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spk00: Good day and thank you for standing by. Welcome to the West Rock Company second quarter physical 2021 results conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star zero. I will now let the hand of conference over to your speaker today, James Armstrong. Please go ahead.
spk06: Thank you. Good morning, and thank you for joining our second fiscal quarter 2021 earnings call. We issued our press release this morning and posted the accompanying slide presentation to the investor relations section of our website. They can be accessed at ir.westrock.com or via a link on the application you're using to view this webcast. With me on today's call are Westrock's Chief Executive Officer, David Sewell, our Chief Financial Officer, Ward Dixon, our Chief Commercial Officer and President of Corrugated Packaging, Jeff Chalovich, as well as our Chief Innovation Officer and President of Consumer Packaging, Pat Lindner. Following our prepared comments, we will open up the call for a question and answer session. During the course of today's call, we will be making forward-looking statements involving our plans, expectations, estimates, and beliefs related to future events. These statements may involve a number of risks and uncertainties that could cause actual results to differ materially from those we discussed during the call. We describe these risks and uncertainties in our filings with the SEC, including our 10-K for the fiscal year ended September 30th, 2020. In addition, we may be making forward-looking statements about the impact of COVID-19 pandemic and the recent ransomware attack on our operational and financial performance. The extent of these impacts, including the duration, scope, and severity, is highly uncertain and cannot be predicted with confidence at this time. We will also be referencing non-GAAP financial measures during the call. We have provided reconciliation of these non-GAAP financial measures to most directly comparable GAAP measures in the appendix of the slide presentation. As mentioned previously, the slide presentation is available on our website. With that said, I'll now turn it over to you, David.
spk08: Thank you, James, and good morning. It's great to be joining you all today on my first earnings call as Westrock's CEO. I've been in this role now for seven weeks and have spent that time meeting with our customers, our business leaders, and teammates. With every interaction, I'm impressed with the capability and strength of the Westrock team and couldn't be more excited about our future prospects. It's still early in this process, but what I'd like to do today is share with you my initial observations since joining and my priorities going forward. Before doing that though, let me touch briefly on our performance in the second quarter, which Ward will discuss in more detail shortly. Faced with dual issues of the ransomware incident and a significant weather disruption, the team focused, executed, and delivered for our customers, generating revenue of $4.4 billion, adjusted segment EBITDA of $641 million, an adjusted EPS of 54 cents per share. The ransomware and weather incidents lowered our adjusted EPS by 23 cents. Ward will provide additional detail about our performance. I'm pleased to say that we have fully restored our IT systems with all sites up and running, and we continue to make excellent progress on restoring our supply chain and customer service levels. During the time we were dealing with this incident, we prioritized serving our customers and incurred additional costs that impacted earnings in the quarter. We are accelerating investments that were on our IT development timeline to further strengthen our infrastructure. Throughout these events, the Westrock team demonstrated incredible resiliency and dedication, and we have made a remarkable recovery. I want to extend my sincere thanks to my Westrock teammates for all they have done and continue to do for the company and our customers. With all of this now behind us, I'm confident in our team, our markets, and our path forward. I mentioned at the start that much of my time over these first seven weeks has been spent getting to know our company. I've toured 12 facilities, met virtually or in person with hundreds of teammates, and spoken with many of our top customers. Westrock has built a unique portfolio, successfully integrating acquisitions and investing to create a differentiated set of capabilities with incredible opportunities for growth. I've seen firsthand how the consumer, corrugated, and machinery businesses work together and believe we can do even more to maximize the performance of our platform. We serve diversified and growing packaging end markets, and the demand for fiber-based paper and packaging continues to gain momentum. Key markets that we serve, such as food and beverage, e-commerce, and healthcare, continue to grow. For example, the demand from customers for safe and secure e-commerce solutions has only been accelerated by the pandemic, and I believe this remains a significant opportunity that Westrock Solutions are well-positioned to address. One of my visits was to our high-quality, low-cost facility in Florence, South Carolina, and it was great to see the new state-of-the-art paper machine up and running. This slide includes a QR code you can use to view a video of the mill and the new equipment. This machine produces high performance container board grades at low basis weights and replaces three machines in our system. This mill is well positioned to serve a diverse set of customers seeking these low basis weights to drive more sustainable packaging solutions. This investment makes Florence one of the lowest cost virgin container board mills in North America. We expect Florence to ramp up to full capacity by the end of our fiscal fourth quarter. The Florence Mill is a great example of a strategic capital investment that improves our capabilities, lowers our costs, and expands margins. Looking forward, there are a few key priorities that I want to focus on. Westrock has a unique portfolio of sustainable fiber-based packaging and great opportunities to leverage the enterprise and help our customers win in their markets. The path to long-term shareholder value creation is through a focus on attractive markets where our differentiated