Graphic Packaging Holding Company

Ladies and gentlemen, thank you for standing by, and welcome to Graphics Packaging's third quarter 2020 earnings 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. If you require any further assistance, please press star 0. I'd now like to hand the conference over to your speaker today, Nellie Skijas, Vice President, Investor Relations. Thank you. Please go ahead.

Good morning, and welcome to Graphic Packaging Holding Company's conference call to discuss our third 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 third quarter earnings presentation, which can be accessed through the webcast via self-directed slides and also on the investor section of our website at www.graphicpkg.com. I would like to remind everyone that statements of our expectations, plans, estimates, and beliefs regarding future performance and events constitute forward-looking statements. Such statements are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the company's present expectations. Information regarding these risks and uncertainties is contained in the company's periodic filings with the Securities and Exchange Commission. Undue reliance should not be placed on forward-looking statements as such statements speak only as of the date on which they are made, and the company undertakes no obligation to update such statements except as required by law. Mike, I'll now turn it over to you.

Thank you, Melanie. Good morning, and thank you for joining us on the call today. We continue to successfully meet growing customer demand in 2020. The third quarter was a continuation of solid financial performance driven by over 4% organic sales growth, exceptional customer service, and strong operational execution. We remain on track to meet or exceed our organic sales growth projections for the full year. As an essential business, our teams continue to adapt to changing consumer demand patterns while providing continuity in the supply chain during these tumultuous times. We are doing this while focusing on the safety, health, and well-being of our employees. I'm very proud of our people and the service levels we continue to provide our customers. Our execution on behalf of customers and focus on innovation is reflected in the strong results year-to-date in a robust new business pipeline. The pandemic has brought many changes to our daily lives, including the necessity to do more from the protected environment of our homes. whether that be working or conducting meetings remotely, helping children with virtual learning, or hosting smaller get-togethers to stay connected with family and friends. Increased time spent in our homes has elevated demand for food and beverage packaging since the end of the first quarter. While we do anticipate an eventual return to more normal activities outside of the home, modest long-term behavior changes in both how and where we consume food and beverages is very supportive of our organic sales growth goals. Importantly, interest from customers for more sustainable fiber-based packaging solutions remains very robust. Our planning with customers on their packaging conversion programs, including machinery installations for our beverage customers, is proceeding nicely with numerous strategic projects in motion over the next 18 months. Our product development team is meeting customer demand for innovation in packaging solutions that offer greater recyclability and enhanced safety and hygienic advantages, along with premiumization opportunities to stand out in the marketplace. We see strong demand for our packaging solutions across existing customers, as well as prospective customers in new end markets, including protein packaging and e-commerce. Our teams are operating very effectively, and I'm very pleased with what has been accomplished here today. We completed a number of strategic initiatives in the quarter, on time and on budget, including the installation of a curtain coder at our West Monroe Mill and a new head box at our Texarkana Mill. In addition, the integration of the converting volume of the two right facilities closed in the third quarter is largely complete. Another 100,000 tons of CRB paperboard integration will take place over the next couple of years as the supply agreement right unwinds. This will further benefit integration in our CRB business and drive our rates higher for the company. During the quarter, we also executed decisions to match our paperboard supply with demand. This included the continued substitution of an annualized 100,000 tons of CUK-based packaging to SBS folding carton grates in order to meet increased CUK demand. We also made the decision to take 30,000 tons of market downtime on our uncoated SBS cup stock paper machine at our Texarkana mill to align the production with lower cup demand. As a reminder, our uncoated SBS paper machine in Texarkana is highly integrated with over 85% of the cup stock produced, converted by us for customers in our five cup converting facilities. Turning to paperboard backlogs, operating rates, and inventory levels. Our backlogs either held steady or increased during the quarter. In fact, backlogs for all three substrates, SPS, CRB, and CUK, are currently at five-plus weeks. As reported by the A&PA, SPS industry operating rates were 85% during the quarter, maintenance and market downtimes. Industry inventory levels in SBS dropped by 86,000 tons during the quarter. In CRB, industry operating rates consistently improved each month during the quarter and were at 96.5% in September. Industry inventory levels in CRB dropped 21,000 tons during the quarter. Our estimated operating rate for CUK continues to be very strong, above 95%, and our CUK inventory levels also declined during the quarter. Driving our integration rate higher over time remains a strategic priority, and we are delivering. Our year-to-date integration rate is 70% across all three substrates we produced, up 200 basis points from 68% last year. Focusing now on the financial performance of the quarter, you can see the details on slides 4 and 5. Our sales grew 7% year-over-year, driven primarily by impressive organic growth sales of over 4%. This is the fourth consecutive quarter of organic sales growth. Confidence in our ability to profitably capture growth opportunities continues to increase given the traction we are seeing in plastic substitution, cooking solutions, and straight packaging solutions we are bringing to the market. It is good to see our customers remain resolute in meeting their own sustainability goals while converting to packaging that is preferred by the consumers. Adjusted EBITDA in the third quarter of $250 million improved $6 million. We delivered EBITDA growth by positive volume and improvements in productivity. Steve will go into more detail during his discussion, but productivity improvements were partially offset by the previously mentioned $12 million unfavorable impact from market downtime in our SPS stock line. Before turning the call to Steve, I'll spend a few minutes highlighting the expanding addressable markets we see for our fiber-based packaging solutions. Our three growth platforms outlined on slide six, plastic substitution, cooking solutions, and string packaging, provide significant runway to capture ongoing organic sales growth. We've talked to you a great deal over the last several quarters about conversions from plastic packaging to our paperboard solutions. While this remains a competitive market, our solutions are winning, as evidenced by the momentum we are experiencing. In beverage packaging, we are rapidly expanding our proprietary technology with customers through installations of our high-speed and efficient machinery solutions around the world. Our planned beverage machinery placements are up close to 40% versus a normal baseline here. Our Keoklips solution, which debuted this year, offers compelling sustainability advantages and merchandising benefits compared to other packaging options. ABI InBev, Coca-Cola, and other large global beverage companies are converting to Keoklips given the consumer appeal of our new solution. We're seeing growing recognition from industry innovation to support sustainability efforts and improve the consumer experience. Last week, Graphic Packaging's Q-Clip was the winner of the top two accolades at the Paperboard Packaging Council's 2020 Carton Competition, Paperboard Package of the Year, and the Innovation Award. I am proud of our teams that work diligently to commercialize the Q-Clip for our customers. Paper seal products was also acknowledged at the competition, taking home the Paperboard Packaging Council Sustainability Award. Notably, paper seal is now commercial in Europe and Australia with many new trials underway globally. Our paper seal tray for chilled protein, produce, and fruit uses significantly less plastic resin than traditional foam and is being well received in the marketplace. Finally, within the food service market, we see ongoing conversions to paper-based cups and bowl solutions. We continue to actively work with customers to commercialize a polyethylene-free cup solution. In cooking solutions, we are benefiting from the enhanced microwave technology and superior packaging functionality. Frozen foods represent an attractive and expanded market opportunity for consumers' growing desire for ease and speed, along with the availability of more gourmet and organic frozen meal options creates a compelling market dynamic. We offer an improved sustainability profile and competitive economics versus the current plastic tray options. Finally, in strength packaging, we are working on new opportunities in e-commerce and with club stores and mass retail channels. We are winning business on this platform as we expand strength packaging solutions for different distribution channels. We are introducing solutions that can reduce excess packaging requirements while maintaining packaging integrity. To wrap up, I'm pleased with our financial performance and agility demonstrated year to date. I look forward to talking to you again in February when we provide full year results and the outlook for the new year. Consistent with our Vision 2025 goals, we expect to achieve both organic sales and EBITDA growth again in 2021. Steve, over to you.

