Sonoco Products Company

Good day and thank you for standing by. Welcome to the second quarter 2021 Sunoco earnings conference call. At this time, all participant lines are in listen only mode. After the presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star then one on your telephone keypad. Please be advised that today's conference may be recorded. If you require any further assistance, please press star then zero. I'd now like to hand the conference over to Roger Schrum, Vice President of Investor Relations.

Thank you, Liz, and good morning, everyone, and welcome to Sunoco's second quarter investor conference call. Joining me today are Howard Coker, President and Chief Executive Officer, Roger Fuller, Executive Vice President, and Julie Albrecht, Vice President and Chief Financial Officer. A news release reporting our financial results was issued before the market opened today and is available on the investor relations website at sunoco.com. In addition, we will be referencing a presentation on our second quarter results, which was also posted on our website this morning. Before we go further, let me remind you that today's call and presentation contains a number of forward-looking statements based on current expectations, estimates, and projections. These statements are not guarantees of future performance and are subject to certain risks and uncertainties. Therefore, actual results may differ materially. Furthermore, today's presentation includes the use of non-GAAP financial measures, which management believes provides useful information to investors about the company's financial condition and results of operations. Further information about the company's use of non-GAAP financial measures including definitions as well as reconciliations of those measures to the most closely related GAAP measure is also available in the investor relations section of our website. Now, let me turn it over to Julie.