portfolio and combination of products and services are valued and rewarded. We will also focus on improving our productivity and operational excellence across the enterprise, which are both important levers to grow earnings and margins. I believe strongly in the leadership role that Westrock can play in improving the circular economy and helping our customers improve the sustainability of their products. We recently refined our sustainability platform to focus on people and communities, bettering the planet, and innovating for our customers and their customers. Whether it's developing new fiber-based packaging solutions that enable our customers to meet their sustainability goals, initiatives to reduce our own environmental impact, or our work to improve the diversity and inclusion of our company, Westrock has substantial capabilities and opportunities to help drive a more sustainable future. And a more sustainable future means that we must focus on innovation to develop new fiber-based packaging that meets the needs of customers and consumers. Removing plastic from packaging and developing more sustainable packaging solutions through design, material science, digital and automation continue to be growth drivers in our industry. Westrock has a capability to create new, recyclable, fiber-based solutions that are good for our customers and the environment. Next, I'd like to share my initial thoughts on capital allocation. I believe that disciplined, balanced capital allocation is a key factor in creating sustainable shareholder value. I'm impressed by the strength and stability of Westrock's cash flows and believe this is a positive attribute for the company and our investors. We will invest in our business to maintain and improve our assets, and investments and acquisitions and strategic capital projects will be tightly aligned to our strategy and deliver returns above our cost of capital. We will remain committed to returning capital to our dividend and intend to steadily increase it every year. We've already taken the first step today with the announcement of a 20% increase to our quarterly dividend. Today's increase reflects our confidence in the outlook and cash flow generation of our business. In addition, we will evaluate share repurchases in the future as another way to return capital to shareholders. We remain committed to our investment grade credit profile and believe that our leverage target of two and a quarter to two and a half times is appropriate. And in the coming months, I'll share more detail about my priorities and vision for West Rock's future. And now I'll turn it over to Ward to provide our financial detail about the quarter. Ward?
spk07: Thanks, David. We were able to serve our customers, deliver solid earnings, and continue to reduce our leverage despite the challenges in the quarter. We generated revenue of $4.4 billion, adjusted segment EBITDA of $641 million, and adjusted EPS of 54 cents per share. These results were impacted by both the ransomware incident and winter weather. The two events negatively impacted revenue by $189 million. Adjusted segment EBITDA by $80 million and adjusted segment EBITDA margins by approximately 110 basis points. Adjusted EPS was 23 cents lower as a result of these events. In addition to the impact of the ransomware incident that we show on the adjusted segment EBITDA bridge, we also incurred $20 million in ransomware recovery costs. The $20 million of recovery cost were excluded from our adjusted segment EBITDA and adjusted earnings per share. We estimate that the total insurance claim will be approximately $75 million, and we expect to recover the claim from our cyber and business interruption insurance coverage in future periods. It's important to look beyond the events in the quarter to see the underlying trends in our business. Demand is strong, and we continue to focus on improving our business mix. In addition, we are currently implementing the published price increases across all of our paper grades. The implementation of these price increases in improved business mix drove $88 million in year-over-year earnings improvement. Notably, we had record second quarter North American box shipments, which increased 5.5% year-over-year on a per-day basis. Cost inflation was driven by a $43 per ton increase in recycled fiber, from Q2 of the prior year, coupled with higher chemical and energy costs resulting from the winter storm. Transportation costs were also higher due to tight availability across all modes. We did not exercise the option to purchase an additional 18.7% equity interest in Group Ogundi. As a result, we recorded a charge of $22.5 million that we excluded from adjusted EPS. As we indicated earlier in the quarter, the lag in customer invoicing from the period when our systems were down negatively impacted our working capital in Q2. As expected, our accounts receivable increased in the second quarter and we expect receivables to normalize in the third quarter. Despite this, our net funded debt declined $74 million from Q1 and our net leverage decreased to 2.8 times. Due to the decisive actions we have taken over the past year to strengthen our balance sheet, we have reduced our adjusted net debt by $1.6 billion. Demand continues to increase for sustainable fiber-based packaging, and we sell into an attractive set of end markets. Our overall packaging volumes increased by 3% in Q2, including e-commerce box volume growth of 18.4% on a per-day basis. Our paper sales represent 27% of our total revenue in the company, and we are focused on reducing our participation in the export container board and specialty SPS markets. The pricing environment has improved across our paper and packaging grades. We are implementing published increases across our paper and packaging businesses as expected. Turning to segment results, our coordinated packaging segment reported revenue of $2.9 billion. and adjusted segment EBITDA $438 million. North American adjusted segment EBITDA would have been $54 million higher and margins approximately 140 basis points higher without the events in the quarter. Corrugated box demand is very strong across most of our end markets, and we reported record per day shipments for the second quarter. As I said earlier, corrugated box shipments were up 5.5% per day year over year, excluding the impact of the ransomware and