Thanks, Mike. Good morning. Turning to slide seven in our sales performance waterfall. Net sales in the third quarter increased 7% from the prior year to $1.7 billion, driven primarily by positive volume mix from net organic sales growth and acquisitions. Reported earnings for the quarter were $0.23 per diluted share, compared to $0.18 in the third quarter of 2019. Third quarter 2020 net income was negatively impacted by a net $9 billion of special charges. When adjusting for these special charges, adjusted net income for the third quarter was $72 million. Adjusted earnings per diluted share grew 30% to 26 cents compared to 20 cents in the third quarter of 2019, benefiting from a lower effective tax rate and fewer shares outstanding. Turning to slide eight in our EBITDA waterfall, third quarter 2020 adjusted EBITDA increased $6 million to $250 million. Just the EBITDA was positively impacted by $15 million of volume mix, $7 million of positive performance, $3 million of commodity input cost deflation, and $3 million of favorable foreign exchange. These benefits were partially offset by $10 million in unfavorable pricing and $12 million in other inflation, primarily labor and benefits. As you can see on the waterfall, net performance would have been approximately $19 million before taking into account our decision to execute SBS Cup stock market downtime. During the third quarter, we again experienced a benign inflationary environment across most commodity categories. We are seeing some pockets of inflation in areas like trucking and chemicals, but these areas were offset by modest declines in other commodities. On Flight 9, you'll see the robust list of strategic projects we've completed over the last 24 months. Notably, the maintenance of recovery boilers completed in 2018, 19, and 20 will not need to be repeated for roughly a decade. The capital and resource allocations necessary to complete these projects are behind us, and we will benefit from the safety, cost, and environmental improvements moving forward. These projects increase operational effectiveness and underpin our goal of achieving $50 to $70 million in net performance each year. Looking ahead, we will complete the recapitalization of our converting facility in the Netherlands during the fourth quarter. The $600 million Kalamazoo CRP investment is progressing well and remains on time and on budget for an early 2022 startup. Moving to liquidity in our balance sheet, We have total available liquidity of $1.6 billion. Our balance sheet remains strong. Last week, we've addressed our $425 million bonds maturing in April of 2022 by entering into a delayed draw term loan with member banks of the farm credit system. We closed the $425 million loan last week, but will not fund the loan until January 2021. the date which corresponds with our call date of the maturing bond. The new loan is a fixed-rate, seven-year, non-amortizing loan that is patronage eligible, which should make the net interest rate of the loan less than 2% annually, a meaningful improvement compared to the 4.75% rate for the maturing bond. We ended the quarter with $3.7 billion of net debt. Net leverage was 3.4 times at the end of the third quarter, compared to 3.3 times at the end of the second quarter. Based on the guidance we're providing today, year-end net leverage will be just slightly above our targeted 2.5 to 3 times range. Moving to a discussion on our return of capital to stakeholders, we returned $367 million to stakeholders during the quarter in share repurchases, dividends, partnership distributions, and partnership redemptions. This included the acquisition of $90 million worth of common shares during the quarter, bringing our total open market shares repurchased in 2020 to $247 million and an average price of $13.30. Capital expenditures in Q3 were $119 million and included the ongoing work with our CRB investment in Kalamazoo, Michigan. Turning now to our guidance on slide 10. We have tightened our adjusted EBITDA range for 2020 to $1.06 to $1.08 billion, reflecting 4% year-over-year growth at the midpoint. We are increasing our free cash flow guidance range. Last quarter, we got it to a range of $200 to $275 million. Our new cash flow guide is a range of $275 to $300 million. Reflecting the progress we have made to decrease paperboard inventory levels year over year across all three substrates. As Mike noted, we look forward to updating you on our full year achievements and 2021 outlook when we speak to you again in February. I will now turn the call back to the operator for questions.

