays, but what we haven't seen is any change in the interest level or the number of placements. And so it's a little bit of a delay, but there's no change in the actual number of installations consistent with our expectations. Okay, that's helpful. I'll turn it over, guys. Thank you.

Thanks, Mark.

Our next question is from Mark Conley of Stevens.

Thank you. If we look at your slide seven and your recovery of price cost, I'm curious what has changed other than just the lag. If we were to experience that kind of inflation scenario that we saw in 16 to 18 today, how much different would the recovery period be? Would it just be a third faster or is there more changing than just that lag?

Mark and Steve, I think I'll start and then Mike can add on. I think you touched on one of the key components. If we were to experience significant inflation on a go-forward basis, clearly the lags would be tighter. And so that's obviously a critical part of our ability to recover. You've seen, as you mentioned on slide seven, we now have fully recovered the dislocation that we did experience, which is fantastic. important to see. I think overall, though, to Mike's point, the reality of the operating rates and the overall supply and demand environment is, of course, critical relative to our view of that. That, too, would play into recovery going forward. The overall three substrates and the operating rates and backlogs of those is obviously relevant.

I think, Mark, I'd add to Steve's comment just again, and you know this, we didn't even own SPS Mills until January 1st of 2018. So now we've got all of these substrates, and our ability to balance those three substrates across the portfolio business, as we're doing right now, if you think about what we're doing on SPS with 100,000 tons, we moved out of CUK in that. That's a big deal for us. So that helps us balance our supply and our demand by being able to manufacture all three substrates. Which is clearly different.

Right. And just a philosophical question, when you announced the CRB hike a while back, the TradeRabs were quoting customers who seemed upset that you wanted to avoid getting into the same mess that we're just talking about. Does that sort of reaction from customers, is that pervasive? And does it, you know, this is a bad time for a price hike attitude. Does that shift their preference or yours for how these contract terms work? You know, either, you know, preferring the cost escalator or maybe the customers do prefer the price index.

I think, you know, and you know this, I mean, really no customers looking forward to a price increase. So the timing is what the timing is. I think in terms of what our resolve is, and you saw us do that when OCC was going up dramatically and we didn't know where it was going to go, we were very aggressive on making sure that we were out in front of recovering that because we want to avoid having to have another slide like the one that we just got done talking about. And so that's how we're looking at it at Graphic. I would say that the other part of that with customers is that they want to be able to plan, and so cost models give them probably a little bit more ability to plan, where they kind of know in the last six months what's happened, and we can kind of keep them up to speed on that, and they can build that into their forecast up or down. Some of our customers find that helpful, and that's obviously something that we offer them, and we'll continue to do so.

Okay, if I could just squeeze one small one in. In your strategic action slide, you didn't highlight the two coders at West Monroe. Is that still on track?

Yeah. Thank you for doing that. We probably should have had something in there. We are putting our curtain coder in in September on our West Monroe number six machine. And so, excuse me, on our number seven machine. And that'll be done in September. So we'll start getting the benefits of that in Q4. And then we're going to take about a year off. And then early 2022, we'll install the last and final one on the other machine. We want to get it up and running in West Monroe and really make sure that we understand the operating parameters around it and then come in behind it and finish the last one.

Very good. Thank you. Thank you. Thanks, Mark.

Your next question is from Brian McGuire of Goldman Sachs.

Hey, good morning, guys. Just wanted to follow up on the reporting metric switch just from the net organic volumes you had talked about before to the net organic sales. And I guess last quarter you reported net organic volumes that were up about 4%, excluding COVID and leap year. I think 5% included COVID but excluded the leap year. And so are you saying that that same number would have been up 6% in 2Q, so it was actually a little bit better in 2Q? And, you know, related to that, are you now sort of committing to even, you know, offsetting the negative mixed impact that you might have going forward to get into the 100 to 200 basis point growth range on an organic sales basis in addition to organic volume basis?