weather incidents per day box shipments would have increased approximately 8%. We lost approximately 121,000 tons of container board production and revenue due to the disruptions in the quarter. This directly impacted our external container board channels sales as we could have sold all of the lost production. We highlighted the primary drivers of cost inflation earlier, higher recycled fiber, energy, chemical, and transportation costs. However, we offset this inflation in the quarter through higher pricing and volume, excluding the impact of the events. We also continue to implement the previously published price increases and expect the benefit of these increases to more than outweigh inflation. Inventory levels remain low as we head into our peak mill outage quarter in Q3 with 112,000 tons of planned maintenance outage downtime. Finally, we are making great progress on our strategic capital projects. The Florence mill continues to increase its production and operate well. As David commented earlier, we expect the mill to be at full production levels at the end of the fourth fiscal quarter. The margins in Brazil have been lower in the past two quarters as a result of the maintenance and capital outage related to the TraceBajas expansion. Demand is strong in the Brazilian market, and we expect margins to improve in the second half of the fiscal year. Turning to consumer packaging, the segment reported revenue of $1.6 billion and adjusted segment EBITDA of $212 million. EBITDA would have been $26 million higher and margins approximately 100 basis points higher without the events in the quarter. Our sales mix is improving by shifting to higher margin food and beverage packaging sales. Food and beverage packaging revenues were up 4.7% year over year driven by improved mix to quick service restaurants and beverage packaging. We lost approximately 46,000 tons of production and corresponding revenue due to the disruptions in the quarter. In addition, we had approximately 20,000 tons of consumer paperboard shipments that were deferred into the third quarter due to these disruptions. Backlogs have increased across all substrates and are currently at six to eight weeks. We are in the process of implementing the previously published price increases, the increased pricing, improvement in our business mix and productivity more than offset inflation in the quarter. We continue to produce container board at our Evadale, Texas mill, given the strong demand and low inventory levels. In addition, we are making progress with CNK production at the Evadale mill and are on track to deliver 25,000 tons of CNK production in FY21 and 50,000 tons of production in FY22. We are able to flex the CNK and container board capacity from SBS with no additional capital investment. Turning to guidance, here are some things to consider for our fiscal third quarter. We expect adjusted segment EBITDA of $775 million to $805 million and adjusted EPS of $0.88 to $0.97 per share. The primary drivers of our sequential increase include the implementation of the previously published price increases, continued strength in packaging demand, and the return to normal operations for the third quarter. These items are partially offset by modest sequential inflation across recycled fiber, chemical, and transportation costs. In addition, we will take approximately 112,000 tons of scheduled maintenance downtime across our North American Container Board mills. Finally, we expect higher incentive accruals due to a stronger earnings outlook. We want to share with you our current outlook for fiscal 2021. We expect the continued flow-through of the previously published price increases as well as packaging growth across our primary and markets. As a result, we expect full-year adjusted segment EBITDA to be approximately $3.05 billion. Given our earnings outlook and continued strong cash flows, we fully expect to be within our leverage target of 2.25 to 2.5 times by the end of the fiscal year. We will provide additional details on our next earnings call. And now I'll hand it back over to David for closing remarks. David? Thanks, Ward.
spk08: I'm excited about the future of Westrock. We have great opportunities to grow our company and provide value to our customers, our teammates, and our shareholders. We have a broad portfolio of products that is uniquely positioned to meet our customers' needs and and we will further leverage the power of the enterprise to create value. We intend to lead in sustainability by being a valued partner to our customers to help them achieve their sustainability goals as we work to achieve ours. To do this, we will focus on accelerating innovation, creating products that enhance the performance and sustainability of our products and services. and we will continue to be disciplined in our capital allocation strategy. We have confidence in our future, evident by the increase in our dividend this quarter. As recovery picks up momentum, we are well positioned with significant financial flexibility to pursue our goals. The future is bright at Westrock, and I am proud to be part of the team. That concludes my prepared remarks. James, we are now ready for Q&A.
spk06: Thank you, David. As a reminder to our audience, to give everybody a chance to ask a question, please limit your question to one with a follow-up as needed. We'll get to as many as time allows. Operator, may we take our first question, please?
spk00: Our first question comes from George Staffos of Bank of America. Your question, please.
spk01: Hi, everyone. Good morning. Thanks for the details.
spk07: David, thanks for the comments, and we're looking forward to working with you. I guess I wanted to spend the first question on your initial comments. You spent time talking with customers. You've obviously been reviewing the operation. Of the things that you enumerated, in your view, what's the one or two things that Westrock has to get right in the next year to position itself for the future? And what are customers saying they think of Westrock and what Westrock needs to get better on a going forward basis. That's question number one. Question number two, if you can comment kind of shorter term, what kind of trends are you seeing in volumes across your businesses early in the fiscal third quarter? And will there be any lingering effect from ransomware? Thank you very much.