Thank you. If you would like to ask a question, please press star followed by the number one on your telephone keypad. We ask that you please limit yourself to one question and one follow-up question. Thank you. Your first question comes from Debbie Jones from Deutsche Bank. Please go ahead. Hi, good morning.

Hi, Debbie.

Hi. The first question I want to ask about is just in your bridge where you talk about the $10 million lower pricing. Can you just walk us through the drivers there and then how you think about that sequentially? Sure.

Yeah, Debbie, it's Steve. Good morning. Yes, the pricing that rolled through in Q3 was as expected and was driven by the two $30 per ton price reductions for CRB and SBS that occurred earlier this year. So that was the natural progression along with the market models and then along with some of the pass-through of the deflation. It was expected. We'll probably see that again here in Q4. Most of that will then be behind us. We'll see a little bit of it roll through the beginning parts of next year's health.

Okay, I think that's kind of helpful. And then you did comment that you are seeing some inflation across your system. And I'm curious, if you look back a couple years ago where you did experience a pretty significant inflationary headwind, can you walk us through how you may be positioned differently? during the last kind of inflationary period? Are there things that we should look to around your contracts or pass-throughs that maybe we didn't see the second time around? And then, you know, comment on your ability to kind of recover it through pricing as well as we think about 2021 if we were to see more material cost inflation.

Yeah, Debbie, let me start, and then Mike can add in. Certainly, you summarized the inflationary environment well. It's been very, very benign. We do see some pockets of modest inflation. If the world stopped today, there would be modest inflation in our business next year. Obviously, that's something that we're monitoring very closely. overall relative to price offsetting cost over time. And certainly, Mike can comment here as well, but we've taken significant action since the last time we had material inflation relative to our contracts and price recovery mechanisms. So overall, price offsetting commodity cost inflation is an absolute priority for us. We know where we are today based upon known pricing. We're obviously in the market today with a price action for CRB. And over time, having those offset with the progress that we've made over the last several years remains a priority as we move out of this year and into next.

Yeah, and I think, Debbie, just to put a little more point on the comment around the contracts, as you know, coming out of that last period, 16 and 17, we made a strategic decision to shrink or collapse, if you will, the lags on the contracts that we have from nine months to six months. So we essentially get a couple openers a year to recover inflation, as Steve just described. So that's materially different than the last time we saw that as well.

Your next question comes from Mark Wilding from Bank of Montreal. Please go ahead.

Good morning. I wondered, Mike, if we could dig in a little bit on the dynamics in the SPS market because, you know, it seems like we've had a lot of closures announced over the last, you know, 12 to 18 months with GP and more recently with Westrock. We've had a lot of big players taking market downtime, and the market still seems to be struggling. So can you just, you know, take a minute or two and sort of unwind the pieces for us And can you also help us kind of reconcile all of that with you reporting five-plus weeks backlog in SPS?

Yeah. Happy to do that, Mark. So, I mean, if you think about it from a graphic packaging standpoint, we operate, you know, four SPS paper machines. As you heard Steve say, in this quarter we actually are at a run rate basis of running almost 100,000 tons of our CUK production on three of those folding carton machines. The fourth machine is the uncoated cup machine. In the case of Graphic, our uncoated cup machine is a highly integrated machine into our own cup operations. As we said, it's over 85% integrated into our own cup making process for customers. So if you kind of look at SPS and what we're seeing, we're seeing strong demand on our, you know, coated machines because we're converting, you know, CUK production on those SPS machines. We're selling that to customers. We're managing our supply and demand to our, you know, demand requirements on our uncoated machine. And so operating rates, if you look at what happened in Q3, SPS as an industry was down around 85%, but it was a very busy maintenance season, as you saw, and graphic took 30,000 tons of economic downtime. Coming out of that, as you saw here in September, inventories went down by 86,000 tons. And when you look at the backlog report, as reported by the APPA, that grew to five weeks. So that's the math, how we think about it.

Okay, and Mike, is it possible for you to talk a little bit about this concept of potentially converting some SPS capacity over to CUK at a point?

Yeah, and so if you really take a step back and look at what we've done with CUK growth, and I'll go back to 2014 and kind of wind that forward to today, we've actually grown our CUK production by over 200,000 tons in that period of time. You don't see that in the AF and PA data because it's commingled with gypsum wall facing. But it's grown 2% to 3% a year based on solid global beverage sales and other carton sales that we've seen, manifesting itself into this year where, because of the growth we've seen on our global beverage platform, we need to actually run some of that production over on our SPS machines. So when we take a step back and look at what optionality we have for the company, what we want to do is take advantage of our low-cost virgin pulp. We want to make the substrates that have the... the highest growth potential and the highest profitability. And so what you'll see us do over time is evaluate how do we push more of that pulp into the grades that we need. And what we're looking to do is do that in a capacity neutral way because it's basically a shift, if you think about it that way, out of one substrate and into the other. And those types of CAPEX projects, Mark, they're very manageable. It's nothing like what we're doing in Kalamazoo. It's kind of what you'd see us do as a strategic project on top of our normal maintenance CAPEX. And so it's very manageable. It would be something that we're looking at and evaluating kind of what the right allocation of that looks like and how to best meet that need over time. But it's a high-class problem. I mean, we've grown our C-U-K consistently year on year. It's a great substrate. It's growing globally, and we've got options to be able to meet it in a very cost-effective way.