Thanks, Roger. I'll begin on slide three where you see that earlier this morning we reported a second quarter loss on a GAAP basis of $3.34 per share and base earnings of $0.84 per share. which is just shy of the midpoint of our guidance range of 82 to 88 cents per share. Despite strong volume growth in many of our businesses, our second quarter operational results were challenged by unparalleled raw material and other operating cost inflation that did outpace our significant price increases and solid productivity results across our portfolio. In terms of the $4.18 difference between base and GAAP EPS, by far the largest item was the $4.04 non-cash charge related to the settlement of approximately $1.4 billion of U.S. pension liabilities as our pension termination process substantially wrapped up in June. This charge was just below the estimates that we've been communicating for a while. The next largest item also relates to a unique transaction in the second quarter. In May, we completed a tender offer for a portion of our 5.75% bonds due in 2040 that resulted in a debt repayment of $63 million. This transaction also resulted in an after-tax loss on the early extinguishment of debt of 15 cents per share. Next, you see our adjustments for normal non-operating pension costs at $0.06 per share, as well as $0.02 related to net favorable restructuring and asset impairments. The last item, all other, at $0.05 per share, is mostly composed of a $0.03 foreign exchange hedge gain on our euro-denominated loan repayment, and another $0.03 gain on a favorable foreign VAT refund plus interest. So moving to our base income statement on slide four and starting with the top line, you see that sales were $1,383,000,000, up $138,000,000, or 11% from the prior year period. I'll review more details about key sales drivers on the sales bridge in just a moment. Growth profit was $263 million, $15 million above the prior year quarter. This performance resulted in a 19% growth profit as a percent of sales, which was 90 basis points below the second quarter of last year. SG&A expenses net of other income were $134 million, an increase of $13 million year over year. This increase was expected and key drivers were higher expenses for normalized management incentives, increased group medical spend, and higher costs for property insurance premiums and strategic IT activities. All of us resulting in second quarter 2021 operating profit of $129 million. And I'll discuss the key drivers on the operating profit bridge in a few minutes. Net interest expense of $17 million was $2 million lower than last year due to reduced debt balances and a more favorable mix of fixed and floating rate debt. Income tax expense of $30 million was $1 million higher than last year due to our higher pre-tax profits somewhat reduced by a modestly lower effective tax rates. our current quarter's base effective tax rate was 26.4%. Moving down to net income, our second quarter 2021 base earnings were $85 million compared to $80 million last year. Now looking at the sales bridge on slide five, you see volume mix was higher by $95 million or 7.6% for the company as a whole with our industrial segment and all other businesses seeing widespread recovery from the pandemic, somewhat reduced by lower volumes as expected in our consumer segment. Consumer packaging volume was down $12 million, or 2.1%, as our global rigid paper containers demand declined almost 6%. This was partially offset by solid growth in our plastic food businesses, which were up nearly 5%, and modest recovery in our flexibles volumes, which was partially offset by an unfavorable mix of sales. Moving to industrial paper packaging, volume mix was up $65 million, or over 14%, with a surge in post-COVID economic recovery across most of this business. Our global tubes and cores franchise rose over 13%, and global paper grew by nearly 4%. In addition, our cones and protective fiber businesses saw outstanding rebounds in demand. And finally, our all-other group saw volume mix growth of $42 million, or 32%, when excluding D&P display and packaging from 2020. This significant recovery was very broad across these businesses. Now moving to price, you see that selling prices were higher year over year by $89 million as we increased prices to battle inflation globally. This was mostly driven by our industrial segment as we worked to recover escalating OCC, freight, and energy costs. We are proactively increasing prices in our consumer segment and all other group, but timing of contractual price resets pushes some recovery of cost inflation into the third and fourth quarters. Moving to acquisitions and divestitures, you see a top-line negative impact of $80 million, which is driven by the recent divestitures of our display and packaging European and U.S. operations partially offset by the canned packaging acquisition completed in August of last year. And finally, the sales impact from foreign exchange and other was positive by $34 million, with the primary driver being foreign exchange translation associated with a weaker U.S. dollar year over year. Moving to the operating profit bridge on slide six and starting with volume mix, Our higher sales volume of $95 million, combined with the impact of MIX, had a positive impact on operating profit of $28 million. Shifting to price cost, I will remind you that this category includes the earnings benefit from higher selling prices, as well as the impact of total inflation. In the second quarter, we had $26 million of unfavorable price costs with most of this impact falling in our consumer packaging segment. Within our consumer businesses, the inflation of resin pricing is much greater than expected and resulted in higher material costs of approximately $15 million in the second quarter. In our all-other business group, resin is also a key raw material, and this inflation drove almost $10 million of higher costs. In our industrial segment, we were chasing higher OCC pricing during the second quarter, but were slightly positive in price cost due to sales price increases. As usual, there is a slide in the appendix that shows recent OCC price trends, and you'll see there that Southeast OCC official board market pricing started the quarter or came into the quarter in March at $90 per ton, until market pressures caused a jump to $125 by June, resulting in an average of $107 per ton in the second quarter. This represents a $7 increase relative to the second quarter of last year, and importantly, a $20 sequential increase over this year's first quarter. Next is the impact of productivity, which includes all results from our productivity actions, including manufacturing, procurement, and fixed cost. You see that our total productivity was a solid $22 million year over year, with a favorable impact across all three segments. Our productivity actions remain a very important focus area across our business as we work to overcome inflation and protect our margins. Moving to acquisitions and divestitures, the $6 million decrease in operating profit is the net impact from the display and packaging divestitures and the canned packaging acquisition. And finally, the operating profit change in foreign exchange and other was unfavorable by $16 million with various moving pieces, but mostly within SG&A expenses. Moving to the segment analysis on slide 7, you see that consumer packaging sales were up over 4%, driven by higher selling prices, positive foreign exchange translation, and the addition of canned packaging, somewhat reduced by lower volumes as COVID eat-at-home behaviors have moderated from the pandemic-driven highs of last year. Consumer segment operating profits fell by 29%, driven by significantly unfavorable price cost and the softer demand. Our consumer segment margin declined to 10 percent versus the second quarter of last year when the margin was a very strong 14.7 percent. Our industrial segment sales grew by almost 34 percent due to year-over-year price increases, strong recovering demand, as well as the impact from positive foreign exchange translation. Industrial's operating profits surged by 74%, driven by the significant global turnaround in demand and the associated leveraging impact on manufacturing productivity. The segment's earnings were also lifted by favorable price costs and procurement productivity. Our industrial segment's operating profit was 9.5%, a strong 220 basis point increase, when compared to 7.3% in the second quarter of last year. And finally, all other sales declined by nearly 19%, driven by the sale of our display and packaging businesses, but significantly offset by the great demand across this segment's businesses. Despite the sale of display and packaging, operating profit increased by 23% due to the strong demand and the associated positive impact on productivity. Operating margins improved to 6.2%, 210 basis points higher than the prior year's 4.1%. For the total company, sales were up 11%, and operating profits improved by 1.6%, resulting in a company-wide operating profit margin of 9.3%. Moving to cash flow on slide eight, in the middle of this slide, you see that our year-to-date second quarter operating cash flow was $102 million compared with $282 million last year, a decrease of $180 million. The primary driver to these lower cash flows was our contribution in the second quarter of $133 million related to our pension, settlement, and termination process. In addition, we consumed $19 million more cash in our net working capital balances, which was driven by both inflation and increased level of business activity. Overall, our management of net working capital remains very strong. So back to the top of this slide, we had year-to-date gap net loss of $262 million compared to a profit of $135 million in the prior year period. Most of this decrease was the $406 million after-tax non-cash settlement charge related to our pension termination process. Moving down to our year-to-date CapEx spend, our net spend was $93 million so far this year, compared to $72 million for year-to-date at second quarter 2020. This $21 million increase is mostly due to spending on Project Horizon. We do expect our CapEx spend to ramp up over the balance of this year as we progress on Project Horizon and other important projects. Howard will be providing additional comments about Project Horizon in a few minutes. So this takes us to free cash flow of $9 million compared with $210 million for the same period of last year. Again, mostly driven by the pension termination process, increased working capital, and higher CapEx spend. Finally, we paid cash dividends of $90 million year to date this year, compared to $86 million for the same period last year. On slide nine, you see that our balance sheet and our liquidity position remain very strong and reflects several strategic actions executed during the second quarter. Our second quarter 2021 consolidated cash balance was $264 million, a $301 million decrease from year-end 2020. This decrease was driven by significant deployments of cash, which included the accelerated share repurchase of $150 million, the tender offer for our 2040 bonds, which retired $63 million of principal, the repayment of our maturing $180 million Euro-denominated debt, and finally, the $133 million of pension contributions. These cash usages were somewhat offset by the display and packaging U.S. gross proceeds of approximately $80 million and operating cash generated by our businesses. Our consolidated debt at the end of the second quarter was approximately $1.6 billion, a decrease of $102 million from year end. This decrease was driven by the debt repayments that I just mentioned, partially offset by our return to the commercial paper market. Finally, on slide 10, For your reference, we've included our quarterly earnings history for the last two years at the top. You can note that the now divested display and packaging businesses contributed eight cents and nine cents of EPS in 2019 and 2020 respectively. But focusing on this year and our third quarter guidance, you see that our range for Q3 base EPS is 87 to 93 cents per share. As Howard will describe further in his comments, this guidance assumes continued solid demand for our products, but also continued inflation headwinds. I'll highlight that our base earnings effective tax rate in the third quarter is estimated at approximately 21.5%. Embedded in this assumption are an approximate 26% tax rate on base earnings and the positive impact from a unique one-time $5.5 million release of a reserve for uncertain tax positions. Specific to our expected full-year effective tax rate, we continue to assume a rate of approximately 25 percent. This is unchanged since our original guidance in February and has always included the impact of this $5.5 million benefit. We were previously uncertain of the timing, but now have visibility for the third quarter. You also see on this slide that we are not changing our full-year base earnings per share guidance range of $3.50 to $3.60. And we're also not changing our full-year free cash flow guidance of $270 million to $300 million, which does exclude the $133 million of pension contributions made in the second quarter to fund our U.S. pension liability settlement. So this concludes my review of our second quarter results and our outlook for the third quarter and full year, so I'll turn it over to Howard.

