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Operator
Thank you for joining Packaging Corporation of America's third quarter 2022 earnings results conference call. Your host today will be Mark Kulzan, Chairman and Chief Executive Officer of PCA. Upon conclusion of this narrative, there will be a Q&A session. I will now turn the conference over to Mr. Kulzan. Please proceed when you are ready.
Mark Kulzan
Thank you, Matt. Good morning and thank you all for participating in Packaging Corporation of America's third quarter 2022 earnings release conference call. I'm Mark Holzan, Chairman and CEO of PCA and with me on the call today is Tom Hasfurther, Executive Vice President who runs our packaging business and Bob Munday, our Chief Financial Officer. I'll begin the call with an overview of our third quarter results and then turn the call over to Tom and Bob who will provide further details. I'll then wrap things up and then we'd be glad to take any questions. Yesterday, we reported third quarter net income of $262 million, or $2.80 per share. Excluding special items, third quarter 2022 net income was $266 million, or $2.83 per share, compared to the third quarter of 2021 net income of $257 million, or $2.69 per share. The third quarter net sales were $2.1 billion in 2022 and $2.0 billion in 2021. Total company EBITDA for the third quarter, excluding the special items, was $477 million in 2022 and $464 million in 2021. Third quarter net income included the special items expenses of three cents per share, primarily for certain costs at the Jackson, Alabama mill for the paper to contain board conversion related activities. Details of all special items for the third quarter of 2022 and 2021 were included in the schedules that accompanied the earnings press release. Excluding the special items, The $0.14 per share increase in third quarter 2022 earnings compared to the third quarter of 2021 was driven primarily by higher prices and mix in our packaging segment of $1.60 and paper segment $0.23. Lower interest expense, $0.04. A lower share count resulting from share repurchases, $0.04. And a lower tax rate, $0.02. These items were partially offset by operating costs, which were 70 cents per share higher, primarily due to inflation-related increases in the areas of energy, repairs, materials and supplies, chemicals, labor and benefits expenses, as well as several other indirect and fixed cost areas. We also had inflation-related increases in our converting costs, which were 4 cents per share higher. The negative impact of lower volume was 52 cents per share in our packaging segment and 5 cents in our paper segment. Freight and logistics expenses were 20 cents above last year, and scheduled outage expenses were 10 cents higher. We also had higher depreciation expense of 7 cents and other expenses of 4 cents. The results were three cents above the third quarter guidance of $2.80 per share, primarily due to the very sound implementation processes around our previously announced price increases in the packaging and paper segments, as well as the continued benefits generated from our mills and plants through process efficiency optimization efforts and material usage initiatives. Looking at our packaging business, EBITDA excluding special items in the third quarter 2022 of $467 million with sales of $1.9 billion resulted in a margin of 24.1% versus last year's EBITDA of $467 million with sales of $1.8 billion and a 25.5% margin. Our teams did a tremendous job of implementing our previously announced price increases However, demand in our packaging segment was well below our expectations for the quarter. Tom will discuss this further in a moment. The container board mills operated in an efficient and cost-effective manner as we balanced our supply with current domestic and export demand. As part of the effort, we began the scheduled maintenance outage in the first phase of the No. 3 machine conversion to container board at our Jackson, Alabama mill a few weeks earlier than originally planned. Total economic-related downtime for the third quarter was approximately 128,000 tons. The outage and conversion work at Jackson will be completed in the fourth quarter and we will remain committed to ramping up our internal capacity according to our customers' demand requirements. Finally, although we are still experiencing historically high inflation within our operating and converting costs, our mills and plants continued to remain focused on delivering numerous cost reduction initiatives, efficiency improvements and integration and optimization enhancements, and capital project benefits that helped minimize the impact. I'll now turn it over to Tom, who will provide more details on the container board sales and corrugated business.
