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GPK > SEC Filings for GPK > Form 10-Q on 30-Oct-2013All Recent SEC Filings

Show all filings for GRAPHIC PACKAGING HOLDING CO | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for GRAPHIC PACKAGING HOLDING CO


30-Oct-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTRODUCTION

This management's discussion and analysis of financial conditions and results of operations is intended to provide investors with an understanding of the Company's past performance, financial condition and prospects. The following will be discussed and analyzed:

Overview of Business

Overview of 2013 Results

Results of Operations

Financial Condition, Liquidity and Capital Resources

Critical Accounting Policies

New Accounting Standards

Business Outlook

OVERVIEW OF BUSINESS

The Company's objective is to strengthen its position as a leading provider of packaging solutions. To achieve this objective, the Company offers customers its paperboard, cartons and packaging machines, either as an integrated solution or separately. Cartons and carriers are designed to protect and contain products. Product offerings include a variety of laminated, coated and printed packaging structures that are produced from the Company's coated unbleached kraft ("CUK"), coated-recycled board ("CRB") and uncoated-recycled board("URB"), as well as other grades of paperboard that are purchased from third party suppliers. Innovative designs and combinations of paperboard, films, foils, metallization, holographics and embossing are customized to the individual needs of the customers. The Company's label business focuses on two product lines: heat transfer labels and lithographic labels.

The Company is a leading supplier of flexible packaging in North America. Products include multi-wall bags, shingle wrap, plastic bags and film for building materials (such as ready-mix concrete), retort pouches (such as meals ready to go), medical test kits, batch inclusion bags and film. Key end-markets include food and agriculture, building and industrial materials, chemicals, minerals, pet foods, and pharmaceutical products.

The Company is implementing strategies (i) to expand market share in its current markets and to identify and penetrate new markets; (ii) to capitalize on the Company's customer relationships, business competencies, and mills and converting assets; (iii) to develop and market innovative, sustainable products and applications; and (iv) to continue to reduce costs by focusing on operational improvements. The Company's ability to fully implement its strategies and achieve its objectives may be influenced by a variety of factors, many of which are beyond its control, such as inflation of raw material and other costs, which the Company cannot always pass through to its customers, and the effect of overcapacity in the worldwide paperboard packaging industry.

Significant Factors That Impact The Company's Business

Impact of Inflation. The Company's cost of sales consists primarily of energy (including natural gas, fuel oil and electricity), pine pulpwood, chemicals, recycled fibers, purchased paperboard, paper, aluminum foil, ink, plastic films and resins, depreciation expense and labor. Inflation increased costs in the first nine months of 2013 by $31.1 million, compared to the first nine months of 2012. The higher costs in 2013 are related to energy costs ($13.2 million) primarily due to the price of natural gas, labor and related benefits ($5.4 million), wood costs ($5.0 million), freight ($3.2 million), corrugated cases ($2.7 million), resin ($0.6 million), and other costs ($6.2 million). These higher costs were partially offset by lower secondary fiber ($3.1 million) and ink and coating ($2.1 million).

The Company has entered into contracts designed to manage risks associated with future variability in cash flows caused by changes in the price of natural gas. The Company has entered into natural gas swap contracts to hedge prices for a portion of its expected usage for the remainder of 2013 and 2014. Since negotiated sales contracts and the market largely determine the pricing for its products, the Company is at times limited in its ability to raise prices and pass through to its customers any inflationary or other cost increases that the Company may incur.

Commitment to Cost Reduction. In light of increasing margin pressure throughout the packaging industry, the Company has programs in place that are designed to reduce costs, improve productivity and increase profitability. The Company utilizes a global continuous improvement initiative that uses statistical process control to help design and manage many types of activities, including production and maintenance. This includes a Six Sigma process focused on reducing variable and fixed manufacturing and administrative costs. The Company expanded the continuous improvement initiative to include the deployment of Lean Sigma principles into manufacturing and supply chain services. As the Company strengthens the systems approach to continuous improvement, Lean Sigma supports the efforts to build a high performing culture. During the first nine months of 2013, the Company achieved approximately $45 million in incremental cost savings as compared to the first nine months of 2012, through its continuous improvement programs and manufacturing initiatives.