Thank you, Julie, and good morning, everyone. Let me provide you with my thoughts on our second quarter performance, also give you a brief update on Project Horizon and our new sustainability commitments. I'll close with what we see entering the second half of the year. Our balanced portfolio of consumer and industrial businesses did well in the second quarter, as we were well within our guidance range, despite unprecedented inflation and some lingering effects of COVID-19, where there were main lockdowns in parts of Asia, Europe, and Latin America, as well as hot spots here in North America. Our industrial segment and all other groups of businesses experienced double-digit volume growth during the second quarter, with demand returning to near-pandemic levels. As we anticipated, consumer volumes normalized from the pantry stocking record set during the second quarter of last year, although demand remains above pre-pandemic levels. As Julie mentioned, our biggest challenge in the second quarter, and frankly, the rest of 2021, is battling significant raw material and non-material inflation. In our consumer business, we have seen some resin prices nearly double from last year's level, while film, metals, paper, packaging and freight are up mid-single to double digits. Old corrugated containers, our largest raw material, have moved up from $85 a ton in January to $145 a ton in July. We now expect our external expenses excluding OCC and labor, to rise an additional 2.5% over our prior estimate made just last quarter. This means our cost globally will increase approximately 8%. In addition, as Julie noted, we've seen S&A expenses increase due to higher property insurance, more normal medical and incentive costs, and additional BT costs. Having said that, I'm extremely proud of how our global team has worked to pull all levers to cover these costs, including driving productivity, controlling expenses, and implementing necessary price increases to fully recover all commodities and other cost increases. The fundamentals of our business are in good shape. Volume, productivity, working capital, cash management, all are exceeding expectations. Inflation is the issue. Now let me switch gears and give you a brief update on Project Horizon. The $115 million conversion of our number 10 corrugated medium machine to a state-of-the-art uncoated recycled board machine with approximately 180,000 tons of annual capacity. We now expect the conversion to be completed by the end of the second quarter of 2022, and there are a number of significant construction projects underway that will modernize the infrastructure of the entire complex and allow for more efficient handling of raw materials and finished goods. A key element of Project Horizon is construction of a new stock prep system to provide approximately 650 times per day of recycled fiber to the rebuilt Number 10 machine and other Hartswell cylinder machines. The new stock prep system will allow for increased consumption of lower cost mixed vapor along with OCC. We expect this system to be operational by the end of October. As previously announced, we expect to exit the corrugated medium market by early 2022 to allow time for the conversion. And our strategy is to keep our URB capacity neutral at approximately 1.2 million times. As a result, we recently announced that we expect to permanently shut down our Hartsfield No. 1 and No. 9 machines which will reduce annual capacity by approximately 70,000 tons. The exact timing of these closures will depend on market conditions, as well as the startup of the converted number 10 machine. As a reminder, last year we permanently shut down a 30,000 ton per year machine in Hartsville and our 95,000 ton per year Trent Valley, Ontario paper mill, which that particular machine produced both recycled liner board and URB. Project Horizon is expected to drive approximately $30 million in annual cost savings by 2023, ensure the long-term viability of the Hartsville Paper Mill Complex, and place our U.S. and Canada mill system into the top four tile of performance from a cost perspective. More and more investors are asking us about sustainability, so I thought I would provide some updates regarding new commitments we have made to reduce our environmental footprint. I think we can all agree that packaging plays a fundamental role in providing sustainable, safe, and hygienic delivery systems for food, medicines, and other essential products around the world. As a top recycler in the U.S. and a global leader in the production of recycled paperboard, along with providing a diverse mix of consumer, industrial, healthcare, and protective packaging, we believe it is our responsibility to address environmental challenges such as climate change based on data-driven scientific criteria. While we have reduced our normalized greenhouse gas emissions by approximately 25% since 2009, we're committed to doing more. After much research and planning, we have set ambitious new targets to reduce our global greenhouse gas emissions in line with the Paris Climate Agreement to limit global temperatures to warming to well below 2 degrees C above pre-industrial levels. Specifically, we've committed to reduce absolute Scope 1 and 2 greenhouse gas emissions by 25% by 2030 from a 2020 baseline. We have also committed to reduce absolute Scope 3 greenhouse gas emissions by 13.5%. In addition, we're actively studying necessary operational changes, technology developments, and market changes that would be required to achieve net zero greenhouse gas emissions by 2050. I'm pleased that our targets have been reviewed and validated by the Science-Based Target Initiative. To drive compliance of our goals, we'll begin incorporating our sustainability and environmental metrics into each of our business units' plans and management incentives. To help our customers achieve their sustainability targets, we continue to expand our environmental sense line of more sustainable packaging that incorporates increased recycled contents, and improved recyclability. EnviroSense is represented across our portfolio from rigid plastics to flexibles to our iconic paper containers. In fact, we're working with customers in Europe to transition their products into our EnviroCan paper containers today. We expect this trend to continue. We'll be providing more detailed information on all our environmental, social, and governance activities, both from a commercial and corporate perspective next week when we publish our annual corporate responsibility report. We hope you'll take some time to download and better understand our commitments to our purpose, our people, and our planet, which happens to be the title of our new report. Let me close by going over some of the things we're seeing heading into the second half of the year. It's been said that the only thing we know about the future is that it's going to be different. Clearly, what we were expecting just six months ago around inflation different than what we're seeing now. As we enter the third quarter, we remain confident that our business will continue to benefit from the post-pandemic economic recovery. In our consumer-related businesses, we expect volumes to remain above pre-pandemic levels despite more normalized demand for food packaging as consumers moderate their at-home eating time. However, we also expect certain COVID impact markets, such as confectionery, food service, and even construction products, should continue to benefit. We also expect further recovery in our industrial markets, as illustrated by the historically high backlogs for our paper board globally, and demand for global tubes, cores, and cones, which are strengthening to pre-pandemic levels. Our biggest challenge will continue to be managing and recovering escalating raw materials and non-material inflation. We believe prices for most resins are nearing a peak and prices could begin to ease into the fourth quarter. Recovered paper prices, on the other hand, may still rise this quarter due to strong domestic demand. That said, we still believe OCC prices will follow historic patterns and likely to climb in the fourth quarter as collections improve and demand should slow. We're currently behind the price-cost curve in several of our businesses. However, our price recovery mechanisms, including announced price increases, should allow us to fully recover these costs over time. We believe Sunoco is well positioned, given our resiliency over the last year and improving trends in our primary served markets. Our strong financial position supports our value creation strategy to invest in ourselves to drive growth and margin improvement while consistently returning cash to shareholders. Now, with that, operator, we would be pleased to review any questions.

