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spk04: Good morning and welcome to the West Rock third fiscal quarter 2022 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone song. To withdraw from the question queue, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Rob Cortaro, Senior Vice President of Investor Relations. Please go ahead.
spk02: Good morning, and thank you for joining our third fiscal quarter 2022 earnings call. We issued our press release this morning and posted the accompanying presentation to the Investor Relations section of our website. They can be accessed at ir.westrock.com or via a link in the application you're using to view this webcast. With me on today's call are West Rock's Chief Executive Officer, David Sewell, and our Chief Financial Officer, Alex Pease. Following our prepared comments, we will open the call for a question and answer session. During today's call, we will be making forward-looking statements involving our plans, expectations, projections, estimates, and beliefs related to future events. These statements involve a number of assumptions, risks, and uncertainties that could cause actual results to differ materially from those we discussed during the call. We describe these assumptions, risks, and uncertainties in our filings with the SEC, including our 10-K for fiscal year ended September 30th, 2021. We will also be referencing non-GAAP financial measures during the call. We have provided reconciliations of these non-GAAP measures to the 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, I'll now turn the call over to you, David.
spk01: Thank you, Rob, and thank you all for joining our earnings call today. On our call today, I'll provide an overview of our fiscal third quarter results, discuss progress toward our transformation, and review our recently announced agreement to acquire the remaining stake in our Grupo Gandhi joint venture. Following that, our CFO, Alex Pease, will provide a deep dive into the quarterly results for our segments and other performance. He'll also provide guidance for the fiscal fourth quarter. We will then move to Q&A to answer any questions you may have. When we spoke at our Investor Day in May, we provided long-term guidance for our business. We remain committed to our goals, and this quarter provides another update on our progress toward achieving our objectives. Our business is healthy and our balance sheet is strong. We are committed to driving our return on invested capital higher improving our margin structure, and delivering above-market growth through our strategic initiatives. Turning to slide three, today we reported record results with fiscal third quarter consolidated adjusted EBITDA above our guidance and adjusted EPS at the top end. Our strong performance reflects the hard work of our talented team at Westrock. Third quarter sales were a record $5.5 billion, an increase of 15% year over year, and for the first time in Westrock's history, consolidated adjusted EBITDA was more than $1 billion. This is an increase of 24% year over year. Adjusted earnings per share of $1.54 increased 54% compared to the prior year. Additionally, the company generated $628 million of adjusted free cash flow, up $75 million year over year. Results were strong across all of our segments, driven by solid demand and the flow-through of previously published price increases. Corrugated packaging adjusted EBITDA margins, excluding trade sales, were 17% as fewer COVID-related absences and less maintenance downtime supported improved productivity compared to last quarter. Our consumer packaging segment remains strong across most end markets, with industry-leading adjusted EBITDA margins well over 18%. Our global paper segment performed extremely well with an adjusted EBITDA margin of 25%, highlighting the business's strategic value. As a reminder, our packaging segments do not include the strong margins we're seeing in our external paper business. During the quarter, we returned $354 million in capital to shareholders. including $290 million in share repurchases and $64 million in dividend payments. We also maintained a net leverage ratio of 2.13 times within our target range of 1.75 times to 2.25 times. Looking forward, economic conditions remain uncertain, and some of our customers have been working to rebalance their inventories. Fortunately, we serve a broad range of end markets that are resilient despite economic trends. For example, paperboard, beverage, healthcare, and retail food remain very strong. Additionally, our consumer backlogs remain at historically high levels. Turning to slide four, as we outlined on our investor day, we have significant self-help opportunities, and we are making progress on these goals. Our recent actions include reducing our average mill cost by $4 per ton, establishing a supply chain pilot in one of our markets, centralizing production planning, inventory management, warehousing, and logistics, launching a systems modernization effort, which is projected to deliver $200 million annually in savings when complete, Announcing two strategic portfolio actions, our Grupo Gandhi acquisition and closure of our Panama City mill. Leveraging the size and strength of Westrock to reduce costs across approximately $1 billion of indirect spend. Increasing operating efficiencies across our mill and converting network. And targeting actions to reduce SG&A and drive increased efficiencies. Through these actions, we are on pace to achieve approximately $250 million in annualized cost savings, and we're just getting started on the $1.5 billion of self-help opportunities we identified at Investor Day. These opportunities, along with our scale, the range of packaging solutions we offer, and our significant cash flow generation, position us well for long-term growth. Turning to slide five, our previously published price increases have continued to more than offset inflation in fiber, labor, freight, energy, and chemicals. In the quarter, we implemented a series of additional paperboard price increases in the range of $50 to $100 per ton, which will continue to flow through the fourth quarter and next fiscal year. Looking forward, we expect the rate of inflation to