Packaging Corporation of America

Thank you for joining Packaging Corporation of America's first quarter 2022 earnings result conference call. Your host today will be Mark Colson, Chairman and Chief Executive Officer of PCA. Upon conclusion of his narrative, there will be a Q&A session. I will now turn the call over to Mr. Colson, and please proceed when you are ready.

Thank you, Patricia. Good morning, everyone, and thank you all for participating in Packaging Corporation of America's first quarter 2022 earnings release conference call. I'm Mark Coles, and chairman and CEO of PCA. And with me on the call today is Tom Hassfurther, executive vice president who runs the packaging business, and Bob Monday, our chief financial officer. I'll begin the call with an overview of the first quarter results. And then I'm going to be turning the call over to Tom and Bob who provide further details. And then I will wrap things up and we'll be glad to take questions. Yesterday we reported first quarter net income of $254 million or $2.70 per share. First quarter net income included special items expenses of two cents per share primarily for certain costs at the Jackson, Alabama mill for paper to container board conversion related activities. Details of the special items for both the first quarter of 2022 and 2021 were included in the schedules that accompanied our earnings press release. Excluding the special items, first quarter 2022 net income was $256 million or $2.72 per share compared to first quarter 2021 net income of $169 million or $1.77 per share. First quarter net sales were $2.1 billion in 2022 and $1.8 billion in 2021. Total company EBITDA for the first quarter excluding special items was $467 million in 2022 and $342 million in 2021. Excluding the special items, the 95 cents per share increase in first quarter 2022 earnings compared to the first quarter of 2021 was driven primarily by higher prices in mix of $1.83 and volume of 23 cents in the packaging segment, higher prices in mix in our paper segment for 15 cents, a lower share count resulting from share repurchases for 3 cents, and lower interest expenses of 2 cents. These items were partially offset by 71 cents of inflation-related operating cost increases, particularly with energy, fiber, chemicals, operating labor, and repair labor and materials. Freight and logistics expenses have now moved higher for seven quarters in a row and were 27 cents per share above the first quarter of 2021, and converting costs were higher by 11 cents per share driven by labor and materials expenses. We also had higher depreciation expenses of seven cents, lower volume in our paper segment for six cents, higher scheduled outage expenses, five cents, a higher tax rate resulting from some favorable items in last year's tax rate of three cents, and other costs, one cent. The results were 22 cents above our first quarter guidance of $2.50 per share, primarily due to higher prices in mix and higher volumes in both our packaging and paper segments, operating cost improvements from efficiency and usage initiatives, and favorable weather conditions. Looking at the packaging business, EBITDA excluding special items in the first quarter of 2022 was $464 million with sales of $1,960,000,000, which resulted in a 23.6% margin versus last year's EBITDA of $352 million and sales of $1.62 billion, or a 21.7% margin. Demand in the packaging segment remained very strong as sales volume in both our container board mills and our corrugated products plants had record-setting performances. The scheduled maintenance outages in our mills went very well, and both machines at our Jackson, Alabama mill produced container board the entire quarter. However, with strong internal and external demand, we ended the quarter once again with container board inventory levels below our targeted and historical levels. Although we still face unprecedented inflationary headwinds in our manufacturing costs as well as freight and logistics expenses, Our facilities continue to deliver on numerous cost reduction initiatives, efficiency improvements, integration and optimization enhancements, and capital project benefits to maximize our returns and our margins. I'll now turn it over to Tom, who'll provide further details on the container board sales and corrugated products business.

Thanks, Mark. As Mark mentioned, corrugated products and container board demand were very strong during the quarter. We set a new all-time total box shipments record as well as a new first quarter shipments per day record. Total volume in our corrugated product plants was up 2.9% and shipments per day were up 1.3% versus a very strong comp in last year's first quarter, which for us was up approximately 8% over the prior year. In addition to supplying the record internal needs of our box plants, our outside sales volume of container board was 46,000 tons above the first quarter of 2021, owing to continued strong domestic and export demand. Outside volume was 26,000 tons below the fourth quarter of 2021 in order to help supply our strong internal demand while managing through the scheduled maintenance outages at our mills. Domestic container board and corrugated products prices and mix contributed $1.60 per share above the first quarter of 2021, and we're up 23 cents per share compared to the fourth quarter of 2021. Export container board prices were up 23 cents per share versus last year's first quarter, and up a penny per share compared to the fourth quarter of 2021. The benefits of our disciplined approach for the implementation of price increases across our customer mix last year was a significant contributor to this year's first quarter results. Very good execution of the initial implementation of our recent March price increase contributed to results in the first quarter as well. I'd also like to point out that the capital spending and optimization strategy within our box plant system that we have been focused on over the last few years also plays a key role in our successful implementation process. The investments from this strategy provide the products and service needs that our customers desire and allows them to grow while focusing on the mix of customers we want to align and partner with. I'll now turn it back to Mark.