spk08: George, thank you. Appreciate the question and your comments. I'll try to answer each one. Of your questions, I'll start with customers. I can't tell you how important it is to get our voice to the customer. I believe in a real outside-in approach, customer-focused approach as we look at the business. You know, one of my first meetings actually was with one of our largest customers, very strategic global account, and we happened to win the supplier of the year award. So hopefully all my customer meetings go like that. But I would say several themes emerged when talking to a variety of customers. And I think it ties into what we need to do as a company. And the first one was sustainability. You know, our large strategic customers want their products to become more sustainable, and they want to partner with us to find those solutions. And this is really especially true with plastics replacement and the opportunity we have there. So concurrent to that, I think innovation is going to play a critical role in our growth and sustainability, but also innovation across all of our products and services and including digital in our machinery businesses. So we've got to get sustainability and innovation right to your point earlier. And then the third thing I heard was service. I think with the pandemic, to your question, I think across multiple industries, It certainly accentuated the stress across supply chains worldwide. So reliable service and quality is critical for our customers. And just take this opportunity to really thank our teammates at Westrock. when we went through the ransomware attack, how well they communicated and kept our customers going. And as Ward alluded to, we did incur some costs to do that, but that was something we absolutely had to do to service our customers. And I think one last thing that I heard from our strategic customers was the value they placed on our enterprise. and the approach in bringing everything together and how that can help them be more effective. So I think all of that fits exceptionally well into our future vision. And, you know, the way I look at it is we really want our customers to come to us with their biggest challenges, and we want to help them be more successful in achieving their goals. So as I – Talk about what we must do. I talked about sustainability and innovation and the enterprise value proposition, that differentiation that we bring. And it's not only from a customer growth standpoint, but I believe it's also from an operational standpoint. Leveraging our manufacturing and supply chain, our footprint and our assets, and just having a relentless drive on productivity. We're going to be really focused here to drive efficiency, lower our costs and improve our margins. And then finally, the last piece would be our acceleration around the discipline and our capital allocation. I talked about the importance of reinvesting in our business for safety and maintenance, but also capital projects that really drive that productivity that we talked about. Really believe in a sustainable growing dividend, and I think today was the first step. in doing and showing the ability to drive that increase. We have a wonderful ability to generate cash in this business. So we look forward to continuing to grow our dividend. Accelerating our leverage to our target range of two and a quarter to two and a half, which Ward mentioned earlier, we will achieve by the end of our fiscal year. And we'll be opportunistic with share repurchases. You know, we We're going to invest our cash. We don't intend to hold onto it. We want it to fuel growth and create value for our shareholders. So we'll continue to do that. And we'll look at M&A as it aligns to our strategy. And those are the real priorities that we have. So I think I've captured everything. And then the last piece of your question, if I got it, George, was trends. You know, a couple things we've seen through the pandemic. We've seen a huge increase in e-commerce and some of our food and beverage and health care segments. We fully expect e-commerce to continue to grow. This is a new reality, we think, of the market. But as we get through the pandemic and things come back, we do believe retail, brick and mortar, beauty, industrial will continue to come back as things open up. And that's why I'm so excited about the breadth of our portfolio, because no matter where the markets take us, we feel confident in the products we have. And I'd love to have Jeff just reemphasize some of the volumes we've seen in April now that we've come out of this and just see the trends that we're seeing.
spk04: Thanks, David. Good morning, George. Overall, the demand in the business was strong across a broad base of end markets that David just outlined. So Ward commented we were up 5.5% in the quarter, and actually if it wasn't for weather and cyber, we would have been up almost 8%. We left April. It's not closed yet, so I don't have the final number, but we were up 12%. in shipments year over year as we left the month which is our record level uh for april shipments and the demand is strong across almost all of our end markets still so econ remains strong our distribution paper retail industrial also our backlogs remain strong coming into may our hot pipeline is up 90 million dollars year over year coming into the quarter almost 22 percent increase and we continue to onboard new and incremental business domestic markets remain strong you asked about lingering effects for us it's really getting our inventories back in line and with the outages this quarter it's probably going to take this quarter into next to really get back to the inventories and we took 160,000 tons out of export so getting back to some of our direct being able to fully supply some of our contract customers we need to make up tonnage as we've significantly reduced in our export markets, even to some of our contract customers the last two quarters. So that's going to linger in effect. But overall, integration rates are up to 82%, up from 78% last year, 80% in the first quarter. Demand is strong in all of our segments. And finally, thankfully, out of this last quarter, we're back to full operations, and we've operated well through April.
spk07: Thank you very much. I'll turn it over.
spk08: Thanks, George.
spk00: Our next question comes from Mark Connolly of Stevens. Your question, please.
spk08: Thanks. David, you talked a lot about cost of productivity, and Florence is obviously a major step for your system there. And Westrock has been making hard choices about which mills to support and not to. But $850 million of sustaining CapEx is a big bogey, and we tend to think that big projects like Florence are a way to help whittle that down. Should we be expecting more big projects like that to help move the system down in a big way rather than incrementally? Yeah, Mark, thanks. Thanks for the question. The way we look at CapEx is, you know, we'll probably have an investment span of about $800 to $900 million this fiscal year. And next year, we'll target $900 to $1 billion. And when you break that down, a portion of that just goes to core maintenance and safety that are critical But at least half of that is going to go to those productivity projects, like Florence, driving enhanced efficiencies, driving down our costs. And so that is going to be a huge focus, and you can expect a continuous investment in that $900 million to $1 billion in CapEx year over year. Okay, that's helpful. And just to follow up, I'm wondering how you and your team are thinking about the puts and takes of business reopening, where it might create some drags and where you're going to get the biggest bang from it. Yeah, what I'll do is I'll have Pat talk about that and then turn it over to Jeff and we can go into depth on their business.