mitigate, specifically in freight, certain raw materials, and labor. While elevated energy prices remain a challenge, we expect price realizations to more than offset overall inflation for the remainder of fiscal 2022 and into fiscal 2023. Moving to slide six, Last week, we announced our entry into an agreement to acquire the remaining 68% stake of our joint venture, Grupo Gandhi, a leading integrated producer of corrugated and consumer packaging in Mexico. This is a final step in a highly strategic partnership that we began in 2016 with total previous investments of approximately $425 million, and we are incredibly excited about the transaction. Grupo Gandhi will complement our existing North American footprint and will increase our presence in the growing Latin American market. As many of you know, we have a long, successful history with Grupo Gandhi. We supply the company container board and paperboard and partner with them on packaging solutions that leverage our patented designs and industry leading beverage packaging machines. Increasing integration with Grupo Gandhi following the acquisition is expected to produce significant synergies in our North American business. In addition to the strategic fit, Grupo Gandhi meets our financial thresholds and firmly aligns with our capital allocation strategy. We expect an ROIC of greater than 10% by year three, including $60 million of synergies, which we have good line of sight to given how familiar we are with the assets. These synergies are expected to include leveraging our sourcing and logistics capabilities, optimizing external paper sales, improving operations across the mills and converting facilities, and executing other cost-saving measures. We plan to close by the end of the first quarter of fiscal 2023. Following the closing, we expect to remain within our target net leverage range of 1.75 times to 2.25 times and anticipate the deal to be adjusted earnings accretive in fiscal 2023. Turning to slide seven, Grupo Gandhi operates four paper mills representing 1.1 million tons of recycled liner board, medium, and CRB capacity. The company is approximately 80% integrated, operating nine corrugated packaging plants and six high graphic plants in Mexico. Some of their high graphic plants are hybrid facilities, providing both corrugated and consumer packaging. Grupo Gandhi is led by a highly respected management team and its proximity to the United States will enable further integration with our existing mill system, positioning us to take advantage of onshoring trends in the Americas. This acquisition will strengthen our position in the strategically important Latin America market. Latin America is projected to grow over 50% faster than North America. driven by economic growth and export product expansion in produce, protein and industrial goods. Grupo Gandhi's assets will enable stronger relationships with many of our large multinational customers operating in the region. Its corrugated and consumer businesses complement our existing business and enhance our service capabilities within Latin America. Additionally, Grupo Gandhi's 14 operating facilities are high-quality, well-capitalized assets. The company recently completed an investment in its world-class Monterey Mill, which makes it one of the most modern container board mills in Latin America. Monterey is currently ramping up and operating at approximately 90% of its expected 440,000 ton capacity. We are excited about the future and we are looking forward to welcoming Grupo Gandhi team members to the Westrock team upon closing. Acquisitions such as this are just one component of the capital allocation strategy we outlined at our investor date. Our priorities include organic investments, maintaining net leverage of 1.75 times to two and a quarter times, a sustainable and growing dividend, tuck-in acquisitions, and opportunistic share repurchases. I'll now turn it over to Alex to discuss our segment results in more detail.
spk05: Thanks, David. Moving to our consolidated quarterly results on slide 8, third quarter net sales increased 15% year-over-year to $5.5 billion, and consolidated adjusted EBITDA increased 24% to more than $1 billion. Consolidated adjusted EBITDA margin was 18.2%, up 140 basis points year-over-year. Price and mix positively contributed approximately $750 million year-over-year. Continued inflation in energy, freight, labor, fiber, and chemicals, along with other challenges, partially offset these benefits. Also, please note that results include an insurance recovery of approximately $19 million related to last year's ransomware and weather events. Turning to slide 9, corrugated packaging sales were $2.4 billion, an increase of $228 million, or 11% year-over-year. Adjusted EBITDA increased $21 million, or 6%. Adjusted EBITDA margin, excluding trade sales, declined 80 basis points year-over-year to 16.8%, but represented a 210 basis point increase from last quarter. We continue to focus on increasing these margins and are confident we will do so. Strong pricing and mix contributed $300 million, largely offset by $218 million of inflation and $35 million from lower volumes. We also had modest operating cost headwinds due in part to the continued labor challenges. As previously mentioned, inflation continued to impact our business with costs higher in energy, freight, labor, fiber, and chemicals during the quarter. While COVID-related absenteeism improved from the second quarter, the tight labor market continues to pose challenges. Recruitment and employee retention remain a strong focus for us to ensure that we're able to serve our customers and improve productivity. Our Latin American business continues to perform well, with Brazil margins over 35%. Our Tres Bajas mill and Porto Feliz box plant continue to ramp up, and with our announced Grupo Gandhi acquisition, we have a strong foundation for long-term growth in Latin America. Turning to the consumer packaging business on slide 10, sales increased $138 million or 12% year-over-year to $1.27 billion. Adjusted EBITDA increased $52 million or 28% and adjusted EBITDA margin was 18.5%, an increase of 230 basis points year-over-year. Strong price and mix contributed $122 million while