Matt
Thank you, Mark. As Mark mentioned, we continue to get excellent realization from the implementation of our previously announced price increases across all product lines. Domestic container board and corrugated products prices and mixed together were $1.54 per share above the third quarter of 2021 and up 35 cents per share compared to the second quarter of 2022. Export container board prices and mix were up 6 cents per share compared to the third quarter of 2021 and up a penny per share compared to the second quarter of 2022. The lower demand in our packaging segment that Mark spoke of was driven by several items, the combined impact of which resulted in our volumes being much lower than we anticipated. Corrugated product shipments were down 6% in total and per workday compared to last year's third quarter. Outside sales volume of container board was 57,000 tons below last year's third quarter, and 61,000 tons below the second quarter of 2022. The ongoing inventory correction in the retail channels is larger than originally thought, and significant inflation continues to negatively impact consumers' purchases of both durable and non-durable goods. In addition, various events and issues in 2021 and this year, including the recent hurricane in Florida, continue to have a negative effect on the agriculture and protein markets. Demand is beginning to experience headwinds from the cooler housing markets as well. These things combined with rising global interest rates, deterioration in U.S. economic conditions, economic weakness in China and Europe, along with China's zero-tolerance COVID policy, all negatively impacted domestic container board and box demand. As we look from the third quarter and into the fourth quarter, we expect the majority of these conditions to continue. And in addition, there are four less shipping days in the fourth quarter compared to the third quarter. Now I'll turn it back to Mark.
Mark Kulzan
Thank you, Tom. Looking at the paper segment, EBITDA excluding special items in the third quarter was $33 million with sales of $165 million or a 20% margin compared to the third quarter of 2021 EBITDA of $18 million and sales of $150 million or a 12% margin. Prices in mix were up 21% from last year's third quarter and moved 6% higher from the second and into the third quarter of 2022 as we continue to implement our previously announced price increases. Sales volume was about 9% below last year's third quarter, primarily due to this year's scheduled outage at our International Falls Mill, as well as last year's third quarter that included paper sales from the Jackson Mills No. 1 machine. The outstanding efforts around implementing our latest price increase together with optimizing the cost structure, inventory, and product mix, delivered excellent margins in the paper business. Now I'll turn it over to Bob.
Tom
Thanks, Mark. Cash provided by operations and free cash flows set all-time quarterly records at $431 million and $251 million, respectively. The primary payments of cash during the quarter included capital expenditures of $180 million Common stock dividends totaled $117 million, $77 million for federal and state income tax payments, pension and other post-employment benefit contributions of $51 million, and net interest payments of $4 million. In addition, we repurchased 1,032,000 shares during the quarter at an average price of $137.60 per share for a total of $142 million. We ended the quarter with $794 million of cash, including marketable securities, and our liquidity on September 30th was $1.1 billion. Lastly, our planned annual maintenance outage expense for the fourth quarter is now expected to be about 38 cents per share, or 11 cents per share higher, moving from the third quarter to the fourth quarter. I'll now turn it back over to Mark.
Mark Kulzan
Thank you, Bob. Looking ahead as we move from the third and into the fourth quarter, as Tom mentioned, we see most of the issues in economic conditions and higher global interest rates that impacted third quarter packaging segment demand continuing. Our box plants will have four less shipping days compared to the third quarter, and we also expect a seasonally less rich mix in corrugated products as well as lower average export container board prices. We'll run our container board system based on this demand outlook along with completing the Jackson Mill scheduled annual maintenance outage in the first phase of the container board conversion work on the number three machine. In our paper segment, we'll continue to implement our previously announced $60 per ton price increase on all office printing and converting grades that took effect on September 6th. However, volume will be lower compared to the seasonally stronger third quarter. As Bob mentioned, scheduled annual outage expenses will be 11 cents per share higher than the third quarter. Lastly, we expect slightly higher operating costs, primarily labor and benefits expenses, along with anticipated colder weather resulting in higher energy costs. Considering all of these items, we expect fourth quarter earnings of $2.22 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 involve inherent risks and uncertainties, including the direction of the economy and those identified as risk factors in our annual report on Form 10-K and subsequent quarterly reports on Form 10-Q filed with the SEC. The actual results could differ materially from those expressed in these forward-looking statements. And with that, Matt, I'd like to open up the call for questions, please.
Operator
Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question will come from George Stafos with Bank of America Securities. Please go ahead.
George Stafos
Hi, this is Sandy Liang. On behalf of George Stafos, he had a small conflict. First, can you please discuss your early 4Q booking and billing trends? And to the extent that you can share, are customers continuing to do stock in the supply chain? Thank you very much.