spk02: Great. Thanks, David. And thanks for the question. This is Pat. So I'll talk a little bit about consumer and what we're seeing. We still see strong demand. And even in last quarter and into this quarter and through the remainder of the year, the demand continues to be strong in general folding carton as well as food and beverage. And certainly the economy is going to shift a little bit with the preferences that people have in terms of getting back to the office and getting back out and and being mobile again but we still see these trends continuing back there was a conference here in mid-february called the consumer analyst group of new york conference and and the about 30 cpg companies were there and they project over the near mid-term about two to three percent uh growth in their businesses so And that included kind of the end or slowing of the stay-at-home pandemic. So we're pretty robust and positive about that. I think health care is also one. We participate in COVID test kits as well as in leaflets and inserts for the vaccine. So we're seeing good results. good strength there and i think the other driver for us that's that's really not dependent at all on the pandemic or recovery is this plastics replacement opportunity that david referred to and we've talked about before we've already since july of 2018 commercialized over 200 million dollars of plastics replacement And we're envisioning right now we're increasing our projection on that up to an incremental $300 million over the next few years. So we think that this is going to be really economically independent. It's really the sustainability trends that our customers have and our ability through new technology, through innovation, to deliver new products for those customers. David, I'll turn it back to you.
spk08: Yeah, Jeff, I don't know if you want to make any comments on your business.
spk04: sure hey mark i'll just add that um you know without having a crystal ball don't know for sure but i can't tell you we do believe the e-commerce trend it's accelerated so two years of growth and in the last year and every one of our customers and retailers are either trying to figure out how to grow in that channel or how to get into the channel if they're not And to Pat's latest point, I think we're uniquely positioned with our automation platform, so our new pack-on-demand machines coming out that are replacing envelopes, a good way, an elegant way to get into smaller packaging and curbside recycling. The stay-at-home categories for us are remaining sticky, and as people will continue to work from home, we see growth staying in processed food, frozen vegetables, meals cooked at home. You might see a fall off in some of the retail or some of the, excuse me, some of the industrial that we have. But overall, I think we're well positioned as food service comes back online to serve broad markets through consumer incorporated. Super helpful. Thank you, everybody.
spk08: Thanks, Mark.
spk00: Our next question comes from Mark Weintraub of Seaport Global. Your question, please.
spk05: Thank you. Welcome, David. One of the comments that you made that sort of did definitely catch my attention, the intention to steadily increase the dividend every year. And obviously we saw the 20% this year of having cut it last year. I understand a big number. Do you have a perspective on what that rate of growth can be on average, and is it something that you think is going to be rateable, so very similar year to year, obviously excluding this year, or is it something that, given this business historically has had some cyclicality, you expect more moving up and down?
spk08: Yeah, thanks, Mark. The way I look at the dividend is, first and foremost, ensure it's a sustainable and growing dividend. And then as part of our capital allocation principles is really allow for flexibility across the cyclicality in the markets that you mentioned. So, if you think about it, the levers that we pull in regards to that, I mentioned the CapEx investments that are going to be constant. I think the team has done a terrific job deleveraging. So, that gives us even more flexibility So with that, we'll take a portion of that available cash that we have, and we'll look for the best return. It'll be a steadily increasing dividend. If there's opportunistic share repurchases, we'll continue to look at that. And if there's M&A that aligns to our strategy, we'll look at that while remaining core to the rest of the principles. The increase that we announced, we believe, was the right amount. We're very comfortable with it. We'll continue to assess it year over year. And to give a specific number, I don't think we're in a state to do that other than saying we're committed to sustainable growing dividend despite market conditions because I think with the cash flows we generate and the flexibility we have, we'll be in a good position.
spk05: Okay, great. And one follow-up, obviously great volumes in the box business. We saw some of the pricing flow through. A couple of the competitors had talked about how getting the container board increase into boxes went exceptionally fast this go-around. Now, you were in a bit of a different situation given ransomware and lots of different other issues. I was curious what your experience had been on that pass-through, and perhaps one way maybe to get at it would be, Jeff, how much of the Box price from the November increase is yet to be gotten in, say, the second quarter versus the first quarter. Is that something you could share with us? And then obviously we've got March, April yet to achieve as well.
spk04: Sure. Hey, Mark. So the November is basically done. We leave the quarters. You know, it's our normal flow through. So we left the quarter over 90%. April, it's complete for $50. And then the 20 and 40 that follows on will follow the same type of pattern. So it's going well. We have a good methodology to run our increases, and there's no change in that. But the $50 is basically complete.