Yeah, Brian, thank you for that. The answer is yes. The 4 and 5% that you referenced last quarter, this quarter was six. So overall, year to date, organic volume growth is up pretty materially, as we mentioned, driven by very strong demand for our conditional core food and beverage business, particularly beverage. As Mike mentioned, that also created the need and the opportunity to pivot a fair amount of volume from CUK to SBS to service primarily food-based customers, moving them into that product category. Yes, we would expect over time that both volume and sales growth would both be in that 100 to 200 basis points of organic growth over time, so no change whatsoever. We just felt that here, as you look at it today, because of this pretty significant change in the mix of our products, that we actually didn't want to kind of, if you will, over what we believe over the long term might be a temporary overstatement, that we actually stepped back and said, let's look at this through the sales lens. But very specifically, volume is up materially through the first half, driven by the 77% of the business where we're seeing the at-home consumption patterns stay very heavy and positive relative to volume.

If you think about it, Brian, what we're trying to do is make sure that you've got more of a look through. We're actually trying to run this for Vision 2025 as opposed to one quarter, which was exceptional from a tonnage standpoint. But we do expect over time, and we don't know what that time frame is, that we see that business come back. And that's the value per ton that Steve talked about being $4,000 a ton versus $4,000. $1,500 a ton. It's a big shift. And so we're just trying to give you a better look through on the narrative. Maybe some would call that a bit conservative, but we think it's right.

You know, that makes sense. I just asked that you would take some of the, you know, the pricing out of it as we, you know, you do need to recover cost inflation and pricing will move up and down. But, you know, kind of a volume mix blended number makes total sense. Just to switch gears a little bit. Yeah.

Brian, let me, for clarity, just so that on that, that sales definition did exclude price and FX. So it's in the same definition, if you will, of the volume mix category. So it is the sales associated with that. So we did remove price. We did remove FX. So that, again, it's very apples to apples and the way to look through the company relative to the role that the the volume of our business as measured in sales rolls forward.

Okay. Yeah, I think that's a very good metric then. Just to switch gears to SBS, on the slides it looks like, you know, you talked about the operating rate for the industry improved a little bit to 97% from, I think, 95 and 1Q in the backlogs. I think you talked about them being four weeks. I think last quarter's slide it was kind of more three to four weeks. and, you know, recognizing a lot of things have changed on the food service side. But it sounds like, you know, some of the industry data has somewhat improved, but then, you know, on your own converting operations, you're having to take some downtime, and I think that's going to, you know, I think you said 20,000 to 30,000 tons of board sort of impact. So, you know, it seems like some inconsistencies between, you know, some of the industry data and the backlog improving, yet they need to take some downtime. So I wonder if you could kind of... reconcile those and talk about whether you think the industry needs to take some capacity out in SDS, whether there's a need for some of the upstream board capacity to come out.

So, Brian, I'll take that one. Let me just tell you what we're doing at Graphic. So at Graphic, what we're doing is we moved on the equivalency of about 100,000 tons, as I mentioned earlier, of C-U-K, predominantly C-U-K business, into our general SPS, so coded SPS, you know, business. And those conversions occurred in the second quarter. You know, they're all done now, and we're using that to balance out our multi-mill system. Specifically where we have the weakness is on that uncoated cup machine because the demand profile of food service being down that 15% to 20% that I referenced to a previous question. So what we're doing about that, in addition to having a normal planned maintenance, pretty significant maintenance outage to take care of that new head box that we're putting on that machine, is taking an additional, think about it this way, 28 days, of downtime in Q3 to balance our supply and our demand. And so that's how we're looking at solving for that. The general SPS market for us that we're participating in is strong, and it's evidenced by the fact those operating rates year-to-date, you know, AFPA's number, 95.3 versus 91.7. you know, last year, and that reflects, you know, the closure of one of our competitors taking a mill out, and the, you know, obviously the bump on that. So within those numbers, the weakness is the food service grade that we make. It's about 400,000 of our 1.2 million tons, and we're managing our supply and our demand by taking some economic downtime, and I just outlined that for you. So I'd ask you to think about it that way.