If you'd like to ask a question at this time, please press the star, then the number one key on your touch-tone telephone. To withdraw your question, press the pound key. Our first question comes from George Staffos with Bank of America.

Hi, everyone. Good morning. Thanks for taking my question. Thanks for the details. Just a quick question maybe to start for the third quarter, Howard and Julie. Could you give us your rough approximation of what you think price cost will be either in millions of dollars or just from an EPS standpoint? And related to that, just for comparison purposes, I think you said the net display and packaging divested businesses were something around $0.08 or $0.09 a quarter, if I heard you correctly. Would that be fair as an adjustment factor we should look at for the third quarter as well, or let me know what should be the case there. So that to start.

Yeah, I think you're right on the D&P side, but based on specificity, I will pass on to Julie.

Thanks, Howard. And hi, George. Yeah. So, yeah, you're right. The vestiture of D&P, you know, with a little bit of offset from the canned packaging acquisition, so call it all of our M&As, There is about $0.08 of, you know, kind of call it a headwind, a pullout from Q3 of last year. And from a price-cost perspective, you know, I'd say we are expecting that to continue to be slightly negative in the third quarter as we, you know, obviously, and Howard and Robert can provide more color, obviously a lot of dynamics going around contract reset timing around price increases as well as just open market price increases. But I think nonetheless, with the inflation we continue to expect, still slightly negative year over year.

Okay. But that implies that you'll see some fairly good improvement sequentially in price-cost 2Q to 3Q. And should we assume that both industrial and consumer markets are slightly negative on price cost, or can industrial keep its net positive as it was in 2Q on a price cost basis in 3Q?

Yeah, we are expecting industrial to stay slightly positive price cost, although, I mean, it could be neutral. Again, the OCC had wins. Roger and Howard can talk a little bit more about that. Obviously, kind of uncertain there, but upward price increases And so it's, you know, I think puts and takes, quite frankly, across the segments. It really is going to depend on the continued inflation in resins and OCC especially. But I don't know if, Roger, you want to add any more color on that?

On the consumer side, George, as you would expect, fairly significant price increases going through in July. Most of our major CPGs in the consumer business, we have quarterly price change mechanisms. where we recover the resin three months in arrears. So for instance, in July, we're implementing March, April, May increases. We calculate in June. We put that in force in July. So we saw more increases in June and July. So we will still see some negative price costs in consumer around resin. In the third quarter, we expect to start catching that up. We will catch that up in the fourth quarter.

OK. Thanks, Roger. My last one, and I'll turn it over. Can you reflect on what you've learned about your consumer packaging businesses, you know, and kind of the top two or three ones as we look out the next several years, right? Paper cans, composite cans had a surge, and now they're normalizing. Obviously, there's a lot of margin in that business. Flexibles has remained somewhat pressured from a volume standpoint, although a lot of that is, you know, the convenience angle and confectionery. and you're seeing growth in consumer, you know, what do you think is the right growth outlook for those businesses looking out the next couple years, and how much do you think the consumer has maybe readopted? You know, what increment to growth normalized do you think you've gained in that business relative to what would have been the case pre-COVID? Thank you very much, and good luck in the quarter.

Thanks, George. You know, I'm not going to try to forecast the exact percentage, but just talking generally, If you talk about our paper can business, we know that volumes are ahead of 2019 levels. We do think there's been continued adoption here in North America in some of the categories. What's really exciting at this point in time is what we're seeing on an international perspective. the anti, let's just call it sustainability efforts, where our funnel is continuing to build and drop through in terms of folks wanting to switch over to a paper container from another substrate. And it really is an exciting opportunity. If we look on the CAN side with Asia, we've seen double-digit growth just quarter over quarter over quarter for a number of years now. And we expect that to continue as well. Flexibles, trays, the plastic tray business, we're really happy with how that business, specifically Flexibles, is being managed right now. Relatively flat in the quarter, but we saw really good productivity throughout the business. We're going to see pickup, I think, as we head into the future, where we saw softness in confectionery. other convenience and holiday-related products, it was actually a bit of a drag on that business. We expect that to be on a positive slant as we move forward. I noted quickly about our plastic food frozen sector. That's the one that's really interesting. The volume is actually tracked ahead of last year during the pantry stock. I think that one's carrying probably more long-term new consumer activity than any other. And the work from home, they will settle down, but there will be more people working from home than ever. And I think that just because these consumers have been driven to the market through pantry stocking, they're finding the product is good. They'll be working from home. They'll be grabbing frozen meals out of the out of their freezers. So really feel very, very bullish about the consumer sector in totality, not through just the end of this year, but into the future.

Thank you very much.

Our next question comes from Josh Spector with UBS.

Hey, guys. Thanks for taking my question. Maybe just to follow up on some of the sequential bridging, I guess if I listen to what you're saying about volumes being consistently strong. You're talking about things getting better. You're getting pricing in the second half, but your updated guidance kind of implies flattish operating income in 3Q and maybe similar for 4Q. What are the incremental negative factors in the second half which hold back you from perhaps lifting guidance versus prior expectations?

Josh, really it's just the continuation and lag of recovery of of this hyperinflation period that we're in right now. I think Roger did a good job in explaining, particularly resin. I mean, that's the one that has escalated the most. We have solid recovery mechanisms. It's just timing. And I think as Roger pointed out, that it's on average we get three months in arrears with the fourth month or the month prior to the quarter is the calculation month. So as we look at Q inflation that we saw in June is going to carry into Q3, and we still are expecting to see inflation in early Q3 with that moderating as we end that quarter and go into Q4, and that's how we're expecting things to play out.

So just so I understand, that gap doesn't get any better sequentially? It still remains similar to what it was in 2Q and 3Q because of that catch-up?