Matt
Sandy, this is Tom. Good morning. So far, our bookings and billings are running about 5% below last year. You asked about stocking and some inventory issues. I will tell you that... I think the good news is, well, first of all, we didn't predict that it would last as long as it is in terms of this inventory issue. There was obviously coming out of the pandemic, retailers and other customers stocked up significantly to try to meet the record-breaking demand that they saw and wanted to maintain that. And, of course, that demand has now waned some. In addition, we find that they ordered excessive amount of boxes as well to meet that kind of demand. So we are going through this period right now of pretty severe inventory adjustment. That's what we're seeing primarily in these down volume numbers. And that's going to take a while to work through the system. We thought that it was going to work through the system in about 30 or 60 days, but this looks like it's going to be probably a couple of quarters to get through this completely.
George Stafos
Thank you.
Mark Kulzan
Next question, please.
Operator
Our next question will come from Mark Weintraub with Seaport Research Partners. Please go ahead.
Mark Weintraub
Thank you. Following up on the demand questions, could you ballpark, and I realize this is just judgment, but yours is certainly going to be as good or better than anybody else's, how much that inventory destocked might have contributed to the down 6%, realizing there are other factors you highlighted as well.
Matt
Mark, this is Tom again. You know, it's significant. There's no question about it. And, you know, it's the primary number. You know, it's quite interesting that just as of yesterday, as a matter of fact, I mean, we had a fairly large customer at one of our plants that who sent an email in and said, I have finally run down my excessive inventory. I'm now ready to order again. So we probably lost, in a lot of cases, one or two of the typical order cycles that some of these customers would go through as they went through this destocking of inventory.
Mark Weintraub
And then you mentioned you thought, whereas originally 30 to 60 days, maybe it's going to be a couple of quarters. So is that your best... is it right to interpret that as meaning we had it in the third quarter and you're hopeful that we'll be done with it through the fourth quarter or might it go beyond there? And do you anticipate it's going to be continuing at as high a level as what we saw in certainly the latter part of the third quarter?
Matt
Well, you know, obviously I can't predict the future, but I can tell you that I believe that when you look at our fourth quarter, as I mentioned, there are a lot of other factors going into the fourth quarter, including this destocking. So if you look at those numbers and you think about those, you would see that the trend is probably we'll begin to work our way out of this inventory issue, but we've got some other headwinds as well, as I mentioned, especially like the ag business in the south that was impacted by the hurricane, and that those crops are are either going to be delayed or, in some cases, lost completely. So I've never experienced this, to be honest with you, in my entire career. So this severity of this building the inventories, the lead times that box plants got to, and kind of, in some cases, almost a panic buy of boxes because they couldn't ship their products without it, obviously. So, you know, it's just going to take a little while to work through this. I look back at the Great Recession, and it was kind of interesting there because in the Great Recession, it took a couple of quarters for the cycle to finally turn and the business to really turn up. Beginning, it still wasn't equal to the previous year. That took a few more quarters. But the first two quarters were the big jumps. So that's the only thing I've really got it to compare to. And so I think... When you think about how many boxes somebody can store or how much product they can have and get rid of, I would think that through this Christmas season, you'll see a lot of destocking take place. Appreciate the color.
Operator
Our next question will come from Adam Josephson with KeyBank Capital Markets. Please go ahead.
Adam Josephson
Thanks so much, everyone. Hope you're well. Tom, just one more question about that. Are you seeing it at the retail level, at your customer? To your point, I wouldn't think that your customers would have room to store that many boxes. So I'm just a little perplexed as to where exactly that destocking is taking place and how much longer it could last for.
Matt
Well, let me get specific on that, Adam. I mean, what we're talking about destocking is we're talking about customers that built their own inventories of their own products to hopefully continue to meet a demand curve that was quite steep and quite good for them. And all of a sudden, when that demand leveled out, they're sitting on a lot of their own inventory. That coupled with the lead times that got out in boxes, they had to store more boxes as a result of those lead times and those lead times have now come back down to a more normal level. So just by coming back down to a normal level, you can miss a whole order cycle.