Okay, that makes sense. Last one for me. It might be a little unfair to compare the EBITDA guidance components, the line items, to the original guidance, but just looking at it, it looks like price is a $25 million unfavorable and commodity cost deflation is a $45 million favorable swing. So I just wondered if you could kind of talk about versus the original plan for the year, why price is a little bit weaker and what's driving the commodity cost to be quite a bit more favorable.

Yeah, Brian, Steve, from the original guide that we provided when we announced Q4 earnings, we had the modest movement down that was on CRB and SPS, which we took into consideration. And then there's been, obviously, in this deflationary environment, some of our cost models. So that's why we have the new range of price in the $0 to $20 million range. When we originally guided, we could do what we felt was a pretty Modest inflation for the year, 1% roughly on the $2.5 billion spend. We actually are now guiding to some modest deflation in the $10 to $30 million range. Obviously, we're in a recessionary environment. We are experiencing some actual deflation. And most of the net of that is occurring in the areas of fiber-related costs. Yes, OCC costs have moved up and have now moved down. But as we talked quite a bit last year, wood was a major inflationary item for us. Last year, wood has normalized in the south back to more historic levels, and that's creating deflation year over year on the wood basket. The rest of the infrastructure of cost, logistics, chemicals, resins, etc., pretty neutral. Overall, the deflation net is generally fiber-based, with wood being the predominant reason for that.

Okay. Thanks very much. Take care. Thanks, Brian.

Your next question is from George Stathis of Bank of America.

Hi, everyone. Good morning. Thanks for taking my question. I hope you guys are doing well. Thanks for the details. I guess I have three questions. You know, we'll go from sort of process and operations to kind of a bigger picture one. But I guess, first of all, when we look at paper seal and we also look at in somewhat a related way, the shift of the CUK tons to SBS. You know, what kind of changes in runnability are you seeing at either your converting locations or in the case of PaperSeal for your customers? Can the customer use that paper tray with existing equipment that they have, or would they have to make modifications? In your converting areas, are you seeing any change at all, any tweaks, any loss of throughput? It doesn't seem that way, by the way, in moving from CUK to Bleachboard.

Okay, thanks, George. I'll take that. In terms of paper seal, that's a new line that the customer would actually purchase, and our interest there is supplying – the paper tray that goes in there, predominantly, as you know, and a lot of those have been polystyrene foam. So we're replacing polystyrene foam with paper, fiber-based packaging, which is what we do. So that's our interest there, and we're working with a number of different people that actually sell those lines, and we're seeing a lot of traction on that in Europe and Australia, as we referenced there. It's a pretty big addressable market, so we find that interesting for us. And our ability to manufacture that It's pretty straightforward with the existing equipment that we've got in really all of our converting plants. In regards to the CUK to SPS shift, You know, we run all three of those substrates all the time in our facilities, so we know how to convert them. The vast majority of what we moved into SBS out of CUK came from there. And so it started, you know, there's some frozen pizza and there's some other things in there that used to be, you know, on SBS, and then we moved it to CUK, and now we've moved it back in order to balance out our demand. We've worked with those customers to make sure we can meet their heightened needs. you know, demand levels, and they've worked with us on that. So it performs well on their lines. It doesn't require material, you know, adjustments to be able to do that. So, you know, all in all, you know, the overall execution on that has been pretty seamless, as you referenced.

Thanks, Mike. As far as Kalamazoo goes, I know one of the intents, at least this is what I recall, one of the intentions with that machine was to have greater fiber flexibility given, you know, the variability. that you see in the different grades of recovered fiber with, you know, graphic paper demand being down so much and implicitly there being a longer term, more inflation in sort of office papers. Does that change at all? Probably not. But does that change all, you know, any of the return assumption that you have for the new Kalamazoo machine? And more broadly, with this machine coming on, are you seeing any increased interest from your customers, recognizing you're going to basically just replacing older capacity and using more CRB in their business mix from what had been previously the case.