higher volumes added an additional $9 million. Shipment volumes increased 3.4% year-over-year. These benefits more than offset a negative impact of $77 million due to inflation, primarily in energy, freight, labor, fiber, and chemicals. We continue to leverage our innovation platform to develop sustainable packaging solutions for our customers in an effort to help them reduce their environmental footprint. Our current run rate for plastic replacements revenue is now approximately $325 million annually. Our consumer business remains robust with strong growth in beverage, healthcare, and retail food. We're also continuing to implement recently published price increases. Our consumer business has an attractive growth profile, leading margins, diversification benefits, and cross-selling opportunities. We continue to execute well and are remarkably excited about the opportunities ahead. Turning to slide 11. Global paper net sales increased $311 million or 24% year-over-year to $1.6 billion. Adjusted EBITDA increased $134 million or 50% and adjusted EBITDA margin increased 440 basis points to 24.8%. Strong price and mix contributed almost $300 million. FX and other contributed $22 million and higher volumes contributed $14 million. Volumes were up 3% on a year-over-year basis. These benefits were partially offset by continued inflation of $163 million and higher operating costs of $36 million. Our strategic global paper business provides flexibility to navigate changing market dynamics by enabling us to optimize between internal and external sales channels as well as paper grades. This flexibility helps to balance our supply with demand and drive overall profitability. Our global paper segment also increases our exposure to resilient end markets and enhances diversification. It improves financial performance and reduces earnings volatility by leveraging our geographic reach, asset flexibility, and channel options. We'll continue to utilize this flexibility to navigate the changing market dynamics ahead. Next, our distribution results are on slide 12. Our distribution performance was solid with revenue increasing 11% year-over-year to $358 million and adjusted EBITDA up 7% year-over-year. Strong price and mix contributed $41 million and lower operating costs contributed $9 million, largely offset by inflation of $47 million and lower volumes of $2 million. Turning to slide 13. During the quarter, we generated $628 million in adjusted free cash flow, up $75 million year-over-year, driven by our strong results. We expect fiscal year 2022 adjusted free cash flow to be approximately $1.2 billion for the year, making this the seventh straight year of adjusted free cash flow above $1 billion. This represents an adjusted free cash flow yield of 11%. Our balance sheet remains strong. with net leverage at the end of the quarter of 2.13 times, well within our targeted range of 1.75 to 2.25 times. Turning to slide 14 in our financial guidance for the fourth quarter. We remain confident in the strength of our diversified portfolio and integrated business model to deliver solid results through any economic cycle. We continue to see healthy demand trends across our paperboard grades, and we are actively managing our business given uncertainty in the macroeconomic environment. Many of our customers are working to rebalance inventories, and we've experienced softer agriculture box demand due to the drought. These trends drove a deceleration in corrugated volumes through the third quarter and into Q4. That said, underlying demand remains solid and we're confident that our broad portfolio will serve us well through these cycles. We have approximately 45,000 tons of scheduled downtime across our system in the fourth quarter, including 30,000 tons that we shifted from our fiscal 2023 to smooth our maintenance schedule and reduce risk. Our forecast for fourth quarter consolidated adjusted EBITDA is $900 million to $1 billion and adjusted earnings per share between $1.24 to $1.53. Some assumptions behind our sequential outlook include, first, a flow-through of previously published price increases. Next, Natural gas of $8.25 per MMDTU. Third, slightly higher OCC costs partially offset by lower virgin fiber costs. Fourth, logistics costs up slightly. Fifth, a tax rate between 24% and 26%. And finally, approximately 257 million diluted shares outstanding. Our updated guidance reflects current trends and our expectations for the remainder of our 2022 fiscal year. We're continuing to evaluate our 2023 fiscal year outlook, and we look forward to providing guidance with our next earnings call. I'll now turn it over to David to conclude before we move to Q&A. David?
spk01: We remain well-positioned with a resilient business model, strong cash flow, and broad range of packaging solutions. We are delivering industry leading margins and growth in our consumer packaging business, our strategic global paper business and integrated machinery solutions also continue to perform exceptionally well. And we are confident in our ability to accelerate our transformation in our corrugated business. As we look forward, we will drive results in all of our businesses, improving margins and growth in the quarters and years to come. We are unwavering in our focus to continue unlocking the value of our broad portfolio and unique fiber-based packaging solutions, and we continue to see tremendous opportunity to reduce costs, improve productivity, and gain market share. We remain laser-focused on executing our strategy, and we believe our shareholders will be greatly rewarded. Thank you. And with that, Rob, let's move to Q&A.
spk02: Thanks, David. Operator, we're ready for questions.
spk04: We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press star then 2. Our first question is from Anthony Petanari of Citi. Please go ahead.
spk10: Good morning. Good morning. I was wondering if you could talk a little bit more about July-August trends and corrugated. You mentioned deceleration potentially into fiscal 4Q. Just wondering if that was sort of consistent with what you saw in 3Q and on a year-over-year basis. Is that flat, down low single digits, down mid single digits? Any kind of finer point you can put on that?