Yeah, that's exactly the point.

Okay. No, I appreciate that. And just one other question just on the rigid plastic side. You know, we're reading more about some challenging growing conditions for certain fruit, vegetables, and specialty crops in the West Coast and North America specifically. Is that something that you – are seeing have an impact on your rigid plastics demand or could have an impact? And is anything from that perspective baked into your guidance for the second half?

Josh, this is Roger. You know, we are seeing some impact on the crops, primarily in the northwest of the United States. You know, we built that headwind into our sales forecast for the second half of the year. Same story there, you know, P.T. since the first of the year is up 30%-ish. So we're moving prices in that business as well. But any headwinds from weather, fires, and all that, we have built that into our forecast. But the answer is yes. For some specific crops in the Northwest, we have seen some impact.

Okay. Thank you.

Our next question comes from Mark Wild with Bank of Montreal.

Great. Good morning, Howard. Morning, Julie, Roger.

Hey, Mark.

Good morning. I wanted just to start out, you know, you've done a good job of kind of walking us through some of the lags there in consumer plastic packaging. Anything you can do to help us with just the cadence of kind of price, cost, catch-up in other parts of the portfolio?

You know, I turn it over to Roger, but what I would say, the headline here is related to resin, and when you say other parts of the portfolio, if you look across... where you see that resin influence really hit us hard in the all-other category, which is effectively a resin-based business. And, of course, as we've just said, on the consumer side. But, Roger, any further thoughts?

I think that's right. If you look at freight inflation, packaging, you name it, Mark, as you know, they're all escalating faster than expected. We're out. on a regular basis with increases in those areas outside of our normal price change mechanism. So that's happening. I'm sure we'll come on to OCC and our industrial side in a minute. But as you're aware, we've announced our fourth $50 increase for URB, which went into effect July the 15th. That went well. followed with a 6% to 7% tubing core increase, which has gone well. So we're trying to stay out in front of industrial, and that's part of the reason we announced that when we did. We're expecting more headwinds in OCC in the second quarter with an upward bias to OCC prices throughout this quarter.

Okay, that's helpful. And is there any difference, Roger, in sort of the – both the order of magnitude of cost increases on OCC in your European business versus North America – And also any timing difference between kind of North America, Europe, and the other markets?

Well, Europe's run up faster. You know, if you convert the European Euro metric ton to U.S. short-term ton, they're up to about $175 a ton on average. But the team there has done a really nice job of staying out in front of that. So I'd say their run-up has happened in front of the U.S. I'm not sure that tells us exactly where the U.S. is going, but that's the comparison. But, again, our team's done a good job there of recovering so far.

Okay. The other question I have is, I guess, probably for Julie. And I'm just curious, if I heard you correctly, it sounds like you're going to stop medium production at Hartsville at the end of the fourth quarter, but the ramp-up on the URB is not until the end of the second quarter next year. And just, you know, kind of looking at the corrugating medium market this year, I'd assume that that machine has to be quite profitable this year. So I'm just curious if you can give us any help as we think about next year, the move into next year, and what the earnings impact of the phase-out of corrugating medium and the ramp-up of URB, what that may be on a year-over-year basis.

Yeah, good question, Mark. In fact, it's probably going to go down a lot of part of the first quarter of next year. and we'll be down for six to seven weeks as we make that conversion. We're not at a point at this point in time where we have even sat down and looked at the overall impact and how that would be reflected in our 2022 assumptions. It'll be coming, but it won't be this year. It'll be a lot of part of the first quarter and into the second quarter of next year.

Howard, without trying to lead you too far on this, but would it be reasonable to assume that you might take a little bit of an earnings hit in 2022 just because you're going to give up very profitable medium production this year and you're going to have not only a period where the machine is not running, but you're going to have kind of a startup curve after the rebuild?

Sure. That's a fair assumption, but you've got – I guess where I'm coming from, we'll have to see what the entire corporate roll-up looks like and how meaning and material that is going to be. But anytime, yes, you're starting up a new process, new plant, new equipment, you've got to walk through that.

Okay. Last one real quickly for me. How's the Halloween season looking in the flexible banking business?

Actually, you know, you need to get your trick-or-treating stuff ready because the CPGs are – are acting as business as normal.

Okay. All right. Sounds good. Thanks, Howard.

Our next question comes from Gansham Punjabi with Baird.

Hi. Good morning. This is actually Matt Krieger sitting in for Gansham. How are you doing today?

Hi, Matt.

Great, great. So I was hoping that we could touch on volumes for the back half of the year. So what are your embedded volume assumptions on a segment basis for the second half of 2021? And what type of underlying market environment are you kind of projecting within these assumptions? If you could provide any detail by region or by product line on kind of the major product basis, that would be really helpful.

You know, to kind of share with you from a macro perspective, it might help to talk about where we thought we were going to be this year, which is about 2% for the year, and we've seen Q1 up 4%, Q2 is up 8%, and our forecast now for Q3 is just over 5%. With the bulk of that, well, you know, our consumer side slightly up 1% to 1.5%. The industrial side continuing to trend upward, 7.5% to 8% or so, and the all-other category showing the biggest ramp-up in this particular quarter to about 12%. I don't know if we're prepared to really talk about each individual business within the sectors, but we do expect to see volume to be very positive going forward.

Great. That's helpful. And then I guess I just wanted to touch on maybe see if you could talk about how inventory levels are trending across the various end markets in which you play. Have you incurred any incremental cost to service customers in an out-of-pattern manner from a freight or supply perspective? And have you had any challenges in gaining access to raw materials in any specific markets or instances?

Yeah, Matt, yes to all of the above. Inventories are tight, particularly in the mill system where it's driving more changeovers, which does impact productivity. But then again, across the company, very pleased with how we've managed productivity, but it certainly has been challenging. A very dynamic situation for us. On an incoming and raw material perspective, yeah, it's tight. We're managing literally, particularly resin-based. That's resins, that's adhesives. We're having to manage that almost on a, well, we are, not almost, daily, if not a seven-day-a-week type situation. Outbound freight, similarly. We're working weekends to make sure that we've got trucks that can come in and make the shipments that we've committed to to our customers. It is a very interesting dynamic situation right now, but again, I can't tell you how pleased I am with how well our team is managing through this.