Your next question comes from Pandabi from Baird. Please go ahead.

Hey, good morning. This is actually Matt Krieger sitting in for Gantram. Hey, Matt. Hey, good morning. So I just wanted to start with a question on volume. So I was hoping that you could provide some added detail behind the drivers of the 4% increase in organic sales growth. And then if you could put a particular emphasis on how much of that improvement was driven by the current stay-at-home orders or the consumption-at-home backdrop, that would be really helpful.

So, Matt, if we kind of take a step back and talk about the concept we shared with you in our second quarter, we see on our food and beverage business, which is about three-quarters of the volume that we've got out there and a quarter of it being food service, there's a bit of that teeter-totter effect, as we talked about, in terms of our core volumes. We continue to see our core beverage and food up there. And this quarter was up almost 8%. And then the food service business down in this quarter roughly 14%, which was sequentially better than what we saw in the second quarter as well. And so on the core volumes, we expect that phenomenon to continue to be that way. If food service grows a little bit, we would expect to see a little bit of a reduction on the beverage and food side of the business. But where the growth is really coming from, and I'd point to our slide six and the materials we've provided to you, it's on our growth platforms. And we are seeing good organic growth on our plastic substitution platform, our cooking solutions platform, and our strength packaging platform. And we've shown you some pictures and some examples of things that we're seeing. We've profiled a couple of things in the comments, you know, our prepared remarks around What we're seeing with Keoklis is an example. We've sold over 20 machines that are ramping up as we speak. Some are already in service. So we've got really good momentum on the new product, our new product innovation. I mean, our backlogs and pipelines are full on those kind of things. So the core volumes, think about it a bit as that teeter-totter, but where the growth is going to come, the organic growth is going to come, is on those platforms. And, you know, that's where we're seeing it.

Great, great. That's helpful. And then flipping over to pricing, with some of the price hikes creeping into a variety of the adjacent kind of product categories across the paper-based packaging space, Can you provide some updated thoughts on the outlook for pricing across your various paper board grades over the next several months and even kind of into the medium term? Are there any areas where you feel that the industry is under-earning even more than usual or most at current levels?

So, Matt, I'm not going to talk about forward-facing pricing decisions other than the fact you're aware publicly we are out with an increase on our CRP grade of $35 a ton. So beyond that, as Steve said in his prepared remarks, as we see inflation flow through the business, we're going to be aggressive in recovering that inflation so that it offsets over time.

Our next question comes from George Stackels from Bank of America. Please go ahead.

Hi, everyone. Good morning. Thanks for all the details. Hope you're doing well. I wanted to take a different approach on the growth outlook question, if we could, Mike. You mentioned e-commerce as being something that you're trying to leverage. Can you talk about, aside from maybe just the pantry load that's occurring, you know, as a consumer is ordering direct to consumers. Is there anything specifically that you're doing to leverage e-commerce? And then I think, you know, maybe back to Matt's question relatedly, can you talk about, I think in the past you said sustainability, the growth platforms could add one to two points of organic growth going forward. Are we getting to a point where maybe you should be increasing, if I refer to it correctly in the first place, the growth outlook from these platforms and from sustainability?

Thanks for that. I think if you kind of look at a couple of examples we showed you on strength packaging, what you're seeing us really go after in that space kind of what we'll call routine replenishment type products. So if you think about a lot of the pet food and some of the consumer staples, these things tend to be unordered and they're pretty consistent in terms of how the consumer really needs them and how they use them. And so as we look at types of products that we're able to provide and that relationship that the customer wants to have with the end-use consumer in an e-commerce channel. We're providing excellent graphics and merchandising capabilities to kind of keep that connection tight. And you can see some of the examples that we shared with you there that do just that. And on the other side of things, as other types of packaging continue to increase in cost, We're replacing tertiary packaging with a carton, and that results in a cost reduction for the retailer, in this case, or the end-use consumer. So that's how we think about e-commerce. We think we've got a bit of a tailwind there, as we talked about in the past, George, and we're pretty focused in terms of where we're going after those niches and looking for that growth. Relative to the 100 to 200 basis points, Look, I think we've told you in the past that growth can be a little lumpy. This was a very good quarter for us. Our teams are executing well. Our backlogs are good. But Steve and I are holding to the 100 to 200 basis points of growth over the horizon because we put that out there for our vision 2025. So I'd ask you guys to keep that as the target as we kind of go forward here realizing, of course, there's going to be some quarters like the one we just had, and then obviously there'll be some where the conversions may not happen quite as fast, but over time we've got a lot of confidence in that 100 to 200 basis points, and I think three quarters of growth in a row that quite frankly exceeds that, you know, validates that that's the right goal for us.

One thing to add to Mike's point is, One thing we do see is the confidence in the 100 to 200 driven by what for us appears to be increasing addressable market. When we look at where we're participating from what we would have articulated a year ago, our confidence that the addressable market is of substance and that optionality in places like new categories like proteins, represent more potential for us. So the addressable market is certainly there in total, which is why we have the confidence in the overall 100 to 200 basis points over time.

Thanks, Steve. My other question, I'll turn it over. And you mentioned looking out to next year, you expect to see organic sales growth. Obviously, the comps are tough and organic EBITDA growth or EBITDA growth. I know you're not going to be able to provide a lot of line item detail beyond those points, but Can you give us some thoughts in terms of what kind of growth, what kind of mixture between food service and traditional food and beverage you might see in terms of volume growth? And most importantly, as food service comes back, what kind of lift do you get in the mix? Thank you, guys.