Adam Josephson
Got it. Okay. But even though they've come back to normal lead times, they're still sitting on, it seems like, much too much inventory for current demand levels.
Matt
Yeah, in some cases, yes. I just told you about a large customer at one of our plants that is now ordering again. But they didn't order. I'll give you another example. A very large account of ours through mid-year was up about a little over 3%, and suddenly the next month it was down 50%. Now, this isn't lost business. This isn't anything other than they have excessive inventory that they're going to have to work off for a while. So we've got to get through this cycle.
Adam Josephson
Yeah, no, I appreciate that. Bob, just on the guidance, can you just walk me through the implied sequential change, the $0.60 decline? I believe you said maintenance is going to be $0.11 higher sequentially, so that leaves another, call it $0.50. Can you help me with how much is inflation, how much is lower container board export, how much is the Jackson conversion work, et cetera? And then within that, Bob, how much would you consider price? essentially one-time items, for instance, you know, elevated maintenance relative to normal, et cetera, if you catch my drift.
Tom
Yeah, Adam. I'll say, you know, as Mark mentioned in his question, comments, you know, we expect to run our container board system, you know, similar to, you know, with the same types of issues we had in the third. So when you consider that, you know, I'd say about half of that sequential movement will end up in the volume side of, so, and then the balance of that, you know, the The items that are probably higher versus what we would normally see going from third quarter to fourth quarter, really a couple of buckets, primarily energy for obvious reasons and labor and benefits, again, for some obvious reasons as that continues to just increase with the situation with the labor force. I'd say one other item that might be a little bit different as well is on the freight side. We certainly are seeing some improvement in the freight world right now, but when you're matching supply with demand, you're not always able to optimize your routes, and you may be shipping things more on one mode versus the other than normal or for longer distances. So that is a reason that we expect that to be up a bit going from 3Q to 4Q.
Adam Josephson
Yeah, I appreciate that. It And Mark, just on the buyback, correct me if I'm wrong, but I think the average price of 137 was comparable to what you did in 4Q of last year. Were you doing that before or after demand did what it did? And I'm just wondering about your thoughts about where the stock is now versus what you've been paying for buybacks in recent quarters in light of the recent demand weakness and otherwise.
Mark Kulzan
You know, as we went through the third quarter, we saw an opportunity based on where the stock price was at the time that it was a good value for us to buy back. And we look at it as a conviction opportunity that we see the value there. We had the cash and took advantage of it. It is historically in line with what we did last year at this same time in the fourth quarter. And... Long term, I think under the circumstances, we will continue to take advantage and be opportunistic in the same manner.
Adam Josephson
Just one last one on that. If you were to compare potential acquisitions to further buybacks, is there one at this juncture that's looking more attractive to you than the other or not necessarily?
Mark Kulzan
Not necessarily. Again, I think we see value in terms of the stock buyback during the third quarter. And so you would have to imagine where the stock is today. We have that same type of conviction. And so we'll update you on the January earnings column on what we actually did. But I think you have to understand, if we do hit the $2.22 number that we're guiding to, we're going to have an $11 earnings year. And so it's going to be a record year for us once again. And so, again, I'm going to use the term conviction. We believe strongly that there's a much higher value embedded in the stock valuation.
Adam Josephson
Thanks so much, Mark.
Mark Kulzan
Thank you. Next question, please.
Operator
Our next question will come from Philip Ng with Jefferies. Please go ahead.
Tom
Hey, Mark, Tom, Bob. This is John Dunnigan on for Phil. Appreciate the color. I want to start off with your own inventory levels. I mean, they ticked up sequentially ahead of the J3 outage as you were planning, but obviously the demand outlook has worsened quite a bit. Can you just give us some color on how you're viewing your own internal inventory levels on the container board side, and is there any economic downtime baked into your guidance?
Mark Kulzan
Yeah, you know, when we went into the third quarter, we – Historically, third quarter is always a robust quarter. People are getting ready for holiday activity. And so you also come out of the second quarter, which is traditionally a bigger annual outage quarter when you've taken mills down and you run your inventory down to the lower side. So you always try to start building back up during that July-August period, which is what we did. Obviously, the demand did not materialize, so we course-corrected. and ran to demand, and so we will continue to do that. I think as far as inventory targets, we don't have a specific target as such. We're looking at what Tom is, you know, understanding about what the market's doing on his side of the business and what we would imagine we would need to supply that. and we will continue to run our mills in that regard to meet the demand. We've got a lot of flexibility. We will be finishing up the Jackson work sometime in November, and then we will, again, using the term, run to our demand.