Understood, understood. That's very helpful. Just one follow-up, and then I'll drop off. Is there any timeline for normalization there that you could feel is reasonable, or is it just kind of a day-to-day assessment?

You know, it's a macro issue. You know, it's not a Sunoco issue. It's throughout North America. You know, we're managing it on a day-by-day basis. I really couldn't forecast out what we're saying These type of costs and issues that we're facing are going to continue for some time to come. Our biggest lever that we're going to be able to pull within all of the headwinds that we're facing is getting this material cost recovery from our customers and just managing the rest of it the best we can.

Great. That's it for me. Thanks.

Our next question comes from Adam Josephson with KeyBank.

Howard, Roger, good morning. Hope you're well.

Morning. Yeah, morning, Adam.

Morning, Howard. Howard or Roger, can you just, on resident OCC, just a little more clarification, if you don't mind. So as of last quarter, I think you were expecting 10% resident cost inflation for the year. Would be interested in knowing what that expectation is now On OCC, I think the last call you were thinking OCC would go up to 120 by June, and you nailed it. And it went up by another 20 in July. And I think, Julie or Roger said you expect further upward pressure. Can you just put a little more meat on that bone? And then lastly, on freight, just can you remind me what your expectations were for the year and are now?

Hi, I'm Roger. I'll give it a shot, and then Howard or Julie can add to this. But yeah, on resin, you know, if you look at what we're expecting now for the calendar year of 2021, and this is expecting some moderation and potentially slight reductions at the end of the year, we're expecting a 30% increase for the year. As you know, I mean, year over year, in many cases, as I think Julie said, resins have doubled, polypropylene is up 140%. So, We buy a basket of resins. We buy about 120 million pounds a quarter. About over half that's PE-based, about 30% is polypropylene, and then a bunch of all others. So we're looking at a 30% increase now, but again, and that's assuming we get moderation in the back of the year of 2021. OCC, as you know, has already moved to 145 in the month of July. And what I said earlier is there's an upward bias. The container mills are still pulling very heavily. We're seeing premiums in the marketplace. So at this point, I wouldn't tell you exactly what it's going to do in the coming months, but there is an upward bias, and that's the way we're looking at it today. On freight, I believe we said 6% to 7% for the year. And then in the first quarter, we're now at 9% to 10%. which is not that significant a move, but the comments Howard made for me are even more important. It's the availability of trucks and trailers and drivers and the added cost of changing schedules that's been a bigger headwind for us. But that's more color. If you need more, we can answer that.

No, thanks, Roger. And just one follow-up on the cost issue, which I think you mentioned in Europe, OCC is up the U.S. equivalent of $175,000. I forget over what time frame you were talking about, but in the U.S., year-to-date, Southeast prices are up 60, I believe. So would that lead you to think that there's a lot more to go in the U.S.? Or how are you thinking about that relationship between Europe and the U.S. in terms of the year-to-date inflation?

Yeah, I'll just say the equivalent price of what we're paying today in Europe in U.S. short times would be $175 a ton. Oh, I'm sorry. So that was the point. And again, I'm not saying we're going to go to 175, but that just shows you the demand globally. And again, container board mills are pulling heavily, so we do see upward bias in the quarter.

Adam, I'm not so sure you can totally create a correlation between the Europe situation and the U.S. to make an assumption that whatever levels they are, we may be heading to I don't think we've seen that historically. It's basically independent market and market dynamics.

Yeah. Thanks, Howard and Roger. And on demand by region, can you just talk about what you're seeing? Obviously, U.S., Brazil have been exceptionally strong all year. Europe's gotten better. China's getting worse, depending on what you read, markedly worse. So can you just talk about what you're seeing by region here? what you think is going on in China. Obviously, Southeast Asia is having COVID problems. China is having other problems. Just what you're seeing by region and your expectations along those lines as embedded in your guidance.

Yeah, and I think you covered it pretty well, actually. If you look at Latin America on the industrial side, very strong, same dynamics we're seeing here, order backlogs, et cetera, on our mill system. South America, as you noted, same. Our consumer business in South America is also very strong. Just as a footnote, we're actually having to, and this is part of our challenges here in North America in terms of mill capacity, but we're actually shipping board out of the U.S. to supplement our mills in South America. So really, in fact, and it's rolling to the bottom line as well. The South American business is performing exceptionally well. on both sides, industrial and consumer. You talked about Europe. Europe is somewhat similar to here, very, very strong. Our mills are full. Demand on the tube and core side is where we would hope it would be. On the consumer side, which is mostly our paper can business, I made comments earlier to George's question that very, very solid demand current demand, and pending new orders. Asia, as we look at, it's relatively small for us in the full scheme. From COVID a year ago to today, we're extremely pleased with the turnaround. I think our cone business, as an example, is about 97% of 2019. That was dropping from about 40%. this time last year. So we're still somewhat enjoying the recovery, but no doubt about it, we're seeing that we expect one thing to settle down, that there's going to be more pressure as it relates to just the overall macroeconomic conditions in China. And I guess lastly, I'll just point to Southeast Asia. COVID is a real issue for us. It's showing in Indonesia where we have our fairly large paper complex, but probably the biggest hit has been our consumer business where we've got our largest Asian paper can facility that has been down for weeks now due to government mandates and new lockdowns, and that continues. This is the first quarter that I can remember I noted earlier, when we're seeing double digits, just quarter after quarter in Asia was actually flat because of that reason that we had a major complex down for the period. That's terrific.

Thanks so much, Howard.

Our next question comes from Kyle White with Deutsche Bank.

Hey, good morning. Thanks for taking the question. I wanted to go to rigid paper containers and food packaging. Are you able to provide any kind of cadence or details on how volumes trended throughout the quarter on a month-to-month basis and into July here? Just trying to understand what impact you're seeing as markets reopen and the kind of at-home consumption trend weakens here a bit.