Thanks, Tom. Looking at the paper segment, EBITDA excluding special items in the first quarter was $29 million with sales of $153 million or an 18.9% margin. compared to the first quarter 2021 EBITDA of $16 million and sales of $165 million for a 9.6% margin. As we mentioned on last quarter's call, volume from our paper segment this year is expected to be fairly representative of the capacity at our International Falls Mill. Accordingly, sales volume was about 19% below last year's first quarter when we were producing paper on the number one machine at our Jackson, Alabama mill. Paper prices in mix were 14% higher than last year's first quarter and 6% above the fourth quarter of 2021, resulting from our previously announced paper price increases. Also, in late March, we notified customers of a $100 per ton price increase effective with shipments beginning May the 2nd for all office printing and converting papers. The efforts of our employees to optimize the cost structure, inventory, and product mix in the paper business helped minimize the inflationary increases we're seeing and deliver solid returns in the quarter. I'll now turn it over to Bob.

Thanks, Mark. For the first quarter, we generated cash from operations of $339 million. and free cash flow of $113 million. Key cash payments during the quarter included capital expenditures of $226 million and common stock dividends of $94 million. We ended the quarter with $629 million of cash on hand or $778 million including marketable securities. Our liquidity on March 31st was $1.1 billion. I want to update you on a revision to the scheduled meal maintenance outage guidance we provided on last quarter's call. Current plans and the scope of work has changed, resulting in a revised total company estimated cost impact for the year of $1.04 per share versus the $1.13 per share previously. The actual impact in the first quarter was $0.15 per share. And the revised estimated impact by quarter for the remainder of the year is now 26 cents per share in the second quarter, 22 cents in the third, and 41 cents per share in the fourth quarter. I'll now turn it back over to Mark.

Thank you, Bob. Looking ahead, as we move from the first and into the second quarter, we expect demand in our packaging segment to remain very strong. and we'll continue implementing the previously announced price increases in both our packaging and paper segments. Volume in the paper segment will be lower with the scheduled outage at our International Falls Mill, and as Bob pointed out, total scheduled outage costs will be 11 cents higher than the first quarter. We also anticipate continued inflation with freight, logistics expenses, as well as most of our operating costs, although recycled fiber prices should be slightly lower. Considering all of these items, we expect second quarter earnings of $2.83 per share. With that, we'd be happy to entertain any questions, but I must remind you that some of the statements we've made on the call constituted forward-looking statements. The statements were based on current estimates, expectations, and projections of the company and do involve inherent risks and uncertainties, including the direction of the economy and those identified as risk factors in the annual report on Form 10-K and on file with the SEC. Actual results could differ materially from those expressed in the forward-looking statements. And with that, Patricia, I'd like to open up the call for questions, please.

Thank you. And at this time, I would like to remind everyone, in order to ask questions, please press star, then the number one on your telephone keypad. Again, that is star one to ask for questions. Your first question comes from the line of George Tapos from Bank of America. Your line is open.

Hey, good morning. It's actually John Babcock on the line for George. Appreciate you taking the time to answer my questions. I guess just first of all, I was wondering if you might be able to talk about the cadence on the price increase implementation this time and if there's any reason to believe it might be different, you know, relative to some of the hikes last year. That would be great.

Go ahead, Tom. Yeah, the implementation is right on track just like the others. You know, we have a very disciplined approach. We usually get the pass through over about a 90-day period. So as I mentioned, we had some that was in the month of March, but the majority of the price increase will be in the second quarter.

Okay, thank you. And the next question, you know, just as it pertains to trucking, I was wondering if you could talk about what you're seeing in terms of spot rates for that. You know, ultimately some of our contacts suggest that prices might be dropping there, so just want to get any color that you might have.

Bob, you want to add a little to that too? Yeah, John, I'll just say that we are seeing a little bit of that relative to the spot market. There are various factors going on that showed a little improvement in the first quarter, but I think as most people would agree, it's still far from being in an ideal situation. In our guidance for the second quarter, again, our freight costs are going up probably another 5% or so, so still a lot to be done there.

I think you need to consider, again, that diesel is still sitting at over $5 a gallon, and that's one of the predominant cost factors. And although some of the drivers in the spot market have become more available, the costs remain at exceptionally high levels.