spk01: Yeah, thanks. Good morning, Anthony. To talk about Our Q4 and how we see that in our box demand, I'll back up to Q3. You know, we feel great about our performance in Q3, and if you break it down, our consumer and paper board business was very strong throughout the quarter, and we see that continuing in Q4 with historical high backlogs. In the second half of Q3, we started to really see our corrugated customers impact of inventory rebalancing. Obviously, with the supply chain disruptions over the past year and a half, two years, customers were building inventory wherever they could. You're seeing that rebalancing now at a lot of retailers and at our customers. But the demand fundamentals are there continuously. Our customers continue to say that, but what they're telling us is they have to rebalance their inventories. And we see that continuing into Q4. We saw that in the second half of Q3. So, from a percentage standpoint, if you remember, we were, we had really strong comps in Q3 on corrugated. We're up 8.9%. We see it flattish in Q4. We see it flattish sequentially from Q3. Obviously, we were down a little bit in our production rate in Q3, but how we exited Q3, we see that continuing. We haven't seen a drop. We just see that stabilization of that rebalancing from where we were. And again, we see it flattish kind of growth in Q4.
spk10: Okay, that's very helpful. And then, you know, you've had some portfolio moves with Panama City and now Gondi. Can you maybe remind us sort of what percentage of container board you might expect to export, adjusting for those portfolio moves, maybe where that's come from to where it will go to? And then just maybe more recently, given domestic volumes have softened a little bit, are you increasing exports? Or just wondering if you could talk about that dynamic there.
spk01: Yeah, thanks, Anthony. It speaks really well to why we think our global paper business is so strategic for our business and how it balances out our portfolio. If you look at Container Board, our export business is less than half of our overall global paper business and Container Board. We're probably 58% domestic, 42% export. But what I would tell you is that our export business and container board is extremely strong, you know, high double digits in the export business. And if you look at craft paper, a little stronger export than domestic and craft paper. So that's why our model we think works so well. And as we look at the markets globally, and again, you know, 60% of our paper business is in segments that we don't cover in our integrated packaging business. So we're able to take advantage of a lot of the value where we can maximize that for our shareholders. So that's how we see export continuing that way. And if you recall, you know, virgin fiber is really in high demand from an export standpoint. So that's why we feel really good about our diverse portfolio in addition to all of the other grades that we're able to provide our customers that are looking for complete solutions.
spk10: Okay. That's very helpful. I'll turn it over. Thanks.
spk04: The next question is from George Stappos of Bank of America. Please go ahead.
spk12: Hey, guys, good morning. Thanks for the details. I joined the call late, so some of this may have only been covered. But first, just a point of clarification on your answer to Anthony's question. I apologize if I missed it. So is your corrugated volume early in 4Q flat with 3Q, and therefore down? Or I can't imagine it's flat with last year's 4Q. I just want to make sure that I'm clear on that.
spk01: Yes, so what we saw in Q3 was flat with our end run rate, how we ended Q3. So we had a stronger start to corrugated at the beginning of Q3. We saw that inventory rebalancing. We did see impact from the drought in our agricultural business as well. So how we exited Q3 and how we're entering Q4 we see is flattish. Okay.
spk12: Thank you, David, for that. And my two quick questions, just one, again, piggybacking a bit, I want to cover exports. The global market seems to be slowing from what we can see, certainly from the macro headlines, yet you're seeing very strong demand for export paper on container boards. You're saying it's related to Kraft Liner and the Virgin Fiber. Where are you finding the most opportunity for your Virgin liner board in the global market? Because again, based on the headlines, it seems different than what we would have expected given what's been happening. And then with Gandhi, can you talk a bit about how the new machine in Monterey fits potentially with the whole of your fleet of machines? And the trim width I know on that machine is a bit fairly customized for the Mexican market. Again, how would that work relative to any customers that you might be shimmying into in North America as the deal closes? Thanks and good luck in the quarter.
spk01: Thanks, George. Appreciate the questions. I'll start on the container board question. Our strength in Q3 was on the export side. I do agree with you that as we look at inventory rebalancing, You know, you'll see that kind of, you know, regroup itself with the demand. Our paper board sales are, you know, extremely strong. We can sell more if we can make more. So we feel great about paper board. That's why we love the diversity of our model. The other piece that we're watching very closely from the export markets is natural gas. Obviously, the energy prices in Europe are very concerning. Many times that creates opportunities for export of our virgin fiber. So, we're looking in that very closely, but we'll see how that plays out. As it relates to Gandhi, it's a very well capitalized new machine. It's integrated businesses into Mexico. But it fits very well with our North America recycle strategy. And so that will be part of our footprint optimization as we look at it with North America. Thank you. Appreciate it, George.
spk04: The next question is from Phil Ng of Jefferies. Please go ahead.
spk00: Good morning, everyone. Strong quarter, good results. I guess just, David, that last point, as you kind of integrate Gandhi, you mentioned you would look at your footprint optimization strategy. Are there any, when you look at holistically in North America, as well as now Latin America, are there opportunities where you see higher cost assets, particularly on a container board that you could do more work on, like some of the work that you did in Panama City?