Yes, thanks for the question on Kalamazoo. I was there two weeks ago. I have to tell you, our team there is doing an outstanding job, as we referenced in the materials. We're on plan, both in terms of the timeline as well as the budget for that project. So I appreciate the question. In regards to the actual input cost and paper that we would use, we're going to have a lot of flexibility there. That machine, like our K1 machine, is going to have a curtain coater on it. So the amount of white paper that we have to use close to the surface, balancing off the coating, if you will, is going to be materially better than anybody else in the space. We'll have a lot more flexibility to be able to do it. We've anticipated that. That's how we built the machine. So yes, the smaller market size of the printing and writing paper Well, certainly something we watch is not, you know, material impact of the overall economics, you know, in terms of what we put on the project. As a matter of fact, it hasn't impacted it at all. We'll be able to deal with those kind of disruptions and dislocations much better than anybody else in the space. And that's part of why we're doing the project in addition to the fact, you know, we're taking on a lot of older capacities you talked about. In regards to how customers are feeling about it, look, you see all the sustainability goals and targets our customers have put out there. So when you look at what that machine is going to do, as I've referenced a few times, we're going to use 300 million gallons less water a year. We're going to buy, you know, 20% less electricity. We're going to generate 18% less greenhouse gases across our CRB platform. And these are real material numbers that will help our customers actually accomplish their sustainability goals. So when people are looking to, you know, find a solution to meet those targets, we've got an answer. And it's a different answer really than anybody else has. So in addition to having, you know, the lowest cost, highest quality material, you know, we've got a great sustainability story there, and they like that.

Thanks, Mike. My last question will turn it over. Brian touched on this in one way in terms of your guidance. In some ways, as we step back, it's remarkable what we've seen over the last quarter. You're more or less back to your prior guidance, both on EBITDA and on free cash flow, yet there's been this tremendous amount of volatility in demand and the economy. Ultimately, not without a lot of effort, I'm sure, you skated through it. So when you think about how ultimately graphic packaging, maybe this isn't the term you'd use, you know, filled the hole, you know, and kept guidance and kept your performance where it needs to be where it had been, what was the biggest driver? Is it that we've gone through this period and the consumer now has a greater appreciation of or paperboard and we've seen a sustainable increase in demand from here? Is it just a one-off where there's a lot of pantry loading and, yes, we got through this year, but next year there's going to be a chickens-come-home-to-roost effect on volume? How do you think you got through this and the sustainability of that improvement into 21 and 22 and beyond? Thank you, guys. Good luck in the quarter.

Thanks, George. Appreciate the question. I think, Guy, to have you look at our market participation strategies and how we have, over the last decade, really built this business. And if you look at our big food business, and you look at our beverage business, and you look at our consumer products business, and all that comprises about 77% of the company. We had food service under it. Yes, food service is down now. But look what's up. We've got the food and beverage up because people are eating and provisioning more at home, to your point. So will food service come back? We believe it will come back. To what level, we don't know for sure, and we don't know what period of time. But I'd ask you to think about that as a little bit of a teeter-totter. As food service comes up, you'll see a little bit of kind of the food and beverage go down, but the net impact of that – balances out for graphic, and what we're able to do then is use our new product innovation and our low-cost investments that we've made to continue to grow the business, and that's what gives us confidence in that 100 to 200 basis points of growth. And so this year has been exceptional in terms of how that has all performed, and we've netted it out well. I appreciate the comment, and as I referenced, I think our team has done an excellent job of executing through a pretty Pretty challenging economic backdrop, but it shows the resiliency of our customer portfolio and the operating model that we've got in place.