Gotcha. And then the last question before I turn it over. With the Eiffel's maintenance downtime that you have this upcoming quarter, could you just talk about the normal steps that you take to ensure that customers you know, get the product they need and ultimately anything that you'll do, you know, around inventory build, you know, just to make sure that you're able to serve their needs.

Yeah, I mean, that's a shutdown that's been planned for the last six months. And so it's a week-long outage that will take place in June. And so you have to assume that we've already, you know, pre-planned the necessary inventory and how we'll take care of customers. And so it's really not an issue. It's all part of the shutdown planning.

Okay, great. Thanks again.

Next question, please.

We have your next question from the line of Mark Wilde from Bank of Montreal. Your line is open.

Thanks. Good morning, Mark. Good morning, Tom. Good morning, Bob. Good morning, Mark. Mark, just to start out, it seems like there's an awful lot of new investment in corrugating capacity, including new wider corrugators kind of coming into the industry because we've been very tight for box capacity. What impact is this having on mills and machine efficiency, if any?

Well, you know, speaking for us, it's really not a factor. We've continued to invest in our own box plants over at least the half dozen years now, We've added new corrugators. There are certain optimal size corrugators that we prefer. A few have gone to the very large 130 inch type corrugators. Again, there's certain optimal levels. I don't think there's a real strong relationship to mill efficiency and corrugator size necessarily. Tom, you want to add a little color to that?

Well, I would just say that if you've got some narrow machines, you know, that can create some issues relative to the wider corrugators. So that to me would be the largest impact you probably see in the mills is just some scheduling issues on narrow machines. From the old machines? Yeah.

Okay, Tom, and I'm curious, you know, it seems like over the last 18 months we've been getting more reports about sort of subcontracting out of corrugated volumes during the pandemic. I think this is because of strong demand and the labor shortages. Have you guys seen any impact from this in your system? Have you had that subcontract out more?

I think, Mark, we have kind of a unique system from the standpoint of we have a lot of corrugated plants and we have a lot of sheet plants. So I think in terms of flexibility, sometimes we have a little bit more than some of our competitors might. And that's where I see a lot of this subcontracting, as you call it, is probably more in the independent sheet network as opposed to anywhere else. And like I said, we're able to handle that type of business. So for us, no, we're cutting up everything, all our demand internally.

Okay, that's helpful. Finally, Mark, I wondered if you could give us just an updated timeline and ultimate capacity on the conversion of the two machines at Jackson.

Well, the primary emphasis at Jackson is the number three machine, and as we called out earlier this year, we pushed that outage off to the October period because of supply chain issues. When that Last phase is completed a year from now. We anticipate that the Jackson number three machine should have a 700,000 ton a year capacity built into it. Right now, the number one machine, we're not planning on any significant upgrades at this time. We've got studies done, as you would imagine. That would be an opportunity for the future if we choose to move in that direction. But, you know, we will have a good opportunity to absorb the full production off number three machine through later next year and into 2024.

What would the capacity at number one be without the upgrade? And then, you know, potentially, what could that go to if you put some capital in?

You know, today, if you think about number one machine at Jackson with With no capital investment, it's somewhere 125,000 tons a year type of run rate with the basis weights we're running, which is a pretty good place to be considering we haven't invested in capital.

Okay, very good.

I'll turn it over. It's like any other machine we've talked about over the decades. It's all a matter of capital. How much capital do you want to spend for how much capacity? Because once you reach a certain critical point, you really get into diminishing returns. Because now you're getting into the bigger pieces of capital required for back end infrastructure, pulping, and all of the related pulp capacity requirements. So there's certainly an economic analysis that takes place that you quickly reach a peak return and then diminish. So I think where we are with what we're looking at, if you're producing 700,000 tons a year on number three machine, and 120, 140,000 tons a year on number one machine, that's a very good place for Jackson, Alabama to be on a cost and a profit curve.

Okay, that's helpful. I'll turn it over, Mark. Thank you.

Okay, next question, please.

Okay, and our next question comes from the line of Mark Weintraub from Seaport Research. Your line is open.

Thank you. Congrats on another well-executed quarter. First, two follow-ups. One, you mentioned it normally takes about 90 days to fully implement from board into box. So can we conclude that a portion of the pricing will show up on an average basis in the third quarter as well, that there will be some additional – we'll see a lot of it in the second quarter, and then we should see some incremental – as we average the numbers from quarter to quarter in the third quarter?

Yeah, Mark, this time, yeah, that would be a good read-in.

Okay.

Go ahead, Mark.