So, George, I'll start with your question there, and then Steve can add some commentary as well. But I think, look, we would expect, and we saw, as a matter of fact, your sequential growth in food service in our Q3. We would expect that to continue into 2021. It's going to take some time for that category to completely recover. As you can appreciate, there's a lot of verticals there, like off-premise consumption of those products, events, hotels. sporting events and that kind of stuff. So it'll take a while for that to really come back. But as we kind of look at what we're seeing even within that category, we're seeing opportunities where we're continuing to win, share, and expand the pie through foam conversions on our cups. And so we'll be in a good position as that comes, and it will be a source of growth for us, again, going forward. of going into the future. And Steve, I'll let you handle this question on Mays.

Yeah, George, the only thing I think I'd add to that is obviously we'll provide details in February, but when we look at the potential for organic sales and even dog growth next year, earning on volume mix and driving productivity are going to be the two primary categories that we'll share with you in February. We expect to have a strong productivity year next year. We'll have less downtime, particularly on the maintenance side, as we talk in the comments. Not needing to do some work around recovery boilers, as an example, that drives year-over-year productivity improvement for us because of the need not to make those investments. So it's going to be a volume mix and productivity discussion that we'll be having as we share those details with you coming up in February.

Your next question comes from Mark Connelly from Stevens. Please go ahead.

Thank you. So the number seven curtain coder is the second of three. How quickly do you know whether you've gotten the savings that you targeted? And I think you also talked about improving sheet quality. Does that expand your customer potential, or is that really just sort of keeping the margins where they were?

Yeah, thanks, Mark. So we're actually now – It's the third of four. So both curtain coders are done in Macon. We did number seven in West Monroe, as you just mentioned. We have number six still to do over in Monroe. Relative to the savings that we see, it's pretty instantaneous within 30 days. Basically, and we've got these pretty well dialed in, as you'd expect. This is the third of four. So the latex and TIO2 reductions, we see the material reductions occur in very quickly and start showing up in our performance results. And so you'll see that in our comp here over here on that. And relative to the fiber usage, in particular in the case of what we did in Texarkana on the head box there, we actually see a reduction in the amount of fiber that we need to use now to make our cup. And we'll dial that in. That's a little longer period of time because you've got to run through trials and kind of work through that through our own integrated cup operations. But it increases the consistency of our formation and the profile of the sheet, which then in turn allows us to run with a lighter basis weight over time.

OK. And just a question on alternative beverage carriers. This summer we started to see more of those heavier plastic six-pack carriers where the plastic covers the top of each can. And now we're starting to see trade press about bioplastic ring carriers that will biodegrade. I was hoping you could talk about where those two fit against a system like yours, which is geared towards more higher volume, because we're really only seeing that plastic stuff in low-volume applications. Given the sort of business you do, how competitive are these new products that we're starting to see?

So it's a competitive market for sure, but I think you've got the read on it the right way. I mean, the high-volume production really needs to go down an integrated line like the ones that we've made that allows our customers to do this at incredibly high speeds with high levels of efficiency. given how they have to run their operations. And ArcheoClip does, in fact, do just that. You'll see different types of options, kind of one-offs, particularly on the craft side, where these are hand-assembled and kind of put together. And again, we compete with those types of products and expect to compete with those types of products. But from a volume standpoint, those are relatively small in nature.

Your next question comes from Adam Joseph from T-Bank. Please go ahead.

Mike and Steve, good morning. I hope you and your families are well. Thank you, Adam. Mike or Steve, just on commodity costs, I know you give the annual consumption and the supplementals in the presentation, but can you give us a sense, just in light of the deflation you're guiding to this year of $10 to $30 million, where your input cost basket is relative to normal? In other words, is your input cost basket in its entirety normal? at normal levels, below average, above average, just trying to get a sense of where you are input cost-wise versus whatever you consider normalcy.

Adam and Steve, obviously it varies by category. As you know the categories well, there are certainly some categories that are at what would be considered historic low levels like you've seen OCC move toward but appears to be there for the foreseeable future given the global dynamic on OCC. would very steady and has returned to more normalized levels. We would say you are seeing, as you mentioned, logistics cost truck particularly does have volatility in it. And we've seen some of that in the short term. It well chronicles that there's been some movement up in spot rates. So right now, it would be moving up above the norms in the short term here. You know, energy, I would characterize you've kind of get a sense from that gas being now kind of more normalized and consistent levels. So the net of all of that for us, as you mentioned, this year, modestly deflationary was pretty neutral in Q3. We would expect it to be neutral to modestly inflationary Q3. in Q4. As we mentioned earlier, when you take the entire basket and if the world stopped rotating on an instantaneous basis, we'd be in a modestly low inflationary environment next year based on a full basket of those commodity costs.

I appreciate that, Tim. And just to follow up on that, on the CRB increase, so if If you're not really seeing much inflation across the business, I guess I wonder why the need for the CRB increase. Relatedly, I'm just trying to understand the timing and the amount of it. You announced a $50 one in the spring. Obviously, Recy did not recognize it. I don't know how much you implemented of the $50. Wondering how that translates to your announcing a $35 a ton increase versus the previous $50. You know, why the timing of it in August. I'm just trying to understand the timing and the magnitude of that increase versus the previous attempted increase, how much you realize, and if any of this has to do with cost inflation, given that you're experiencing input cost deflation this year. Thank you.

Yeah, so Adam, I guess the way I would answer that, if you look at our Q3 AF and PA data, as we talked about, I mean, the operating rates are quite strong, finishing September at 96.5%. Demand actually outstripped production in the quarter by 21,000 tons, and backlogs are strong at five-plus weeks. So when you look at all of that together, supply and demand has a bearing on pricing, as you know, and so that's why we did what we did.