spk05: I don't know if you're willing to share, but how much in terms of the average that you achieved in the fiscal quarter, how much would then carry over into this quarter from the first increase?
spk04: That's a smaller amount. I mean, it's like I said, most of it was done. It's over 90%. So there's a small amount left in the quarter. And really now we're focused on the 20 and the $40.
spk05: Okay, I'm a little confused with the $20 and the $40. I thought it was a $60 in March, April.
spk04: Yeah, that's $20 in March and April. Oh, got it. Okay, understood. Thank you.
spk00: Our next question comes from Mark Wilde of Bank of Montreal. Your question, please.
spk08: Good morning and welcome, David. Thank you. Good morning. I wondered, just to start off, Jeff, go back on this e-commerce for a moment.
spk06: What footprint changes might you have to make to kind of deal with the higher level of e-commerce activity going forward? And does that even ripple back to more changes in terms of what you're producing in the middle level?
spk04: Good morning, Mark. So on the footprint, I think in general what we're doing is increasing some of the eval locations that we've had so we've added in the northeast texas we're having to expand so every plant in texas we're investing el paso houston fort worth and mesquite so the footprint there it's not just e-commerce but e-commerce is a part of that but there's a large broad base in that area our midwest up in michigan our new plants from Box on Demand that we moved to Brownstown, we're actually going to make a box plant out of that plant. So we're going to continue to increase and invest in the eBall platform, high-yield rotary die cutters. And then we're continuing to innovate in our machine business. So our 2.0 Pack on Demand 2.0, our Boxizer, those machinery investments are paying off and we have great opportunity to expand on that one. We also expanded some investments and the box-on-demand sheep feeders where we have patents on tube technology on the corrugators. So we're actually making pouches coming off of our corrugators that had made fan fold. So that's another investment that we're continuing to make. As far as new locations, we're going to look at and see what we might have to do in the future. And then also Victory, adding the 65 distribution centers for Victory, has put us in a good spot to help distribute into some of the retailers, into some of the e-comm business for our customers who can't change their inventory or need quick turns in distribution. And that's a great way to work between the box plants and Victory. So a lot of positive things for us in our footprint investments and then Victory in our machine business.
spk06: Okay. And then, David, as a follow-on, if I could. Sure. You talked about the discussions that you've had with customers. I'd just like to get a few more thoughts on this idea of kind of selling kind of a full range of packaging because, like, through my career, we've heard a lot about this, you know. But it seems like in reality, for the most part, the decisions about packaging, corrugated purchases and folding carton purchases have pretty much been made separate from each other. So it always seems like the rhetoric is much better than the reality.
spk08: What is your take on this? Yeah, and I appreciate the question. I think about it in the way how customers buy. And to your point, I think different customers buy differently. So I wouldn't make a blanket statement of 100%, but I would say that that there are many customers that I've already talked to that really like the approach of an enterprise to help them be more efficient. And I mean, you heard Jeff talk about the machine. When you think about machinery, corrugated and consumer for some of these customers, we can really tie all that together. And there's innovation to be had when we do that. And so when we have that ability to strategically align with our customers, for those complete solutions, that's where we'll focus. And there will certainly be some customers that separated the way you mentioned, and we'll treat them the way they want to buy. So it's not 100%, but there is significant value there. And just as a data point, I would tell you that our growth rate with enterprise customers is higher than non-enterprise customers. So We see this as a significant opportunity. It's already a multibillion-dollar sales platform for us. And then when you tie in the operational piece internally to really leverage our assets from an enterprise standpoint, we think there's tremendous value there, and that's something unique that we can bring to the market as we innovate in our approach in doing so. Okay, that's helpful. Thanks very much, and good luck. Thanks, Mark. Appreciate it.
spk00: Our next question comes from Kyle White of Deutsche Bank. Your question, please.
spk03: Hey, thank you. Good morning. And congrats, David, on the new role. Thank you. I apologize if I missed this in the remarks, but do you have an idea in terms of the potential proceeds from insurance related to the ransomware incident or the weather impact and also the timeline on when you expect to receive these?
spk07: Yeah, so we, Kyle, this award, we estimated the total claim right now for the ransomware attack to be approximately $75 million. We are initiating the claim process as we speak. So there'll be both recovery of the one time expenses and the business interruption and lost profits, but those will be the components of that claim. And we do not have a timeline for when we're going to recover it, but we're confident that we're going to recover substantially all of the claim. We have not gone through. We are evaluating the process right now to assess whether we have a potential claim on the weather events. Because it impacted so many different facilities, I think it impacted over 30 converting facilities in multiple mills. We're aggregating that analysis right now, and we'll share more with you as we learn more about that.
spk03: Got it. That's helpful. And then, Ward, prior to the pandemic, WestRock would provide some form of cash flow guidance, and you have it here. Just wondering, you know, the reasoning why you chose not to. Was there just too much uncertainty regarding your working capital or something else?