spk01: Well, I would say, well, good morning, Phil, first off, and thanks for the question. I would say, you know, we're always looking at our portfolio, and we talked a little bit about that at Investor Day. We are going to optimize our mill cost footprint, and, you know, we've committed to a $20 reduction in our cost per ton. And so, there's going to be a variety of everything. So, first thing we look at is to invest. We get great investments, like you saw in Florence and Tres Bajas. But where we need to invest to get to where we want, like Panama City, if the return on invested capital isn't there, we're going to, you know, have to make the tough decision. So we're continuing to look at that footprint and how we move forward with Gandhi. That is going to play a part of it because, you know, that Monterey Mill is really a world-class asset and we'll take advantage of it.
spk00: Okay, super. As your price increases continue to layer in in the coming quarters, and I think Alex mentioned that you're starting to see some signs that inflation is moderating a little bit. Do you have enough price to fully offset inflation looking out to 2023? And then pricing certainly was really strong in consumer and growth was really good. I think in the past, your lags were a little longer on the downstream side, call it about nine months. Have you been able to shorten some of that lag dynamic just given how extended backlogs are right now?
spk05: Yeah, I'll go ahead and take that one, Phil, and then David can pile on. So first off, we're not in a position to give guidance on 2023 at this point. I do think if you look historically, you know, price has always offset or more than offset inflation, and I don't see any reason why we wouldn't think that continues to be the case. As we look into Q4, we do see the continued flow through a previously published price impact um that will be more pronounced on the paper board side than the container board side just given when we rolled out various price increases of different grades but as we think about q4 we we see price realization uh you know in the same order as what we've seen for the for the balance of the year so we do continue to see strong price realization and we do see it continuing to more than offset inflation anything you'd add david
spk01: No, just to your point on the lag effect from a price increase to implementation, your timing's about right. That's what we're seeing. Although the comment I would say, and we talked a little bit about it at Investor Day, is, you know, we're working really closely with our customers on pricing moving forward. So we're exploring, you know, how to do that with PPW pricing and other mechanisms as well. So we're continuing to be very strategic in how we approach price. And as contracts come up, you know, you may see that lag effect alter just a bit. Okay. Thanks a lot, guys. Appreciate it. Thanks.
spk04: The next question is from Mark Weintraub of Seaport. Please go ahead.
spk03: Thank you. Just maybe one quick clarification on the last comment. Was that specific to the consumer packaging business? when you're talking about changing in the way that the contracts are set up and lengths of lags?
spk01: Yeah, Mark, I would say it's actually to both. We have, we are, our contract situation, or I should say how we do contracts as it ties to PPW is much greater on the corrugated side of our business versus the consumer side of our business. But, you know, we think pricing with the way the market's been over the last, you know, couple years with inflation, and the volatility, we want to really stabilize that, and our customers want to stabilize that, so we think there's ways we can continue to do that, and that'll come over time as we work through as contracts come up. Okay, interesting.
spk03: So as we think about, so you had a very strong fiscal third quarter results. Guidance for the full year at the top end has come down a little bit. If we think about sort of is that primarily a reflection of business slowing on the margin or is that the costs going higher or are there other – how would you capture what sort of the dynamics at work there? And maybe just as a part of that, if I look at your press release and I just look at the box shipments and it looks like they're down about 3%. Does that get me the sort of, can I get to the right number looking at the data you provide to sort of get a sense as to what your box shipments did in the just-ended quarter?
spk01: Yeah, Mark, really good question. And I'll just answer very briefly, but then I'll turn it over to Alex to give you a little bit more detail on it. I think there's a couple things that happen. And first, I'd say we're still with well within our range that we gave at the beginning of the year, so we feel really good about that. We felt great about third quarter. Inventory rebalancing is very real, and we see that as a piece that happened very quickly, and I think you're seeing that in the markets in general. And I think inflation, especially natural gas, is something that you know, was well beyond our forecast. And I'll turn over to Alex to maybe provide more detail.
spk05: Yeah, I think, so David hit the nail on the head. I think the demand trends that we saw, which is related to his answer to Anthony's question, the demand trends that we're seeing are in line with where we exited the quarter. So I think we see that being relatively consistent on the demand side as this inventory rebalancing takes hold. Really the biggest driver are energy costs. So if you think about where we, you know, exited last year at around $3 an MMBTU for gas, we've been running really north of $6. And then if you look at the assumption we provided for the fiscal Q4, we're at $8.25 per MMBTU. So just to help you dimensionalize that on an annual basis, we consume about 90 million MMBTUs of natural gas. So that's a that $2 is a meaningful difference on an annualized basis. Now, fortunately, we are able to offset that with the positive pricing that we talked about, but that is something that we didn't anticipate going into the year. So if you were to look at our full-year basis for natural gas, you'd see it around, call it $6.50 versus last year, full year was around $3. So that's a pretty meaningful difference. OCC continues to be... continues to be higher than last year. So we exited last year at around $100 a ton. I think we're probably around 50% higher than that. In the prepared remarks, we said that's roughly 4% higher in the quarter sequentially. Fortunately, that'll be offset by some modest improvement, about 2% improvement in inversion fiber. And then logistics costs continue to be up slightly. So really the story is, Mark, is more about inflation than it is demand. And fortunately, given the diversification of the portfolio and the strong pricing power that we have, we're able to more than offset the effects of inflation with price.