Our next question comes from Brian McGuire from Goldman Sachs. Please go ahead.

Hey, good morning. Thanks for taking the question. I was hoping to get some more real-time color, if you could provide it on trends in the food service business. Week in through most of the summer. I just wonder if you're seeing any signs of improvement in October, or do you think that more economic downtime might be needed in 4Q if passing any increase in that market?

Good morning, Brian. So as you saw, we saw sequential improvement, albeit slight, in our Q3 over our Q2. And we continue to see that trend continue on here into Q4. Relative to any downtime that we would take relative to our cup stock line, we're not planning on any right now in our fourth quarter. But as we said in the past, we'll match our supply with our demand based on what we're seeing there. It's a highly integrated machine. that is over 85% integrated in our own cup operations. So if you think about that for a minute, and just to kind of parse it out a bit, we make 3.8 million tons as a corporation. And of those 3.8 million tons, around 10% of that would be that cup machine in Texarkana. The rest of our portfolio is quite busy. You know, RCRB is busy, RCUK is busy, and the free-coded SBS machines are busy. So that's how I would have you think about that and what we're doing to balance our supply and demand on the Cupstock line. You just saw QSQ3, and we'll continue to monitor that as we go forward.

Okay, and then just a question on the EBITDA guidance components. It looks like the performance bucket is – kind of going the wrong way by about $20 million. Just wondering if you can comment on what the driveries are there versus the prior guide. And then related to that, is there any kind of initial thoughts on where 2021 CapEx might fall?

Yeah, Brian, all we were doing on the guide was just tightening up all of the numbers. We were very pleased that we were earning on the volume mix, and so we moved that up a little bit. We recognized in the guide on performance that we took the market downtime for SPS. That's now in there. There's a little bit of year-over-year comp that is in the net performance numbers. So we were really just cleaning those up in total. There was no move. And then, obviously, we'll come forward, and you know the major projects that we have underway with Kalamazoo and kind of our core CapEx. We'll be more definitive on CapEx as we roll into February.

As a reminder, we ask that questioners ask one question and one follow-up question. Your next question comes from Steve Chercover from VA Davidson. Your line is open.

Thanks. Good morning, everyone. So first question, did the hurricanes that hit Louisiana and other parts south have any impact on your operations or log costs in the third quarter? And going forward, might there be a benefit from inexpensive salvage logs?

Yes. We incurred a very, very modest amount of downtime, most precautionary downtime at our converting plant in West Monroe that we shut down as a result of one of the hurricane preparations, but we did not lose any time at our West Monroe mill or our Texarkana mill. Relative to salvage log recovery, we were in those markets every day. A lot of that was south of where we were at. As a reminder, we buy all softwood material in Monroe. We do buy hardwood, obviously, in Texarkana. But I think our costs for wood have been very good this year, and we expect, based on what we see right now as we go into Q4, for that to continue to be the case.

Great. And then with respect to Kalamazoo, it's good to hear that it's on time and on budget. Since the models will soon be looking into 2022, can you help us understand how that $100 million benefit is going to flow through? I think some of the savings might start from Battle Creek and Middletown might start to accrue in 2021. So if you can kind of tell us the cadence, so to speak.

Yeah, Steve, at a high level, what we've conveyed previously is that of the $100 million of expected EBITDA improvement, roughly half of it would come in in 22, with the other remaining $50 million coming in in 23. That right now is the right operating and modeling assumption to your question. No real benefit in 21.

Your next question comes from Anthony Petunari from Citi. Please go ahead.

Good morning. Just following up on George and Brian's questions, you mentioned a number of customer channels that may have to come back before you can run more fully in SBS. Is there one or two that are particularly important or that we should watch, whether it's coffee change or institutional or big events? that we should focus on. And when you think about sort of a post-COVID recovery, we've seen a lot of retail closures, you know, big coffee chains closing, you know, a big chunk of stores. Just wondering if you think there could be any sort of permanent impact to cup demand, even if we get, you know, somewhere back to normal in 2021, or how do you think about offsets?

Yeah, again, Anthony, what I'll go back to is talk about the four SPS machines we operate, three coating machines actually are quite busy because we're running a lot of our CUK material over there. In regards to our cup line, in particular, you said it, we're seeing some you know, declines, obviously, in some of those verticals that we talked about already relative to a year-over-year, you know, comp basis. And it is true, if you think about on the coffee channel, while the drive-thru window remains quite robust, you know, the actual consumption within, you know, some of those stores is down and some of those just have not reopened. And so we're anticipating that to be the case as we go into the fall here and into 2021. We expect that that would recover, you know, here as there's a vaccine and a treatment plan that works and people get comfortable with. When that is, you know, it's very hard to actually put a finger on. But we would expect that particular vertical to be a source of growth in the future again. But it's going to take some time for it to recover. In the meantime, the good news for us is we've got a highly integrated paper machine into five integrated plants, and we've demonstrated an ability to grow our top line quite well, even with that as a headwind. So we think we're positioned very well to respond through this pandemic.

Okay, that's helpful. And then you have a fairly sizable European business, and we're seeing some of those markets go into increased restrictions or lockdowns. I'm just wondering if you could talk about your exposure there, whether it's sort of on-premise or consumer slash grocery, and how current conditions are or maybe are not impacting your business in Europe.

Yeah, our business in Europe is actually much lower indexed to food service, and it's much more indexed to food and beverage. Beverage is a very big business for us in Europe, as a matter of fact. And so when you think about kind of the pandemic, what we saw in Q1 and early Q2, of this year when Europe was a little bit, you know, ahead of where North America was relative to the COVID-19 pandemic, we saw solid volumes. And we would expect in that kind of situation, you know, for that to be, you know, the case again here going into the fall.