The Company's ability to continue to successfully implement its business strategies and to realize anticipated savings and operating efficiencies is subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the


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Company's control. If the Company cannot successfully implement the strategic cost reductions or other cost savings plans it may not be able to continue to compete successfully against other manufacturers. In addition, any failure to generate the anticipated efficiencies and savings could adversely affect the Company's financial results.

Competition and Market Factors. As some products can be packaged in different types of materials, the Company's sales are affected by competition from other manufacturers' CUK board and other substrates such as solid bleached sulfate and recycled clay-coated news. Substitute products also include plastic, shrink film and corrugated containers. In addition, while the Company has long-term relationships with many of its customers, the underlying contracts may be re-bid or renegotiated from time to time, and the Company may not be successful in renewing on favorable terms or at all. The Company works to maintain market share through efficiency, product innovation and strategic sourcing to its customers; however, pricing and other competitive pressures may occasionally result in the loss of a customer relationship.

In addition, the Company's sales historically are driven by consumer buying habits in the markets its customers serve. Increases in the costs of living, the condition of the residential real estate market, unemployment rates, access to credit markets, as well as other macroeconomic factors, may significantly negatively affect consumer spending behavior, which could have a material adverse effect on demand for the Company's products. New product introductions and promotional activity by the Company's customers and the Company's introduction of new packaging products also impact its sales. The Company's containerboard business is subject to conditions in the cyclical worldwide commodity paperboard markets, which have a significant impact on containerboard sales.

Debt Obligations. The Company had $2,232.8 million of outstanding debt obligations as of September 30, 2013. This debt can have consequences for the Company, as it requires a portion of cash flow from operations to be used for the payment of principal and interest, exposes the Company to the risk of increased interest rates and restricts the Company's ability to obtain additional financing. Covenants in the Credit Agreement and the Indenture also prohibits or restricts, among other things, the disposal of assets, the incurrence of additional indebtedness (including guarantees), payment of dividends, loans or advances, and certain other types of transactions. These restrictions could limit the Company's flexibility to respond to changing market conditions and competitive pressures. The Credit Agreement also requires compliance with a maximum Consolidated Total Leverage Ratio and a minimum Consolidated Interest Coverage Ratio. The Company's ability to comply in future periods with these financial covenants will depend on its ongoing financial and operating performance, which in turn will be subject to many other factors, many of which are beyond the Company's control. See "Financial Condition, Liquidity and Capital Resources - Liquidity and Capital Resources" for additional information regarding the Company's debt obligations.

The debt and the restrictions under the Credit Agreement and the Indenture could limit the Company's flexibility to respond to changing market conditions and competitive pressures. The outstanding debt obligations and the restrictions may also leave the Company more vulnerable to a downturn in general economic conditions or its business, or unable to carry out capital expenditures that are necessary or important to its growth strategy and productivity improvement programs.

OVERVIEW OF 2013 RESULTS

This management's discussion and analysis contains an analysis of Net Sales, Income from Operations and other information relevant to an understanding of results of operations.

Net Sales for the three months ended September 30, 2013 increased by $58.3 million, or 5.3%, to $1,163.0 million from $1,104.7 million for the three months ended September 30, 2012 primarily due to higher volume due to the European Acquisitions completed in the fourth quarter of 2012 and new consumer product business and open market sales. This increase was partially offset by lower volume in flexible packaging due to continued general market softness and the internalization of paper, lower global beverage sales, lower pricing and unfavorable exchange rates primarily in Japan.

Income from Operations for the three months ended September 30, 2013 increased to $105.7 million from Income from Operations of $91.4 million for the three months ended September 30, 2012. The increase was driven primarily by the gain on the sale of the flexible plastics business and improved performance due to cost savings through continous improvement programs and other strategic initiatives. These increases were partially offset by higher inflation primarily for secondary fiber and labor and benefits, the unfavorable exchange rates and the lower pricing.

During the third quarter of 2013, certain shareholders of the Company sold 15 million shares of common stock in a secondary public offering at $8.45 per share. The shares were sold by certain affiliates of TPG Capital, L.P. (the "TPG Entities"), certain Coors family trusts (the "Coors Family Trusts"), Clayton, Dubilier & Rice Fund V Limited Partnership (the "CD&R Fund") and Old Town, S.A. ("Old Town"). The shares outstanding held by the selling stockholders in this offering decreased from approximately 39% to approximately 35%.