Yeah, and George, just to add to that, because it was an exceptional effort across the entire organization to manage significant increases in demand as well as obviously the areas of weakness. And one of the things that hasn't been touched on, but I'll touch on it, is on volume mix, that resulted in a modest increase headwind on volume mix because we were scrambling in a significant way to obviously take out capacity in our cup making business appropriately to match the needs of making actual cups. But more importantly, moving that SBS from CUK, moving production into facilities that maybe haven't made a beverage carton but now are, shifting the actual portfolio in a pretty material way. which cost a little bit on the volume mix, but we've now achieved that, and as we continue to roll forward, we can optimize from there. So our overall, and I think it's critical to what Mike's saying, our overall belief relative to the organic growth profile of the business, kind of seeing through that in the 100 to 200 basis points, remains intact with a different mix and some phenomenal work being done across the organization to manage both the ups and the downs through this environment of people needing to eat and drink.

Thank you very much.

Thank you.

As a reminder to those in the queue, please limit yourself to one question and one follow-up question. Our next question is from Phil Ng of Jeffrey.

Hey, good morning, everyone. Congrats on a really solid quarter in a tough environment. Um, appreciate your taking the downtime to kind of balance supply demand, but curious, how's the pricing environment and competitive landscape for your cups business, uh, and food service business.

I'm sorry, Phil, welcome back. As in terms of our customers, were you referring to our, our customers?

Uh, we're just trying to get a better sense of how the competitive landscape is in terms of who you compete with on the cup side. Uh, Is everyone behaving nicely, the pricing environment in terms of what you're selling your products? I'm trying to get it just because demand is obviously down quite a bit.

Hey, Phil, it's Mike. And, again, welcome back. We're not going to talk about the competitive rivalry out in the market. I mean, what I want you to know is what we're doing to actually, you know, compete in that space and meet those requirements. And if you heard Steve, what he just got done talking about, we've right-sized our converting platform in terms of, the amount of people and the amount of lines that we're running to match up with the actual demand we have. And then in Q3 here, we're taking a fair amount of market-related downtime on our cup machine to balance that out. And that's all reflected in the AF and PA numbers year-to-date, so it's a pretty healthy operating rate. So I think I'd point to that. And it's reflected in the guide as well.

Got it. That's really helpful. And appreciating if you choose to use GPK stock, it's not that diluted at all. but the potential incremental 250 million stake from IP potentially becoming available in the back half. Are you comfortable utilizing your cash flow and balance sheet to fund the event? Certainly have a lot of liquidity.

Yeah, thanks, Bill. And I think what we were trying to do on page 12 is to just remind us that we do have incredible flexibility on how we monetize an IP stake. Obviously, they began that process in the first half and the next opportunity to begin to do so is tomorrow, actually, in terms of the next potential for them to begin to potentially monetize. And what we were conveying was just that. We've got a great balance sheet, excellent flexibility. And I'll remind you, and you know this, we've actually bought back $157 million of the company year to date. That price is in the mid-12s. We've got line of sight leverage that's in that two and a half to three times range. Our original guidance indicated that we could acquire back the second $250 million and still be at the high end of our two and a half to three times. That's only modestly changed, mostly because we've acquired back the business into acquiring our own GPK shares. we really continue to like the flexibility we have in the context of our capital allocation strategies, in the context of the value of our currency. That means GPK shares. So excellent flexibility, dependent upon how they choose to continue with their monetization, assuming they choose to do so.

Okay. That's really helpful. Thanks, Mike.

Good luck in the court. Yeah, thanks, Bill.

Your next question is from Debbie Jones of Deutsche Bank.

Hi, good morning. My first question is I was wondering just because your free cash flow range is a little wider than your EBITDA range, what has to happen for you to hit kind of the high end of your targeted free cash flow range?

Hey, Debbie, it's Steve. I think the high end, if you kind of look at the variability, will be around working capital. I think overall that would be in terms of the cash flow, we've got very – plans for inventory coming out of the business in the second half of the year. We have materially more natural planned market-related downtime in the second half. In addition, or excuse me, planned natural maintenance downtime, and then as Mike mentioned, the incremental market-related downtime. So driving inventory out of the business first half to second half will be a key indicator for being at the higher end of the range, assuming kind of, if you will, kind of a natural midpoint on the adjusted EBITDA. I think that's really the, you know, for the most part, our interest expense and taxes and pension will be in line with the midpoint of the range roughly that we have for you.