Your next question comes from Neil Kumar from Morgan Stanley. Please go ahead.

Hi. Good morning. Thanks for taking my question. You talked about moving 100,000 tons from CUK to SPS. What has the customer receptivity been to switching grades given the perception that CUK is a more sustainable product? And can you just remind us, following the closure of the medium machine at West Monroe, how much incremental CUK volume can we get out of this and, you know, the timing of that?

Yeah, Neil, so I guess if you think about customer receptivity, our customers have been thrilled that we've run a robust supply chain for them, particularly as you look at what happened in Q2 and into Q3. We've been able to keep them in products. In some cases, their volumes have grown dramatically, and we've been able to supply their needs. And so we did that in a way that kind of used our substrates that we manufacture in a way that kept them in business and obviously – they've been able to excel with our support. So it's been very high in that regard. In regards to Paul in Monroe, as I mentioned, if you look at the paper machine we shut down in 2015, which was a bag machine, and now they the liner machine, the liner medium machine, we've consumed the vast majority of that pulp. In fact, we've grown 2% to 3%. From a creep standpoint, every year over 200,000 tons between Macon and West Monroe, with West Monroe being the largest gaining item. So we've been quite active in taking advantage of that pulp that we have.

Your next question comes from Aaron Viswanathan from RBC Capital Markets. Please go ahead.

Great. Thanks. Good morning. Congratulations, reporter. I guess I just wanted to ask about food service to begin with. So maybe you could characterize where you are in that recovery on a year-on-year basis. Have your monthly trends kind of slowly, steadily improved? And how do you see that business kind of trending over the next little while? And do you think there's been any structural damage there that would require that you kind of shift your focus? You know, I know you highlighted potentially moving some SVS into CUK, but what are some other things you're considering there, and how should we think about your food service evolving over the next, you know, say six months or so?

Yeah, Rudy and Steve, Mike touched on a fair amount of that just a moment ago. I think, you know, 14% down in the quarter was modestly improved. We're down 11%. year to date, we would expect for a flow and consistent improvement, but it will take some time. And as such, we're taking the actions that we've talked about. We'll match supply and demand on that singular one machine that's 85% integrated to match it with our cup production. Those are actions that we'll clearly take. And then we'll consistently assess the other three machines, which are very busy today, five-plus-week backlogs on them driven by C-U-K conversions. And as Mike articulated earlier, we're obviously exploring options for investing in the pulp capabilities on those other machines as well to create very cost-effective solutions in growing applications.

Okay. Thanks for that. I also wanted to ask about, you know, I guess longer term, if you're thinking about this business and, you know, I just lost my train of thought here, but, yeah, so maybe we can just ask and pivot towards M&A then. Are you seeing any opportunities for bolt-ons, you know, in Europe and on the converting side, you know, or are you kind of solely focused internally on your organic investment business? What should we expect on that front?

So if you really look at the two acquisitions we did earlier this year, both Quad and the Greif, you know, converting assets, we're thrilled with those acquisitions. And they're largely integrated into our operations. As you heard, Steve's saying his prepared marks. You know, we shut down two facilities, you know, two converting facilities, and we've largely completed those activities. That business is where it belongs in its new location. And we're driving synergies through the business. We've got a supply agreement that will unwind over the next couple of years. And so that whole part of how we thought about the business and driving our integration rates up is really working to plan and as we expected it to. Relative to ongoing M&A, as we said last quarter, the bar is really high. We've got a lot to do here already. We're executing well. We're growing organically. We're investing in our R&D and new product development activities. We're investing heavily back into our own corporation, our converting operations activities. about what we've done in Monroe and how differentiating that is, you know, from anything else anybody else is doing in the industry. Or in what we're doing in Kalamazoo, it's going to have a whole different profile, you know, for us. And so we like our ability to drive this organic growth for, you know, the next, you know, few years for sure as part of our vision 2025 and that 100 to 200 basis points. So what we'll compare and contrast against is, more investment organically versus M&A, and like I said, it's a really high bar. Not to say we don't look, because we do, but we're very thoughtful in terms of how we'll allocate capital in that kind of an environment.

Your next question comes from Mark Weintraub from Seaport Global. Please go ahead.

Thank you. Just a couple kind of cleanup questions. One was last quarter you had an outage cost impact table. I don't see that this quarter. Is what we saw last quarter still relevant for what would be in Q4, or is there going to be downtime at Texarkana to factor in?

Yeah, hey Mark, it's Steve. We eliminated the table because it was kind of there more to help with the quarters. So apologies for that. All it was there to help with quarters. Since we're now talking about Q4, there's been no real change. And as Mike articulated earlier, we don't have plans for downtime across the cup machine in the quarter.

Okay, great. And then lastly, as you point out on slide nine, lots of projects in 2019 and 2020 which would have impacted maintenance. How much higher would you say is maintenance expenses than this year and or last year versus what would be more normal or kind of reasonable, recognizing perhaps you haven't fine-tuned it, but as we think about next year?

Yeah, Mark, think about it, and we touched on it, significant investments that we have been making, certainly in recovery boilers and the curtain coders and the head box. Think of it as probably a $20 million year-over-year improvement opportunity by not having to do as much of that from 20 to 21. We'll come back and talk about that in more detail, but it's in that kind of a range.

Your next question comes from Ing from Jefferies. Please go ahead.

Hey, guys. Good morning, everyone. If I heard you guys correctly, it sounds like you're not taking any downtime in bleach support in the fourth quarter. So curious, is the West Rock-Ethel line closure, is that a big deal for you? Because I don't have a great feel for the overlap that line may have, whether it's food service or folding carts.