Tom
Understood. I guess... I guess leading up to this quarter, you had talked about being still pretty tight on inventories. Obviously, there's a course correction. I'm sure it's a little bit of a moving target in terms of the inventory levels. But I guess my takeaway is that you're feeling comfortable with your inventory levels now. There isn't some big destock that you feel like you have to do yourself with the pullback on the demand side.
Mark Kulzan
No, we're in a good place. And again, we're at a place now we can move the tons in inventories where we where we see we need to move them. So we're in a healthy place.
Tom
Great. Okay. And then just shifting over to the paper side, my expectation I thought from last quarter was that paper volumes would be about flat sequentially in the third quarter. Obviously it came in much higher, you know, seasonally stronger quarter. Was there anything that kind of stood out on the paper side for drivers, you know, that we should expect maybe going forward?
Mark Kulzan
No, it was just, again, it was a good quarter for us. We've also right-sized the business. We've got, you know, International Falls running in a manner now in terms of it's split between cut size and offset converting type grades. And so we're in a good place there. We worked off the final inventory from the Jackson production that was produced last year. So, you know, we see the market is in a balanced state. place right now, and we're capable of supplying the nationwide demand we have.
Tom
Excellent. Thank you for the call, Ari, and I'll turn it over.
Mark Kulzan
Next question, please.
Operator
Again, if you have a question, please press star then 1. Our next question will come from Anthony Petanari with Citi. Please go ahead.
Anthony Petanari
Good morning.
Mark Kulzan
Morning.
Anthony Petanari
Hey, you know, We've seen a big step down in OCC over the last couple of months, and understanding you have more of kind of a virgin leverage system, I think you've made some investments in recent years to add flexibility there. I'm just wondering if you can remind us how much OCC you can consume, how much you can swing into potentially to take advantage of some of these low costs. Any thoughts there?
Mark Kulzan
I think the best way to look at it is on a percentage basis. If you think about the total capacity of our mill system, we'd still be around that 20%, you know, low 20% capability of fibering up our mills. And so it's, you know, whether at a point in time with pricing, you're running 15% recycle to the system or taking advantage of opportunities on price and availability and ramping it up into the lower 20% recycle. I think that's how we look at it, and that's the kind of capability we have.
Anthony Petanari
Okay, that's very helpful. And then there are some competitor capacity projects that maybe will come online by the end of the year or early next year. I think some of those have explicitly targeted the independent box market. You have a very high integration rate. I guess to the extent that you can, are you seeing any of that new capacity in the market or entering discussions, or does your integration rate kind of insulate you from that? Just any thoughts about some of these new projects and impact on the market, whether you're seeing it or not.
Matt
I want to let Tom comment on that. Anthony, number one is you summarized it correctly based on our integration level. That's been a target of ours, a very high integration level. That's where we come from. And we've said many, many times, You know, what other people decide to do and the investments they decide to make, that's strictly up to them. And, you know, we've talked about what we see the independent market being or the quote-unquote open market and what's happened to acquisitions over the last decade or more. You know, that market has changed quite dramatically in terms of size. So... I would just say that we're a little bit ambivalent to what others decide to do.
Anthony Petanari
Okay. That's helpful. I'll turn it over.
Mark Kulzan
Thank you. Next question?
Operator
Our next question is a follow-up from Adam Josephson with KeyBank Capital Markets. Please go ahead.
Adam Josephson
Thanks so much, everyone. Tom, just one more thought, which is in 3Q, shipments were down 6, and you're talking about Excuse me. Yeah, in 4Q, you're talking about bookings and millings down about five. Can you just remind me how that compares to 2019 levels and what you think a reasonable expectation for demand is at this juncture relative to 19 levels? There have been obviously so many distortions at the onset of the pandemic and thereafter. I'm just wondering how you're thinking about that issue. I got it.