spk03: Great. That's helpful. And just on the box shipments, if I look at the press release, it looks like it's down about 3%. Is that accurate for your third quarter?
spk05: That's right. Just over. So 3.2%, I think, is what we said. Okay. Thank you. I mean, that is lapping a really tough comp. So the comp in Q3 of last year was, I think, 8.9%, something like that. Positive.
spk03: Appreciate it.
spk05: Thanks, Mark.
spk04: The next question is from Kyle White of Deutsche Bank. Please go ahead.
spk11: Hey, good morning. Thanks for taking the question. On the Groupo Gandhi acquisition, are you able to give us any kind of level of what you think EPS accretion will be for that acquisition as well as the free cash flow of that business?
spk05: So we haven't provided that information publicly. I'll sort of maybe help you get there. If you think about depreciation, depreciation going to be in the order of $70 million. The midpoint of the EBITDA is $205 million interest. Call it, make your assumption, 3.5% or so on $1 billion. And then a tax rate in line with ours. That should sort of help you do the math. we are going to be subject to normal purchase accounting adjustments. The biggest one of those will likely be the step up in inventory, but we'll back that out of our adjusted results. So hopefully that helps you get there.
spk11: Yeah, that's very helpful. And then on inventories and corrugated packaging in the container board business, can you just talk about inventory levels and where you are versus where you would like? And then also, we've seen other manufacturers Choosing to carry more inventory in this challenging supply chain environment, is that something you're looking to do as well here?
spk01: Well, we see inventories on the corrugated side about where we want to be as we head into fourth quarter. So we're feeling pretty good about that. We don't think one way or the other it's anything material. We like the position we're at with inventory.
spk05: I will say, just to pile on a little bit, if you were to look at the balance sheet, you'd see inventory levels a bit higher. That's one of the reasons that the cash flow number is where it is. That's probably the predominant reason why the cash flow number is where it is. That's actually deliberate. As you know, when we go into the first calendar year quarter, we typically, that's our highest maintenance outage quarter, and so we typically build inventory in anticipation of that cycle.
spk01: Got it. I'll turn it over. Thanks, Kyle.
spk04: The next question is from Mark Wilde of BMO. Please go ahead.
spk06: Thanks. Good morning, David. Good morning, Alex. Morning, Mark. Morning. David, I wonder just to start, can you talk about any impact that you see at this point from the strength in the dollar? And I'm thinking particularly is that would impact both export volumes and export pricing?
spk01: Yeah, it's a good question, Mark. We're watching it closely. And, you know, from a FX standpoint in Q3, it was really not material for us. You know, there's a lot going on in Europe right now. And we're really pleasantly surprised with our European business. It's been very resilient. You know, there's growth there. And so, you know, we're watching it closely in Q4. I think we have it down $11 million in Q4. It does, it could have a play on the export markets both ways. So, we're watching it closely. But, you know, energy prices is also mitigating some of that. you know, from European manufacturing. So we're not at a point where it's materially affecting us. We actually are really pleasantly surprised with how resilient our European business has been, the margins of that business. It's something we're keeping an eye on, but nothing overly materialistic.
spk05: Maybe, Mark, just a few points I'll make that are additive. If you think David mentioned the $11 million in Q4, if you look at that on an annualized basis, it's in the zip code of, call it, $20, $25 million. So again, to David's point, not particularly material. As you see offsets in the euro, you see gains, or we have seen gains in the AI from Brazil, so sort of a a bit of a natural hedge, at least the way currency movements are happening now. The only other point I'd make, which might be on people's minds, is our increased exposure now to the Mexican peso. I think it's important just to point out for the folks on the call that about 40% of Gandhi's earnings are denominated in U.S. dollars. So that exposure is not as significant as it might appear on the surface of things.
spk06: Okay. All right. Well, I agree that this – the currency impact could be significantly impacted or offset by what we're seeing in gas. I guess the other question I had, more for Alex, is just an update on kind of the asset sale process and also, you know, whether this is being delayed at all by kind of the turmoil that we see in the debt markets.
spk05: Yeah, so I don't know. I'll I don't know that we have an update on a dramatic portfolio action beyond what we've announced with Panama City. And with Panama City, we are opportunistically pursuing liquidation of those assets where we can. The city has been interested in purchasing the land for industrial redevelopment. Obviously, some of the equipment we can repurpose and sell. So that actually is going quite well. on sort of the more strategic actions, and David can layer on here. We're not going to comment on anything that may or may not be contemplated or in flight. I will tell you that, you know, the market remains active. So there's certain portions of the market that are more challenging because of, you know, the high-yield market and everything that's going on in the high-yield market. But the bank market's you know, open for people with attractive credit. And certainly the strategic market, there's a lot of interesting things happening strategically. But David can layer on top if he has anything.
spk01: No, I think you answered it well. Okay.
spk06: Sounds good. That's it for me.
spk01: Thanks. Appreciate it.
spk04: Okay. And if you have a question, please press star, then 1. The next question is from Adam Josephson of KeyBank. Please go ahead.