So, Phil, we had a competitor that announced they were taking a machine down. It's a 200,000-ton machine, 5.2 million-ton market. So when you do the math on that, it's 3% to 4% of the capacity that comes out. We talked about, in the case of Graphic, how we're operating our three folding carton-grade machines and our cup machine. So what you'd expect over time is that operating rates would improve as the denominator gets adjusted on that.

Okay. Do you know any color from your perspective, your intelligence, whether it was there a lot overlapping like folding cars or cops as it relates to that line that they idled? I just don't have a good feel for it. We don't know. Okay. That's fine. And then the momentum you guys called out in your business and backlogs, part of that is your advice on these conversions and some of these growth platforms. So I'm curious, are you seeing more wins come through recently, or is this more of the wins that you had last year that's actually finally flown through recently?

No, we're seeing more wins and we're seeing more opportunities. I mean, the addressable market, as Steve said, continues to grow. And we'll put a little bit more emphasis on that when we talk to you again in February. We're doing a lot of work on this. We're investing, as I said, in terms of resources that will help drive new product development, growth, and commercialization. So you're going to see us really get over our skis here, and we're going to lead. you know, be the clear leader here on, you know, fiber-based consumer packaging, and we're investing behind it to make sure that that happens both in terms of people and in terms of our capabilities, and that's pretty exciting.

Your next question comes from Mark Welby from Bank of Montreal. Go ahead.

Yeah, just a couple follow-ons again over on food service, Mike. I wonder if you guys can give us a sense, where you're at with volumes just in the cup business versus where you're expected to be at this point. And then, you know, is the kind of stress in food service, could that be creating some opportunities to maybe consolidate and rationalize in the space? It's a space you've long wanted to grow in.

Yeah, so I'll start and then Steve can comment. I guess, you know, in terms of, like I said, the drive-thru windows market remained quite busy as we've seen the economy open back up again. Where we're seeing the issue or the reduction, which is the event-based stuff, the on-premise stuff. And that's a wide range of categories. You think about movie theaters, you think about sporting events, you think about hotels and that kind of stuff. So it's difficult to know exactly how that comes back or how fast it comes back. As we said, we still believe that this will be a source of growth for us again in the future, but it's going to take some time. Relative to conversion opportunities, I mean, we talked a little bit about, you know, what we see on the SPS side of the business for CUK. So I believe that's what you were talking about, so I won't repeat my comments on that. But the other part of it is we're pretty aggressive, as you know, taking a look at our footprint elsewhere. every year, our converting footprint every year, and making sure that we're lined up with where our customer demand is coming from. So we'll continue to be very thoughtful in terms of what that looks like. But when you're driving the kind of growth that we're driving now, we need that capacity to help us make sure that we're ensuring customer service and meeting their demand needs. So we're repurposing some of that capacity maybe a little differently than how it was originally intended to

And Mark, to your question on consolidation, M&A type consolidation, as Mike said, we have a high bar, but certainly we're always opportunistic and thoughtful. If there was an opportunity for consolidation, it would be something we would take a serious look at because there is the possibility, of course, businesses being disrupted and may have a need for a change. So that's always on our radar as you'd expect it. And generally, our integrated cup business is down in very similar percentages as what we articulate for the whole food service business, so there's not a material change there. As Mike said, it's really that last 15%, 14% is driven by theaters, airlines, hotels, events. That's kind of what is really driving that component. It's a pretty long tail.

Your last question comes from George Stafford from Bank of America. Please go ahead.

Thanks for taking my final question. Hi, guys. I want to take another approach to that question that Mark had teed up. You know, you see one of the other traditional B2B packaging companies in the market in a different substrate developing a consumer cup business with a very large investment. You have some potentially excess capacity right now in bleachboard in your cup business for obvious reasons within food service. I recognize you don't want to make a decision for the next three years based on the last two quarters, but is there an opportunity to creatively use maybe your bleached capacity in your cup making for a consumer offering, either at retail or direct-to-consumer Have you looked at that at all, and what's the return payoff if you have? Thank you, guys, and good luck on the quarter.

George, just for clarification, are you talking about kind of moving out of institutional cups and into retail cups?

Yeah, that's what I was thinking about. I don't know if you have available cup-making capacity, but my guess is you might because of what's been happening in food service lines overall. So there's an opportunity to take that capacity forward. and offer it either to retail for the consumer or direct to the consumer in some way to fill up that capacity, not knowing what investments you'd have to make on web platforms, marketing, and so on. Maybe it's not worth it, but just I figured I would tee the question up.

Yeah, so thank you for that. I understand it. From our standpoint, as you know, we're over-indexed on the institutional side, which is really where we're set up and we've got the ability to really have scale and drive cost efficiency through our business there. Relative to building a brand, you won't see us do that. Relative to a customer that comes to us and maybe wants a private label consumer as an example and wanted some cups made, we could absolutely and would look at those kind of opportunities. So that's how I believe we would approach that in the marketplace is what happened.

We have no further questions. I'd like to turn the call over to Mike Doss for closing remarks.

Our solid results in 2020 are reflective of the long-term value our packaging solutions provide the food, beverage, and food service industries. We are delivering on our promises, advancing our strategic priorities, and boasting growth in both organic sales and EBITDA. We're excited about the business and extending our clear leadership in fiber-based consumer packaging through new product rollouts, consistent execution, and service to customers. Our dedication to employees and partners is unwavering as we pivot to a growth culture. Our role in advancing the global sustainability movement is nothing short of exciting and energizes our employees and partners. And with that, we look forward to talking to you again in February.

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