And can you give us any sense, if we looked back historically, what percentage might typically show up in that period, what in this case would be the third quarter?

No, it's, you know, it's, you know, I think, you know, as I said, I mean, these things roll in over a 90-day period. I mean, there are a few accounts that, you know, have certain contracts that may go even beyond that. But, you know, for the most part, it's the 90-day period. And, you know, we've indicated that there's some, you know, in March and that the bulk will be in the second quarter. And, yeah, there might be a little rollover into the third quarter. But that's the only guidance I can give you. Okay, so just a little, though. Okay, thank you.

And then you mentioned the Jackson machine going to 700. Is it about 500,000 now? What's the production capacity currently, Jackson?

You're in that probably 440,000 tons a year, 450,000 tons a year on that machine. And, again, it just depends on the grade mix we're running. And then the 125,000 tons, you know, If you look at last year, you know, running the machine for one quarter, we produced 459,000 tons for the year. For the first quarter, we just produced 136,000 tons. So, you know, you're talking about for the full year run rate, if we continue to run at this pace, you're, you know, somewhere 550,000 tons for the year expected out of Jackson.

Okay, thank you. And then lastly, you mentioned the packaging demand looking good. into the second quarter. Can you update us on what your bookings were through the first part of April? Yeah, so far in April, we're up 3.5%.

So keep in mind, though, that last April we were up 12%. So this is a big, big jump on top of last April. So demand still remains very good. I appreciate all the color. Thank you.

We have your next question from the line of Phil Ng from Jefferies. Your line is open. Phil Ng, your line is open. Your next question is from the line of Anthony Pettinari from Citigroup. Your line is open.

Good morning. Morning, Anthony. Can you maybe talk a little bit more about inventory levels in terms of where you are versus where you'd like to be and maybe a potential timeline for getting there? And then given supply chain constraints, do you think just structurally you might hold a higher level of inventory than in the pre-pandemic period? And then I guess finally, anything that your customers have said about their inventories that's maybe worsened or gotten better or any kind of read from them?

You know, as we've called out, we're still below where we would want to be. We're still below our historical target levels. And a lot of it obviously has to do with the pandemic-related supply chain, transportation matters. And so You know, we're into the heavy shutdown period for the year. As we come out of that, things generally improve. But I think also part of your question, we would anticipate for the time being trying to hold a higher level than we had historically held prior to the pandemic. But again, with business volume continuing to grow at the rate it's growing, logistics, supply chain issues, railroad, trucking, doing what they've been doing, it's very difficult to build to the necessary inventory levels.

Okay, that's helpful. And then just on the very strong demand that you've seen, is there any finer point you'd put on customer groups or end markets that are seeing especially stronger demand or maybe some demand that's softening a little bit And then just broadly, are your local accounts, are they maybe outperforming national accounts, or just any color you can give on what has been extremely strong demand? It seems like it's continuing into April.

Anthony, this is Tom. I'll handle the demand piece. Demand, as I said, is very strong. I think representative of some of that strength is If you just look at our top 50 accounts in the first quarter, they were up 7% on average. Now, that includes some that were up double digits. It includes some that were down slightly, but depending on the business that they're in. But if you just look kind of broadly across just, like I said, those 50 accounts, you see that they're in lots of different businesses, and demand remains very strong across all of those businesses. relative to local versus national. I mean, you know, you've got the puts and the takes, you know, as I just talked about. But generally speaking, I think that the larger accounts have a little bit more of an ability to work through some of the issues that are going on, perhaps more so than some of the smaller accounts. But again, everybody says they can grow a lot more than what they're currently able to grow. They're just held up by, you know, all these supply chain issues primarily and the labor issues that we've talked about in the past.

Okay.

That's a great caller. I'll turn it over. Thank you. Next question, please.

We have your next question from Cleve Rueckert from UBS. Your line is open.

Great. Thanks, everybody, for taking my questions this morning. I don't want to beat a dead horse, but just to follow up quickly on demand, PCA has done, frankly, a very impressive job of taking market share in this business over the last 12 to 18 months, call it. Do you have a sense of whether the growth you're seeing is end-demand market growth, or are you just continuing to execute well and take market share?

Well, I would say that our long-term strategy, and I just mentioned it in the commentary too, is to really spend a lot of time making sure we align with the right kind of customers. And we've been doing that for decades. So the great majority of our growth comes from our existing accounts and their ability to grow and our ability to help them grow in whatever way we possibly can. So, you know, that's the majority of where PCA's growth comes from. And we've demonstrated that not just in the recent past, but certainly over the long term.