spk07: David and Alex, good morning. Thanks very much for taking my questions. On container board versus box board, with the Gandhi acquisition, perhaps this is for Alex, can you help me with what your pro forma sales or EBITDA exposure is now, container board versus box board? And just given your commentary about your record backlogs in consumer versus the deceleration that you're seeing in corrugated, I would think that your view on consumer might be more favorable than that on container board. But by your actions, it seems that that's not necessarily the case. So can you tell me how you're thinking about those two businesses as distinct from each other? Is one more attractive to you than the other? And if not, why not?
spk01: Maybe I'll jump in first and then Alex. And a couple of things to keep in mind on Gandhi. Gandhi does have CRB, so keep that in mind. If you look at Gandhi's profile, it's only a little bit over 50% that's in the corrugated space. So there's a diversification in Mexico. And the way that customers work, you know, we've got great exposure to them over the past several years with our relationship. There is a, I mean, when we talk about connectivity and enterprise between corrugated consumer high graphics, which is how it's kind of referred to in Mexico, that connectivity is huge. And so that is one of the other reasons why it's such an attractive market. It goes to our diversification. And the other thing that Gandhi does, which fits very well how we think about things and optimizing our assets, you know, several of their plants are hybrid plants. Well, they'll do corrugated and consumer in the same plant. It lowers their cost basis. It services customers very well. So there's a great diversification in Gandhi, and so that's why we think it fits so well into our portfolio.
spk05: Yeah, maybe just a couple other things to pile on. The first is, I think somebody asked this question earlier. So Gandhi is around 80%, 85% integrated. So it does help with the level of vertical integration. I think also David mentioned the Monterey mill. I think it's important to point out, you know, that's about a 440,000 ton mill with costs, you know, below $300 a ton. So it's really a world-class asset and it does enable us to take other actions on further optimizing the portfolio to the extent we have mills that aren't operating at those levels in the North American footprint. So there is In addition to the synergy David mentioned in Latin America, there's enormous synergy in North America as well.
spk01: Yeah, and I appreciate it. Go ahead. I apologize. Go right ahead.
spk07: Okay. Sorry to interrupt. Just a related question is just, again, it seems like consumer is going from strength to strength for you and for the industry right now where backlogs are at historically high levels. You're experiencing demand growth there. Corrugated is quite a bit different, and everyone knows about the weakness that is happening domestically and globally. Historically, Kraft Paper, Container Board, Box Board have moved roughly in line with one another. Just look at a historical price chart as an example, and it seems as though there's a major divergence happening now in the sense that Container Board and Kraft Paper are weakening with the economy, yet Box Board isn't somehow. Would you expect that divergence to persist if the economy gets weaker? Or how do you think about the relationship among those grades in a recession or in any economic environment for that matter?
spk01: Adam, I think it's a good point. The first thing I would say is what's why we love our model. We really like the courteous side of our business in addition to the consumer side. And as market conditions change and different cycles come on, we're able to pull a lot of different levers together. to take advantage globally of what's happening in the market. I would say if you look historically that consumer kind of volume trends tend to follow corrugated, but I think there's a couple of dynamics happening. Plastics replacement is very real. Alex mentioned earlier in prepared remarks our continued growth in plastics replacement. The other piece is we're really seeing customers value our enterprise sales aspects of our business. So I think that's why you're seeing that, and that's why corrugated is really an important part of what's happening. And I think once this inventory rebalancing kind of comes to fruition and stabilizes, we feel great about the corrugated business and the model that we have between both consumer and corrugated. And on craft paper, again, plastics replacement continues on the craft paper side. And that market we see is very fruitful in the future as well. Thanks a lot, David. Thank you.
spk04: The next question is from Cleve Rueckert of UBS. Please go ahead.
spk09: Hey, good morning, everybody. Thanks for taking my questions. Just a couple of follow-ups, really, from me. There's been a lot of discussion about Gandhi and about integration. I'm just wondering if you could tell us what level of integration you'll have, you know, at the corporate level after that is closed. And then just sort of, you know, I guess building on that, given the strength you're seeing in the paper segment, you know, I think it's quite impressive to all of us on the call. Is, you know, is increasing integration still kind of a, is that a strategic priority at this point?
spk01: Really, really good question. Appreciate it. I would answer the first part of your question with Gandhi. Our vertical integration on the corrugated side of our business will be at about 80%. Obviously, we've talked about on the consumer side closer to 50%. And I think because the way we've pulled out our global paper business to the second part of your question, We just love the flexibility in our mills and the global paper business to balance where we can bring the most value. And we saw that in Q3. So how we think about it is we're going to actively manage the business to take advantage of the market conditions. We absolutely do not want to be 100% vertically integrated. We think that limits us, and we think we can bring more value. Being diverse and being open to the merchant market Customers truly value that we have all of the substrates that we can provide them for their solutions. And so our ability to flex manufacture, our ability to flex where the growth in the markets are allows us to maximize return for the shareholder. Now, having said that, if we see things on the horizon where we want to tighten our integration, We can do that. We've made a couple of moves. We did the Panama City Mill. We are doing a greenfield on Longview. That will tighten some of it. So we're going to continue to run our business that maximizes the most value for our shareholders.