Okay, thanks. That's helpful. And then second question, Mike, you mentioned helping your customers hit their sustainability goals. Can you help us understand, you know, what percentage or ballpark of your customer base is leaning on you to help improve their value chain metrics? And then what beyond the new mill that you can do to help them with that?

You know, Debbie, I'd say over 90%. I mean, really the smallest customers that we have, maybe perhaps some of them aren't as aggressive on some of those goals. But if you look at our top 25 accounts, for sure every one of them has got a very ambitious goal. you know, for cost takeout. Well, not just cost takeout, but carbon takeout if you think about it over that period of time in terms of what they want on greenhouse gases and electricity and water and those types of things. And so it's very important that we have answers that move the needle. That's part of how we're making those investments and really looking back into it. So I'd say it's, you know, the majority of them.

Okay, thanks. I'll turn it over. Thanks, Tammy.

Your next question is from Mark Weintraub of Seaport Global.

Thank you. You had mentioned the teeter-totter between cartons and food service, and hopefully that's going to teeter back the other way. Is food service more profitable? Is that one of the issues on the impact to mix as well? And so does that become a favorable if it does go back the other way?

Mark and Steve, now I wouldn't necessarily go down that path. Overall, as you know, our economics and big platforms have some commonality to them. We've been improving the overall economics of the SPS platform in the cup business since acquiring that business two and a half years ago. So I don't think you'll see material movements in terms of that impacting volume mix. It really goes back to what we talked about a moment ago We had a lot of activity here in the quarter adjusting to both the ins and the outs. But overall, we would expect over time to earn volume mix positive across the portfolio of products as we look out over the next several years. So I wouldn't characterize it as a difference in profitability. It's more a difference in kind of the top line mix and the tons that are utilized to support that business.

Mark, the only thing I'd add, of course, we're going to spend $12 million. We expect to spend $12 million in the quarter in terms of that market economic downtime. So obviously that would go away if food service comes back. But that's in our guide.

Okay. And two other real quick ones. One, you had a couple of acquisitions, which presumably wouldn't have been in your original EBITDA. Of course, you didn't have FX as a negative either. But order of magnitude, on the acquisitions, how much – Might that be contributing to the 2020 numbers?

Consistent with what we originally guided, Mark, overall, in terms of what we acquired and committed to, we're on the trajectory. So it's that favorable EBITDA that was in our kind of early guides, if you will, based as we put those out there, I think announced after Q1. So we're really pleased, as I mentioned in the commentary, with the Synergy capture, we're consolidating some facilities into lower cost facilities. We're capturing logistics improvements across the CRB platforms. So overall, we're in line with the commitments for both the Greif business and the Quad businesses that we acquired to meet the couple year expectations we had for EBITDA and Synergy capture.

Okay, great. So Quad was in the original guide back in January. I understood. I didn't realize that.

It was.

Thanks. And then lastly, so with the commodity input costs having been favorable, are there contractual givebacks or is Wood treated differently somehow perhaps than some of the other input items, or is that something that, you know, you'll work to offset it in other ways, but how should we think about that?

You know, the vast majority of our contracts that would use virgin wood are market-based, so, you know, that it's not impacted by any reduction there, nor if it runs like it did last year is a comfort mark. So I ask you to think about it that way. Those kind of contracts are more in our recycled business, on our CRP business, the cost models.

Super. Thank you.

Our next question is from Anthony Pettinieri of Citi.

Good morning. You know, there's been some commentary in the trade press about slightly more input pressure in SBS and CRB, and it sounds like, you know, most of your SBS markets are strong and you're taking adjustments where you need to. I'm just wondering if you had any thoughts on imports or whether that's something that you're sort of increasingly coming up against.