On September 30, 2013, the Company completed the sale of certain assets related to the flexible plastics business and the sale of its URB mill. The Company had previously announced the closure of its Brampton, Ontario facility which was also part of the flexible plastics business.


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RESULTS OF OPERATIONS

Segment Information

The Company reports its results in two reportable segments: paperboard packaging
and flexible packaging.

                                  Three Months Ended           Nine Months Ended
                                     September 30,               September 30,
In millions                       2013          2012          2013          2012
NET SALES:
Paperboard Packaging           $   996.3     $   929.0     $ 2,904.5     $ 2,740.4
Flexible Packaging                 166.7         175.7         498.7         543.4
Total                          $ 1,163.0     $ 1,104.7     $ 3,403.2     $ 3,283.8

INCOME (LOSS) FROM OPERATIONS:
Paperboard Packaging           $   109.1     $   115.3     $   316.2     $   325.4
Flexible Packaging                   8.8          (9.4 )         3.6         (18.3 )
Corporate                          (12.2 )       (14.5 )       (41.2 )       (48.0 )
Total                          $   105.7     $    91.4     $   278.6     $   259.1

THIRD QUARTER 2013 COMPARED WITH THIRD QUARTER 2012

Net Sales

                                   Three Months Ended September 30,
                                                                          Percent
In millions             2013          2012        Increase (Decrease)      Change
Paperboard Packaging $    996.3    $   929.0    $             67.3          7.2  %
Flexible Packaging        166.7        175.7                  (9.0 )       (5.1 )%
Total                $  1,163.0    $ 1,104.7    $             58.3          5.3  %

The components of the change in Net Sales by segment are as follows:

                                          Three Months Ended September 30,
                                                     Variances
In millions             2012       Price      Volume/Mix     Exchange      Total        2013
Paperboard Packaging $   929.0    $ (5.9 )   $     79.3     $    (6.1 )   $ 67.3     $   996.3
Flexible Packaging       175.7       0.7           (9.3 )        (0.4 )     (9.0 )       166.7
Total                $ 1,104.7    $ (5.2 )   $     70.0     $    (6.5 )   $ 58.3     $ 1,163.0

Paperboard Packaging

The Company's Net Sales from paperboard packaging for the three months ended September 30, 2013 increased by $67.3 million, or 7.2%, to $996.3 million from $929.0 million for the same period in 2012 as a result of the European Acquisitions, new consumer product business and open market sales. This was partially offset by lower volume due to general market softness in global beverage and cereal businesses, lower pricing due to deflationary cost pass throughs and the impact of unfavorable exchange rates primarily in Japan.

Flexible Packaging

The Company's Net Sales from flexible packaging for the three months ended September 30, 2013 decreased by $9.0 million or 5.1%, to $166.7 million from $175.7 million for the same period in 2012 primarily due to lower volume and exchange. The decrease in volume was primarily a result of internalization as more paper was consumed internally. In addition, continued market softness in certain agriculture sectors and industrial sectors contributed to reduced volume. The decrease in volume was partially offset by higher pricing.


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Income (Loss) from Operations

                                  Three Months Ended September 30,
                                                                         Percent
In millions             2013         2012        Increase (Decrease)     Change
Paperboard Packaging $   109.1     $ 115.3     $             (6.2 )      (5.4)%
Flexible Packaging         8.8        (9.4 )                 18.2        N.M (a)
Corporate                (12.2 )     (14.5 )                  2.3        N.M (a)
Total                $   105.7     $  91.4     $             14.3         15.6%

(a) Percentage is not meaningful.

The components of the change in Income (Loss) from Operations by segment are as follows:

                                                           Three Months Ended September 30,
                                                                      Variances
In millions              2012       Price       Volume/Mix      Inflation      Exchange       Other(a)      Total       2013
Paperboard Packaging   $ 115.3     $ (5.9 )   $        0.1     $     (8.7 )   $    (4.4 )   $     12.7     $ (6.2 )   $ 109.1
Flexible Packaging        (9.4 )      0.7              1.2           (6.0 )        (1.0 )         23.3       18.2         8.8
Corporate                (14.5 )        -                -            0.4           0.4            1.5        2.3       (12.2 )
Total                  $  91.4     $ (5.2 )   $        1.3     $    (14.3 )   $    (5.0 )   $     37.5     $ 14.3     $ 105.7

(a) Includes the Company's cost reduction initiatives, expenses related to integration activities, and the gain on the sale of assets and shutdown costs.