Okay, that's clear. And then just a couple of quick follow-ups. You know, first, I want to follow up on John's question about freight and trucking. You know, we're seeing the same things about spot pricing, but we've also heard some of the you know, logistics is moving out of the spot market and into the contract market. I'd just be curious to know if you're changing your strategy at all, you know, especially as it relates to the trucking market.

No, you know, we're not necessarily changing strategy. We're taking advantage of some of the, uh, availability improving, but, but there's no major change in strategy. Tom, you want to add anything?

No, we've, we've been, we've, you know, we've been under contracts, uh, for the most part. And, uh, We don't use that much spot, to tell you the truth.

Yeah, okay, that's clear. And then just on labor productivity, I think we heard pretty broadly last quarter that labor, especially in the box system, was kind of a constraint to production and constrained productivity. I mean, you guys obviously burned inventory this quarter, but I'd just be curious to know if that's easing at all or if there's any sort of bottleneck on the labor side that's holding you back on the productivity side.

Yeah, again, keep in mind, if you think about commentary we've made over the last year with our capital investment in the last few years, we've been able to make significant improvements in the productivity in our box plants and continue to grow our capability in terms of productivity per unit, man-hour employed. But that being said, with the labor market there, there's still an incredible amount of stress on the labor pool in the converting side and the mill side? Tom, don't you have a little color to the converting side?

Yeah, there's no question. I mean, our labor situation improved as a result of the COVID, especially the Omicron variant going down some. So that was a help to our labor situation. But on the other hand, trying to hire new people, and replace retirees, et cetera, is still a bit of a challenge and will remain so. If you just look at any of the statistics and, you know, the 8 million jobs that are sitting there open, the highest labor participation rate in decades, you know, we've got certainly, I think, everybody in any industry would attest to the fact that labor is a real challenge.

That is all good. very clear. Thanks for answering the questions. I appreciate it, guys. Okay.

Next question, please.

Thank you. And again, to ask a question, please press star 1 on your telephone. Again, that's star 1 on your telephone. We have your next question from the line of Mark Wilde from Bank of Montreal. Your line is open.

Thanks. I've got a couple of follow-ups. One, is it possible for you to just help us differentiate kind of the level of inflation you're seeing at the mill level versus what you're seeing at the converting level, it does seem like converting plants are seeing more cost pressure than I've ever seen in my career between labor, starches, pallets, energy, other issues.

Yeah, I think, again, it's relative, Mark. Across the board, you'd have to understand that everything is under tremendous inflationary pressure, but What you just said is correct. Tom, you want to go ahead and add some detail to that?

Well, I'm just going to agree wholeheartedly with you, Mark. I have never seen anything like the across-the-board inflation we're dealing with in box plants. We can talk about some of the big numbers, transportation, those sorts of things, but when you start talking about all the things you just mentioned, the labor, the starch, the pallets, the ink, the dyes, any equipment, repairs, any of those sorts of things, It's just these are numbers that I've never seen before, upwards of as much as 200% in some cases.

Okay. Mark, the other question I had is, you know, you've created a lot of incremental benefits by taking advantage of conversion opportunities at Derrida, at Wallula, now at Jackson. Is there anything at International Falls that would prevent you from doing the same kind of thing there at some point in time,

No, as a matter of fact, High Falls is another example of a mill that if the market dictated, we could take advantage of in a very, very good way as far as paper market and then how that plays into our growth in our corrugated products business. Again, as you've heard us talk about, we're always studying and planning and looking at opportunities. And we've got the plans put in the file on what we'd want to do someday if the market conditions were such that it dictated we needed to make a decision about I-Falls. But keep in mind that the big machine at I-Falls, the I-1 machine, is quite frankly a better version of what we have at Jackson on J-3. They were both essentially sister machines installed at a similar time frame. a few decades ago and their tremendous capability. The mill infrastructure at Eye Falls has tremendous capability to support conversion. But again, it's all about box demand versus paper demand and profitability. So we have that opportunity, but yes, Eye Falls is another one of the opportunities that's sitting there that could be taken advantage of someday.

Okay. Would it just be fair to assume, Mark, given that it's primarily a hardwood mill right now, that you'd be more likely to take that toward corrugating medium rather than liner board, or is that not a good assumption?

That's a bad assumption. Okay. Good enough. Thanks. Yeah. Next question, please.

Mr. Colson, I'm not seeing any more questions. Do you have any closing comments?

Again, thanks everybody for joining us today on the call, and we look forward to talking with you at the latter part of July. Have a good day, everybody. Thanks.

And this concludes today's conference call. Thank you all for participating. You may now