Yeah, not within the quarter. I think we noted that in total we were down about 5%, but we were above where we were in 2019. Julie, I really don't have that data in front of me.

Yeah, not as much from a monthly perspective, but I think, you know, so I think basically volume trends during the quarter were, you know, I'd say relatively steady, and I don't think anything unusual on a month-to-month basis during the quarter. You know, as Howard just mentioned, I think maybe you're talking about global cans being down about 6%. But again, it was a really tough comp. Again, the plastics food business had a very solid, again, year-over-year growth after a very strong second quarter of 2020. And so that volume growth continues to be very solid. But I'd say I don't think there was anything terribly unusual monthly during the second quarter.

Got it. And then going to all other, what are you seeing or expecting in terms of the flu season this year for that business? And then what are you hearing from your customers in terms of how sustainable some of the vaccine demand will be going forward?

Yeah, hi, it's Roger. Flu season, we're expecting a good flu season. You know, we typically capture, you know, over half of that volume, $15 to $20 million. One thing we are seeing is the main customers are pulling earlier. with some concerns about supply constraints as we get into the fall. So we saw some of that volume come in in the second quarter. We'll see the balance in the third quarter. So we're expecting a normally pretty solid flu season from a COVID vaccine standpoint. It's playing out almost like we talked last quarter to the point of, you know, we see this turning into more of a vaccine type similar to the flu season. You know, as we get in now to booster shots, as we get into some of these shots for younger children, you know, 5 to 11, what we're hearing from our customers is it's going to turn into more of a standard thermoset package or temperature control package, and we expect, you know, about a $15 to $25 million impact on an annual basis for COVID vaccines. So really no change to the guidance from the last quarter.

Got it. Thank you, and good luck for the balance of the year.

Thanks.

Our next question comes from Salvatore Tiano with Seaport Research Partners.

Yeah, hi. Thanks for taking my questions. So, firstly, I know you mentioned that TAF comes in rigid paper containers globally, but as we look at kind of the end market demand, can you tell us a little bit about the trends? Why are you seeing essentially the deviation with the rigid plastic specifically? even though both benefited from pantry loading.

So, Sal, to make sure I understand your question, you're asking why plastics?

Essentially, why plastics outperform the rigid paper containers.

Yeah, I understand. I think it's just the nature of the products that we're serving. Back to my earlier points, with the frozen, well, QSR opening up with fast food has certainly been a benefit, but equally so is that truly the acceptance of the consumer of frozen meals that some of the consumers were reintroduced or first time consumed through COVID are continuing to go back and continue. So we're actually seeing the frozen side slightly up over the peak of last year. If you look at the can business, a lot of that is related to snacks and other items, refrigerated dough. And we just saw a bit of a pullback here in North America. Again, Europe was in good shape. actually just slightly up, and then I've already talked to the scenario in Asia as it relates to the shutdown that we had there.

Okay, great. I wonder if you can also elaborate a little bit on the margin differential between the two, because I think when we think about the $15 million negative price cost for the consumer packaging business that you mentioned, that leaves a pretty steep operating income decline here and here, given the just 2% volume So I would imagine the rigid paper cans have a much higher margin. Was that the reason for the, I guess, the incremental margins being so high?

Julie?

You know, it's interesting, you know, the dynamics among, you know, between those kind of two, or really several parts of our consumer business. You know, you've got different dynamics in productivity and, you know, labor challenges, as well as the different Inflation, you know, whether it's very resin-oriented in the plastics food business and flexibles versus other types of inflation being more prevalent in the cans business. So, you know, I think there's no simple answer there, quite frankly. The dynamics around, again, the different raw materials across our consumer businesses, you know, again, labor challenges. I mean, we have a broad footprint across all these businesses, and depending on COVID impacts labor availability, et cetera, obviously impacts productivity. And so just lots of moving pieces that really we won't be able to now get into any more granularity about that with the dynamics of what's impacting the margins in the different key parts of our consumer segment.

Yeah, I'd say, Sal, just in summary, the inflation that we're seeing is really, as we've said, in our resin-based businesses. And so we're getting hit really hard. Even though volumes are up on the plastic trade side, we're back to this whole price cost and capturing that resident inflation.

Okay, perfect. Just quickly, can you provide a little bit more color on the inflation, the cost differential between what you're seeing in the consumer packaging business and the other businesses, the other segment, I guess, because Obviously, a $10 million price cost headwind for other is super substantial for such a small segment. Can you elaborate on the differential in terms of pastures and resins that you use in the other segment versus consumer packaging?

It is exactly that. It's back to the resins. All other is almost 100% resin-based businesses embedded in there. It's just as simple as that, really. That's what's driving that large number.

Okay, great. Thank you very much.

Our next question comes from Gabe Haight with Wells Fargo Securities.

Howard, Julie, Roger, good afternoon, I guess. Thanks for taking the question late in the call. I was curious, there's been a lot of sort of exogenous factors influencing OCC, let's say, over the past 18 months in terms of China's actions, obviously the COVID impact, and then what we're seeing right now in terms of, I think, mill operating rates and stuff like that. But I'm curious if there's anything that you would view as instructive in terms of kind of what the new normal might look like for OCC and And really the genesis or what's behind the question is, you know, I'm looking at a list of 25 to 30 recycled pulp projects across the globe, and it seems like China kind of has reached the upper limit in terms of what they can maybe collect domestically. And obviously we know they're not going to be importing OCC, but potentially obviously recycled pulp. So I'm just curious if there's potential for OCC to remain active I don't know, above $100 a ton or something like that in the foreseeable future.

You know, the potential is certainly there. And if it does, it's really about stability, right? You know, right now we've seen, what, nine consecutive months of increase in OCC. It eventually will reach its plateau. and, you know, hopefully get back to a normal-type trending. If it's 100, it plateaus at, so be it. If it's 150, so be it. But, you know, we've caught up. You know, price has been passed through. I mean, cost has been passed through, and you're back in a normalized situation. What is really the issue today is just that. It's month after month after month after month. It's the chase. In terms of, you know, how the global market is going to settle, really hard to say.