Paperboard Packaging

The Company's Income from Operations from paperboard packaging for the three months ended September 30, 2013 decreased by $6.2 million, or 5.4%, to $109.1 million from $115.3 million for the same period in 2012 as a result of the lower pricing, inflation in certain commodities, integration related expenses, and unfavorable currency exchange rates, primarily in Japan. These decreases were partially offset by cost savings through continuous improvement programs and other strategic initiatives and the volume from the European Acquisitions. The inflation was primarily related to higher energy ($5.3 million), corrugated cases ($1.3 million), labor and benefits ($1.2 million), freight ($0.6 million), wood ($0.5 million) and other costs ($1.7 million). These higher costs were partially offset by lower chemical-based inputs ($1.9 million).

Flexible Packaging

The Company's Income from Operations from flexible packaging for the three months ended September 30, 2013 was $8.8 million compared to Loss from Operations of $9.4 million for the same period in 2012 as a result of the gain on the sale of the flexible plastics business and improved performance due to synergies and cost savings programs and the improved pricing. The improvements were partially offset by inflation and shutdown costs related to the closure of the facility in Brampton, Ontario. The inflation was related to labor and benefits, and resin. During the quarter, there was improvement in the productivity at the New Philadelphia, OH converting facility.

Corporate

The Company's Loss from Operations from corporate for the three months ended September 30, 2013 was $12.2 million compared to $14.5 million for the same period in 2012 primarily as a result of lower incentive compensation.


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FIRST NINE MONTHS 2013 COMPARED WITH FIRST NINE MONTHS 2012

Net Sales

                                   Nine Months Ended September 30,
                                                                        Percent
In millions             2013         2012       Increase (Decrease)      Change
Paperboard Packaging $ 2,904.5    $ 2,740.4    $            164.1         6.0  %
Flexible Packaging       498.7        543.4                 (44.7 )      (8.2 )%
Total                $ 3,403.2    $ 3,283.8    $            119.4         3.6  %

The components of the change in Net Sales by segment are as follows:

                                           Nine Months Ended September 30,
                                                      Variances
In millions             2012        Price      Volume/Mix      Exchange      Total        2013
Paperboard Packaging $ 2,740.4    $ (24.6 )   $     203.9     $  (15.2 )   $ 164.1     $ 2,904.5
Flexible Packaging       543.4       (1.2 )         (42.8 )       (0.7 )     (44.7 )       498.7
Total                $ 3,283.8    $ (25.8 )   $     161.1     $  (15.9 )   $ 119.4     $ 3,403.2

Paperboard Packaging

The Company's Net Sales from paperboard packaging for the first nine months of 2013 increased by $164.1 million, or 6.0%, to $2,904.5 million from $2,740.4 million for the same period in 2012 as a result of the European Acquisitions, new consumer product introductions and open market sales. These increases were partially offset by lower volume due to general market softness in global beverage and cereal, lower pricing due to deflationary cost pass throughs and the impact of unfavorable exchange rates primarily in Japan.

Flexible Packaging

The Company's Net Sales from flexible packaging for the first nine months of 2013 decreased by $44.7 million, or 8.2%, to $498.7 million from $543.4 million for the same period in 2012 primarily as a result of higher internalization of board. In addition, there was lower organic volume/mix due to market softness in certain agriculture sectors, construction and other industrial sectors.

Income (Loss) from Operations

                                     Nine Months Ended September 30,
In millions            2013        2012        Increase (Decrease)     Percent Change
Paperboard Packaging $ 316.2     $ 325.4     $             (9.2 )          (2.8)%
Flexible Packaging       3.6       (18.3 )                 21.9           N.M. (a)
Corporate              (41.2 )     (48.0 )                  6.8           N.M. (a)
Total                $ 278.6     $ 259.1     $             19.5             7.5%

(a) Percentage is not meaningful.


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The components of the change in Income (Loss) from Operations by segment are as follows:

                                                         Nine Months Ended September 30,
                                                                    Variances
In millions            2012        Price      Volume/Mix     Inflation      Exchange       Other(a)       Total       2013
Paperboard Packaging $ 325.4     $ (24.6 )   $     (7.1 )   $    (18.4 )   $    (7.9 )   $     48.8     $  (9.2 )   $ 316.2
Flexible Packaging     (18.3 )      (1.2 )          1.1          (13.6 )        (1.4 )         37.0        21.9         3.6
Corporate              (48.0 )         -              -            0.9           1.0            4.9         6.8       (41.2 )
Total                $ 259.1     $ (25.8 )   $     (6.0 )   $    (31.1 )   $    (8.3 )   $     90.7     $  19.5     $ 278.6

Note:

(a) Includes the Company's cost reduction initiatives, expenses related to integration activities, and the gain on the sale of assets and shutdown costs.