Yeah, thanks a lot, Anthony, for the question. Let's break down really and do all three substrates in terms of working off the census data, which is the best we have in terms of imports. And if you start with CRB in the beginning, when you look at CRB, most of the CRB historically has come from either Canada or or Korea. A little bit from China, but not much of any recent time. And actually, those numbers are down year-to-date on the CRP in terms of imports into the U.S. So on that one, that would be the case. And of course, we operate one of those mills in Canada that makes CRP, so some of that could be us just shifting our business around over time. If we look at CUK or CUK equivalents, specifically from South America. You know, the combined production and imports last year, you know, here were roughly 50,000 tons. In year to date, it's up 2,000 tons, so pretty small. I mean, less than 2% of the overall market, if you think about it that way. In regards to FBB, that's been the biggest one. principally coming out of Europe. You've got, you know, Finland and Sweden here today, best we can tell, are up about 30,000 tons. That's consistent with, you know, really what our expectations would have been, but that's been partially offset by a pretty significant drop-off in ivory borer from China. So, you know, the net of all that is it's very de minimis in terms of imports.

Okay, that's extremely helpful detail. And then just following up maybe on George's earlier question, I mean, in your view, is any of the food in BEV demand that you saw in 2Q, which seemed pretty strong, was any of that sort of, you know, pantry loading or stockpiling or channel fill that doesn't show up in 3Q? Or do you think, I mean, roughly that rate of demand should be fairly consistent with 3Q? Sure.

You know, it's a great question, and I don't know if we have a perfect answer, you know, but what we can tell you is we're seeing a similar trend here, you know, in July to what we saw in Q2. You know, so I'd answer it that way. I mean, best we know, you know, it's holding up, you know, about the same. People have worked through that stuff at home, I would think, and there's more meals being eaten at home right now and less meals being eaten out, and it shows in our numbers that But, you know, the great thing about the resiliency of our portfolio is that that balances out in a way that we're still able to, you know, generate economic value here for our shareholders.

Yeah, I think, Anthony, it's tough to argue a pantry load five to six months into a pandemic. I think things do turn over pretty naturally.

Great. That's very helpful. I'll turn it over.

Your next question is from Gansham Panjabi of Bayer.

Hey, guys. Good morning. I guess just as a follow-up to the last question, a lot of food companies have been talking about, you know, just purely matching point of sale, just given elevated sales at the retail level and inventories are pretty low as it is. I guess on the flip side of what you just said, you know, are we setting up for a period where, you know, the 77% of your portfolio that is non-food service continues to outgrow their legacy baseline, even as food service normalizes? I mean, what's your sense just talking to customers?

Dr. Steve, I think as we were just talking, Mike and I were just talking with you and others here earlier, I think, yes, there'll be some natural normalization of volumes as people do turn eventually out into a work base and away from home environment. But that being said, the organic volume growth commitments we have through sustainability related conversion So beverage growth on a global basis, cup conversions, bowl conversions, that really was the catalyst for our vision 2025. And so you kind of have to look through the realities of in and out, if you will, of this difficult and unusual time, and look through our view of the actual net organic volume initiatives that we're executing on, which give us the confidence that organic volume and sales growth will be consistent and available based upon the actual initiatives we have underway.

Okay, and then I'm sorry if I missed this, but, you know, can you touch on how Europe performed during the quarter? I mean, a lot of companies have been talking about beverages being particularly weak in Europe, especially southern Europe. You know, what did you see in the second quarter, and what are your expectations for the back half of that region?

Our business in Europe is strong, and again, we're running a little different race than some because we're replacing a lot of shrink wrap film and other plastics with fully enclosed fiber and keel clip and those kind of projects. So we're driving some real growth year on year, and it's a strong business for us.

Got it. Thanks so much.

And at this time, I'd like to turn the call back to Mike Doss for any closing remarks.

Thank you for joining us on our earnings call today. We look forward to talking to you again in October.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.