spk09: Got it. That's well said. And then, David, just following up on a comment you made earlier, you know, talking about paperboard. You said you like paperboard. And I think if I caught it correctly, you said you could sell more if you could make more. I'm just wondering if you could expand on that a little bit and maybe give us – is that focused on certain grades, certain markets, certain regions? I'd appreciate a little bit more color there if you could.
spk01: Yeah. The answer is yes. We're seeing it across all of our substrates. We just have a very strong backlog there. And I would just go back because I think the historic thinking of just, you know, typical core growth in this segment has the fundamentals have changed. The growth we're getting in plastics replacement is significant. Our new product innovation backlog is significant in plastics replacement. You tie that with our machinery and automation business, with our enterprise capability, And so we're just seeing an increase in demand, and it's truly organic. So I think we're growing the market size in this segment. Got it. Appreciate it. Thank you very much. Thank you.
spk04: The next question is from Gabe Hatch of Wells Fargo. Please go ahead.
spk08: David, Alex, good morning. Thanks for taking this question. I wanted to dial in a little bit on free cash flow. Obviously, you guys kind of trimmed a little bit, I guess, the top line, but also free cash flow coming in by about $100 million or so. Can you maybe quantify for us what the working capital drag might be this year, and does it in any way relate to some of the accelerated, I guess, maintenance downtime that you talked about? into fiscal Q4, and then I guess if we were to hold things constant, which we know is not realistic, would you say that next year you'd anticipate another working capital build, or should it be more neutral to cash flow?
spk05: No, so I'll just sort of help Bridget for you year over year. The biggest driver of the free cash flow headwind is really the the inventory that I mentioned. So we had the build and inventory in Q3. That really is what explains it. There was also slightly higher cash taxes. So those were really the two, kind of the two biggest things. You shouldn't expect that to be a continued headwind. I think we normally have that sort of working capital volatility. We talked last quarter a bit about some... some underperformance on the accounts receivable side linked to a lot of the pricing actions and customers' response to a lot of the pricing actions. A lot of that is behind us now, so our AR performance is pretty good. Our AP performance is pretty good. So just to dimensionalize it for the quarter, the combination of cash tax and inventory explains about $140 million headwind against about $194 million tailwind in higher results. So that kind of gets you there. Obviously, EBITDA is the biggest driver of where cash flow lands. And you'll see, I don't know if we said it in the remarks, but we did – Our CapEx forecast for the year is in the order now of about $900 million. So does that help?
spk08: It does. That was actually going to be my follow-up on CapEx. It looked like it was tracking a little bit behind, and I suspect maybe some of that's supply chain related. Does that kind of push into 23, or are those projects maybe being reconsidered at this point?
spk05: No, you hit the nail on the head. A lot of the CapEx – issues are related to basically the deployment of the capital because, you know, it's taking longer to get crews, it's taking longer to get machines, all of those sorts of things. We do expect 2023, and again, we're not guiding to 2023, but we do, you know, expect to stay within the diet that we articulated in Investor Day, you know, between $900 and a billion of kind of base-level CapEx with an incremental $200 to $500 million of strategic opportunity.
spk08: Thank you, Alex. If I could squeeze one last one in, and this is really kind of presentation semantics, but when I look at your kind of year-over-year bridges and you present, you know, price mix inflation and op costs, given the fact that you guys are going to be delivering a lot of this $1.5 billion in terms of productivity savings, should we expect to see kind of a discrete line item for that so we can kind of hold you accountable, I guess? Or will that kind of simply show up in op costs where we've got non-material inflation offset by this productivity bucket? Thank you.
spk05: Yeah, so yes, we will be as transparent as we can around how the performance transformation is developing. And I think we started that today when we pointed to the $250 million of sort of opportunities that were already actioning against the $1.5 billion of self-help Where you would find that in the bridges is within that operating cost chunk. I don't think we're going to undertake to say, you know, X percent of that is procurement related, Y percent of that is SG&A related. You know, we're not going to get to that level of granularity, but you certainly should be able to track it through the productivity and operating expense bridges.
spk01: Yeah, and the only other thing I would add to that is you will also see the benefits of that in overall segment margins. So, you know, as we brought consumer and MPS together, there was a lot of optimization from an SG&A standpoint on our mills, on our productivity. You know, you see a lot of that in our paper margins, and that's why we feel really good about the direction where we're going on our margin enhancements. We're probably a little further along on consumer and the mills and corrugated. We feel really good about the transformation opportunities there that are going to be coming. And we will share those with you as we continue quarter over quarter.
spk08: Thank you again.
spk01: Thanks.
spk04: This concludes our question and answer session. I would like to turn the conference back over to Rob Cortaro for closing remarks.
spk02: Great. Thank you very much. Thank you, everybody, for joining the call today. As usual, James and I will be available if you have any additional questions. And we look forward to updating you again next quarter.
spk04: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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