Paperboard Packaging

The Company's Income from Operations from paperboard packaging for the first nine months of 2013 decreased by $9.2 million, or 2.8%, to $316.2 million from $325.4 million for the same period in 2012 as a result of the lower pricing due to deflationary cost pass throughs, higher inflation, integration related expenses, and unfavorable currency exchange rates. These decreases were partially offset by the European Acquisitions. The inflation was primarily related to higher energy costs ($12.8 million), mainly due to the price of natural gas, wood ($4.8 million), freight ($2.7 million), corrugated cases ($2.7 million) and labor and benefits ($2.4 million). These higher costs were partially offset by lower secondary fiber ($3.6 million), inks & coatings ($1.8 million), externally purchased board ($0.9 million) and other costs ($0.7 million).

Flexible Packaging

The Company's Income from Operations from flexible packaging for the first nine months of 2013 was $3.6 million, compared to Loss from Operations of $18.3 million for the same period in 2012 as a result of the gain on the sale of the flexible plastics business and improved performance due to synergies and cost saving programs. These increases were offset by inflation, shutdown costs in Brampton, higher production costs at New Philadelphia, OH and the lower pricing. The inflation was related to externally purchased paper ($6.3 million), labor and benefits ($4.0 million), resin ($0.7 million), freight ($0.5 million), secondary fiber ($0.5 million) and other costs ($1.6 million).

Corporate

The Company's Loss from Operations from corporate for the nine months of 2013 was $41.2 million compared to $48.0 million for the same period in 2012. The change was primarily due to lower incentive compensation and outside consulting.

INTEREST EXPENSE, NET AND INCOME TAX EXPENSE

Interest Expense, Net

Interest Expense, Net was $80.4 million and $85.6 million for the first nine months of 2013 and 2012, respectively. Interest Expense, Net decreased due to lower average interest rates on the Company's debt. As of September 30, 2013, approximately 44% of the Company's total debt was subject to floating interest rates.

Income Tax Expense

During the three months and nine months ended September 30, 2013, the Company recognized Income Tax Expense of $35.8 million and $70.9 million on Income before Income Taxes and Equity Income of Unconsolidated Entities of $81.0 million and $171.1 million, respectively. The effective tax rate for the nine months ended September 30, 2013 was different than the statutory rate primarily due to the mix and levels between foreign and domestic earnings including losses in jurisdictions with full valuation allowances, as well as the effects of certain discrete tax items. During the three months and nine months ended September 30, 2012, the Company recognized Income Tax Expense of $27.0 million and $68.6 million on Income before Income Taxes and Equity Income of Unconsolidated Entities of $65.3 million and $164.6 million, respectively. The effective tax rate for the nine months ended September 30, 2012 was different than the statutory rate primarily due to the mix and levels between foreign and domestic earnings, including losses in jurisdictions with full valuation allowances, as well as the effects of certain discrete tax items. The Company has approximately $766 million of Net Operating Losses ("NOLs") for U.S. federal income tax purposes, which are currently being used and may be used to offset future taxable income.


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FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

The Company broadly defines liquidity as its ability to generate sufficient funds from both internal and external sources to meet its obligations and commitments. In addition, liquidity includes the ability to obtain appropriate debt and equity financing and to convert into cash those assets that are no longer required to meet existing strategic and financial objectives. Therefore, liquidity cannot be considered separately from capital resources that consist of current or potentially available funds for use in achieving long-range business objectives and meeting debt service commitments.

Cash Flows
                                             Nine Months Ended
                                               September 30,
In millions                                  2013         2012
Net Cash Provided by Operating Activities $   269.5     $ 288.3
Net Cash Used in Investing Activities         (95.9 )    (114.2 )
Net Cash Used in Financing Activities        (131.5 )    (410.7 )

Net cash provided by operating activities for the first nine months of 2013 totaled $269.5 million, compared to $288.3 million for the same period in 2012. . . .

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