spk07: No, you know, prior to the pandemic, we were giving full year guidance, right? And then during the pandemic, we went to sequential earnings guidance. And so we stopped that, obviously, on the call in January because of the timing of the ransomware event. But so what we thought it was important to do as we exited the quarter and put these events behind us, we wanted to give you clarity for earnings for Q3, and then we gave you a reference point for the full year. for earnings. But I'll shift to cash flow, and I'll talk about the strength of cash flow. So clearly, we had a really good first quarter from a cash flow point of view. Q2 was negatively impacted by the ransomware, as we had talked about during the quarter. And we're going to start to recover from that in Q3 and Q4. Seasonally, we always drive a large portion of our cash flow in the second half of the year. I'll just give you some reference points to demonstrate to you the power of the cash flow generation. So If you look over the last two years, if you take our adjusted EBITDA, we convert 75% of that roughly to adjusted operating cash flow. You take that with the midpoint of the CapEx guidance that we've given you, and you see very, very strong cash flow generation for the full year and our ability to deliver very quickly from where we are right now.
spk03: Got it. I'll turn it over.
spk00: Our next question comes from Phil Ng of Jefferies. Your question, please.
spk01: Hey, David. Looking forward to working with you, and congratulations. Thanks. I look forward to it. Under your watch going forward, are you going to use a different lens in terms of metrics and methodology, in terms of cap employment, and any changes in terms of how you're going to structure incentive comp and, once again, metrics that you're going to be looking at?
spk08: Yeah. So as you would expect, I'm looking at everything. So we would, I do believe, you know, aligning our metrics to our strategy is critically important, and we'll absolutely do that. And we'll look at it across the company in our cap projects, cap allocation, as well as, you know, our incentive plans. So we're going to look at all of that.
spk01: Okay. That's super helpful. And I guess a question for Ward. Within your guide, can you give us a little more color how you're thinking about inflation for the full year? Certainly very elevated right now. On the quarter in 2Q, it seems like inflation was a bit more outsized for corrugated versus consumer. Any color on what's driving that spread? Sure.
spk07: It's the impact of the recycled fiber. So we talked about it, and I prepared remarks. I think we said recycled fiber was up – almost $43 a ton, I think, approximately year over year. So as you think going forward, remember that the comparison of recycled fiber, especially in Q2, is off at very low levels during FY20. So my guidance as we think about Q3 and Q4 for inflation from where we are today is we're estimating that recycled fiber will be up approximately $15 from Q2 to Q3. Q2 to Q3, and then another $5 from Q3 to Q4. If you look at the single biggest driver of inflation for us, and I've been signaling this all year long, was going to be recycled fiber. Recycled fiber on a year-over-year basis for the full year could be approximately $150 million based on the consumption of fiber that we have across our system. Then the other elements have been elevated energy costs off of last year's lows. And then we've talked about the tightening freight markets. I gave guidance earlier in the year that I thought freight for the full year would be 3% to 5% on a year-over-year basis for the full year. We're on the high end of that range now. And then given the events that occurred in – in Texas related to the winter weather, that has had some impact on some of our chemicals. So, historically, I've said that if you look at the average inflation for this business since the inception of WestRock, it's averaged about $225 million a year. It's going to be elevated this year simply because of the elevated energy and recycled fiber. And really, I've embedded those in our guidance. The sequential inflation outlook that I just talked about was included in our guidance for Q3 and then for the full year. And it just reinforces our need to drive productivity across the business. Okay. Super helpful, guys. Thank you.
spk00: Our next question comes from Anthony Petanari of Citi. Your question, please.
spk07: Good morning and welcome, David. Thank you. Just piggybacking on some previous questions on capital allocation, I think you could argue M&A has been pretty integral to Westrock's DNA, maybe Rock 10 before that. And obviously not asking about anything sort of near-term or specific, but just longer-term, do you view consolidation and paper-based packaging as an opportunity? How do you think about criteria and strategic importance of acquisitions. And, you know, when you looked at the company's history of acquisitions coming, you know, from an outsider perspective, what were your sort of lessons learned?
spk08: Yeah, so I think I think we'll certainly be open to M&A. It'll be part of our, you know, our inorganic growth platform moving forward. But we're going to be really disciplined in our approach. It's got to align to our strategy. It's got to meet our expectations for returns. And the piece on the multiple integration, the acquisitions we've made to your question, my observation is it's critical that we extract all the value from bringing these businesses together. So, you know, I think about it, how do you make one plus one equal three? So it's driving the productivity. It's ensuring our return on assets. It's leveraging the scale that we have and ensuring we get the return for the investments we've made. So that's why I mentioned earlier that critical importance of driving that productivity and optimization from our past acquisitions and on future acquisitions. acquisitions as they fit the strategy and they fit our return criteria, it'll certainly be part of our process.