Okay. I'm just curious. I know it's difficult in terms of visibility, but I guess from some of the work that we've done, it appears as if your customers' inventories are starting to normalize, where before it felt like they were living kind of hand-to-mouth a little bit. Any thoughts? visibility there in terms of where customer inventories are at. And then real quick on CapEx, I think you talked about incurring most of Project Horizon spend this year, call it $100 million, such that $15 would fall in the next year. I know you're not giving guidance for next year, but directionally in that $200 million of CapEx for spend, knowing what we know today?

You know, that's what we've modeled out as an incremental, you know, finishing up on our free cash flow guidance. I think you can go to the bridge that Julie provided that we're assuming that we will spend to that 300 level. I can tell you that, you know, with the delays we've seen associated with COVID, et cetera, you know, that could push out into next year. It's too early right now for us to make that call. I think by the time we're together in October, we'll be able to really have pure visibility in terms of how much of this CapEx is going to fall into this year or maybe even bleed into next year. On the other... Hi, this is Roger.

On the customer side, as you said, on the food side, you're right. I think our customers are saying their inventory is have stabilized, so we're not seeing anything there. You know, just like us, they're struggling with some raw materials, but, you know, I would say on average they're back to more normal levels. Any customer that's dealing with, like, appliances and automotive, the chip shortage, we're seeing it. You know, in both cases, our sales of those customers were up, obviously, significantly over the second quarter of last year. We could have sold more, and our customers could have sold more appliances. You know, appliance sales were up 23%. year over year, but they could have been up higher. Automotive sales, you all know the story there. So I think in anything to do with housing or anything to do with the chip shortage, I think our customers still have plenty of upside from a sales standpoint, which means upside to us.

Okay. Thank you and good luck.

Our next question comes from George Staffos with Bank of America.

Hey, guys, sorry to come in late here. I'll make it real quick. So could you, Howard, remind us, with Project Horizon, the cost of the project has moved higher over time, you know, to the current level of, you know, whatever, $150 million. How much of that is just inflation in the construction materials, and how much of that is flexibility that perhaps you're building into the system, maybe optionality that even though you're net neutral on capacity with all of the closures that maybe, you know, if URB grows on a more secular basis, coming off some very strong growth that we're seeing now, you know, that you'd have the flexibility to hit that demand if that happens. And then the second question I had, just, you know, what preparation, if anything at all, other than trying to get pricing up, are you doing in advance of, you know, hurricane season, which always brings a little bit of volatility to resin? Thanks, guys, and again, good luck in the quarter.

Thanks, George. Yeah, we did increase the original capital of Horizon, but that was really built on the backs of incremental opportunity that the team had identified after completion of the first capital submission. So the incremental $30 million that brought it up to that $115 million range was where a very justifiable and a good return opportunity presented itself to to basically redo not just the paper machine, but the complex in terms of raw material flow outside warehousing. So when you come to the campus next, you'll see a new 120,000 foot warehouse. You'll see how the flow of the OCC now is appropriate to the back end of the machines. So that's where that incremental amount came from. And it was, again, justified on on the savings we would achieve by spending that. The second question was around the demand profile. As I noted in my comments, we've announced the close of a couple of machines. But that's all pending on market conditions. So we'll see what things look like. Hopefully, the demand that we're seeing today will continue. lead us to continue operations versus bring down machines. But the closure timing that I shared with you earlier today is just our communication to our internal team, giving them an annual notice so that we can make appropriate, our employees can make appropriate choices. But it could be. We're saying we've got the new machine going and the other ones are full, too, and we're going to keep that situation for whatever time period that goes. Hurricane prep, we've talked a lot about it. For us, hurricane prep is not an operational issue, but more of a supply chain issue. We should all be concerned about that, yes. Inventories, as Roger spoke to, are low. Supply chains are being managed on a day-to-day basis. So you're not seeing within the Gulf Coast supply chain the normal pre-build of materials in anticipation of such an event. So it's something that we should all be concerned about. But we'll see what Mother Nature brings us there.

All right. Thank you very much.

Our next question comes from Adam Josephson with KeyBank.

Howard, thanks so much for taking my follow-ups just really quickly. On that hurricane issue, just to be clear, are you – I know it's impossible to forecast hurricanes, but what, if any, supply chain disruptions are you expecting in your updated full-year resin cost forecast? And then, In terms of your OCC assumptions, I think you're expecting OCC prices to go down in the fourth quarter as collections improve and demand slows. But obviously with e-commerce, box demand has been exceptionally strong in recent fourth quarter. So I'm just wondering why you would expect demand to slow and therefore OCC prices to go down seasonally in the fourth quarter. Thanks very much.

You know, Adam, supply chain, this is fascinating. Nothing new. We have never really built in any type of forecast of what could happen if we have a hurricane. But forever, we have always managed to maintain stock in the event that our suppliers go down for a week or whatever period of time they may go down to ensure that we have raw materials to continue to operate. My only point here, and it's something I just cannot forecast, We'll figure a way. We always do. But we, as in I assume others, including our suppliers who typically push material out ahead of the season, that's not happening this year. So there's no way to forecast what the ultimate impact of that would be. With OCC, Roger, you may want to talk about it. I think you spoke with Johnny this morning. You know, we're just following the traditional seasonal trends. You know, I will say one thing, whether it will carry through the fourth quarter, I don't know, but we have seen that exports are starting to drop as prices have risen, as we're seeing India and others starting to pull further back out of the market. That's creating more supply within North America. As you know, it's a very complicated, dynamic market. But that is our expectation at this point in time, that we should see things start to moderate to come down.

Great. Thanks a lot, Howard.

Nope, showing no further questions in queue at this time.

Well, thank you, Liz, and thank you, everyone, for joining us today. And again, we certainly appreciate your interest in the company. And as always, if you have further questions, please don't hesitate to contact us. We'd be glad to talk further. Thanks for the call today.