Matt
Yeah. Well, Adam, we'll still be, you know, quite a bit above 2019 levels. So, you know, in spite of this, and I think that a big portion of this is, as I said, inventory restocking. So I haven't changed, I really haven't changed my viewpoint even from the last call we had in terms of, you know, that we will retain quite a bit of the gains that took place during the pandemic going forward. This isn't, you know, severe demand destruction or anything like that. Obviously, inflation's, you know, taking some toll. But, you know, this is more of a, you know, a couple of quarter phenomenon, I think, regarding these excessive inventories.
Adam Josephson
And what gives you confidence in that, that you would hold some of the volume you gained post-2019, just again, given that there was this extraordinary surge with all the government stimulus, you name it, and now we're seeing the other side of that. So I guess what would give you confidence that you would hold those post-2019 gains, if you will?
Matt
Well, a couple things. No different from you having a discussion with me about my viewpoints, I have the same discussions with our customers about their business and about what they project going forward. And, you know, based on their – forecasts and what they see and what they expect to be doing in their business, the capital investments they're making in their businesses, et cetera, I have a high degree of confidence. The other thing that gives me some confidence is regarding the consumer themselves. You know, consumer spending and the consumer relative to savings and other things like that has held up pretty well in spite of this, you know, big step up in inflation. So, you know, I think I think some of these things, some of these phenomenons we're dealing with here in the short term are going to wane. And, you know, it's going to be it's going to be relatively positive going forward.
Adam Josephson
I appreciate it. Just one. I think you mentioned that the impact that COVID lockdowns are having, COVID lockdowns in China, excuse me, are having on domestic demand. Can you just talk about just give your perspective as to the impact on the U.S. economy from what's happening in China?
Matt
Well, interestingly enough, you know, we set the all-time record for onshoring of manufacturing just in the last quarter in the U.S. It's not talked about very much, and it's a little subtle, but certainly very impactful for our business. And, you know, I think that'll continue to be the case. I can tell you the supply chains are still a big problem. It continues to be a problem for our customers who rely on certain parts or chips or whatever the case might be coming from China and the continuous disruption of that supply. That's beginning to really drive more on-shoring, not only here in the United States, but in Mexico and other related countries that border the U.S., which will be much more beneficial going forward for our box business.
Adam Josephson
Thanks so much, Tom. Next question.
Operator
Again, if you have a question, please press star then 1. Our next question will come from Mark Weintraub with Seaport Research Partners. Please go ahead.
Mark Weintraub
Thank you. First, just a clarification. You had mentioned that Outages, I think we're going to be about 11 cents higher than you had previously anticipated in the fourth quarter. Did I hear that right? What is that number kind of on a per share basis expected to be in the fourth quarter versus the third quarter?
Tom
In the fourth quarter, if I follow your question, it's 11 cents, Mark. Mark, it's 11 cents going from the third quarter to the fourth quarter.
Mark Weintraub
Got it. So it was like 26 cents or so in the third quarter going to 37, is that right?
Tom
It was, yeah, it was like 20, yeah, yeah, 26, 27 cents, yep.
Mark Weintraub
Okay, very good. And then the other question I have is, with the Jackson project, one of the things it was also going to do was reduce your costs meaningfully. And, you know, hopefully under certain environments that would show up in 2023. Is that dependent on demand getting back to strong levels? or are there ways you can run your system that that benefit's going to show up regardless, do you think? Or, again, is it that it'll show up, but we'll have to wait until the demand is back to stronger levels?
Mark Kulzan
Yeah, you just answered your own question. When you run the mill, the way it's designed and the way we're finishing up the work that we're doing, it will be a low-cost operation for us. And so we built that capability into it, and we'll be able to take advantage of it. But as we stand by the position that we'll run the entire system to demand, and that means rationalizing from a nationwide point of view where we need the tons to come from.
Mark Weintraub
Okay. So basically, for the full benefit, obviously you need demand to get stronger. That's the right – Conclusion? Yes. Okay. Thank you.
Operator
Mr. Colzan, I see there are no more questions. Do you have any closing comments?
Mark Kulzan
Yes. Thank you for joining us on the call today, and we look forward to talking with you in January for the full year fourth quarter earnings event. Take care. Have a good holiday.
Operator
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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