spk07: Okay, that's very helpful. And then just maybe a follow-up for you or maybe Jeff. On e-commerce and corrugated, as you increase your mix into e-commerce, should we think about that as sort of margin accretive? Is it margin neutral versus non-e-commerce customers? And, you know, understanding it's hard to tell in a dynamic market, and you had ransomware and some other stuff, but do you think you're growing faster than the market or faster than your peers in the e-commerce category? And if so, why?
spk04: Good morning. It's hard to tell on just head-to-head e-commerce growth. I think we're continuing to grow the business broad-based. And the margins, if you look at our margins, the packaging margins are the best channel we have. So not comparing e-comm to other. It's how you run the business. We've set up our manufacturing facilities to be highly efficient to run. whatever product we're putting through the plants. It's revenue per machine hour and contribution per machine hour. And we've equipped our plants to be able to maximize whatever product we're running through those. And I think we'll continue to do that. And keep in mind, as we look at our 90% integration, uh rate the the tons that we move into packaging are considerably better than exported at any price uh in the cycle so we'll continue to do that and it will be overall the volume and the packaging whether it's e-commerce or anything else will be accreted for us okay that's very helpful i'll turn it over thank you our next question comes from cleve rookard of ubs your question please
spk03: Great. Good morning, everybody. Thanks for taking my questions.
spk07: I just wanted to follow up on recycled fiber. I appreciate the inflation there, but I was curious to understand what you're seeing in terms of recycled fiber supply in the domestic U.S. market. I mean, we've been hearing reports that the residential channel recycling rates are much lower than commercial So I was wondering what you're seeing on that side of the business and if you expect it to change with reopening playing out.
spk04: Hi, Cleve. It's Jeff. So on the supply-demand, the generation in the typical large grocery stores, the box stores, has been good. There is less collection in the residential, but the recycling centers are investing to be able to capture more of that as they're coming up. I think what's really driving The demand now is some of the startups, the robustness of the business, the startups of some of the recycled mills. So you're getting upward pressure on that. And then export into the Asia, India area, not China, but it's all the places around China, but also strong and robust because the global economy for packaging paper right now is strong everywhere. So that's really what's putting some of the upward pressure on the pricing.
spk03: Okay, that's clear. And I just, you know, I wanted to follow up on something from sort of earlier on in the prepared remarks. So you mentioned that customers in container borders seeking low-basis weight products.
spk05: I'm wondering if you could give us a sense of some color on who those customers are and, you know, what maybe besides sustainability is driving that shift.
spk04: Sure. It's not just low-basis weights. It's really... Lower basis weights but with the strength properties, and that's what the Florence investment will do. So you have better strength properties at a lower basis weight. So less fiber, definitely lower cost, the sustainability play, but it's really performance that they're after. So what we do is spec to performance, and it depends on the end-use market. So the lower basis weights you can put into some of the e-commerce markets, some of the less industrial, and then we have a great – and diverse products. And so when you look at our protein or produce, they're looking at 100% virgin, heavier weights, semi-chem mediums that are heavy weights. So it's really about the full complement of products across a basis weight, and we're really well-suited across our system to be able to supply whatever our customers need.
spk03: Got it. That's clear. Thanks very much, and good luck this quarter. Thank you.
spk00: Our final question comes from Adam Josephson of KeyBank. Your question, please.
spk08: Thanks. And, David, best of luck in your new role and look forward to working with you. Me as well. Thank you, Adam. So just two-parter on cap allocation. One is just others have asked about M&A and the company's M&A history. So as a result, you have boxes, folding cartons, distribution, URB, Brazil. I'm just wondering, David, how you think about the necessity of all of these businesses, if there are areas of pruning, or do you think that the company as currently constructed is the right business mix? And then relatedly, if a big acquisition opportunity were to come up, would you pursue it or are you really, would you much prefer to be more balanced in terms of buying back stock every so often? increasing the dividend and then selective, perhaps, bolt-on M&A instead of large-scale M&A, as has been the case in recent years of the company? Yeah, thanks, Adam. I look at it a couple ways. The first one is ensuring that we are really dialed in on our strategy and our portfolio and Going through that process now to assess what our strategy and portfolio looks like as it relates to our products, our markets, our infrastructure, and our footprint. Really, you know, how do we best serve our customers? How do we provide the most value for our shareholders? But also, there's an opportunity to truly be differentiated from our competitors. So bringing that all together is extremely important. So I'll probably be able to be in a better position over the next, you know, coming months to share a lot more detail on that. And when we come out of that, we will be extremely well aligned as an organization, what our path forward is to our strategic foundation. And then from there, we'll just be relentlessly focused on executing to our strategy. And then as far as M&A goes, you know, it would tie right into the strategy. So I think, you know, Ward and the team have done a phenomenal job deleveraging. So our balance sheet is strong. And if the right opportunity came up that met our strategy, that, you know, met our return criteria, we'll look at it. But we're going to dial in and not shift from our strategic platform. Thanks a lot, Dave. Thank you.
spk00: And ladies and gentlemen, this concludes today's West Rock Company second quarter physical 2021 results conference call. Thank you for participating. You may now disconnect.
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