Alex Ovshey - Graphic Packaging Holding Co. Michael P. Doss - Graphic Packaging Holding Co. Stephen R. Scherger - Graphic Packaging Holding Co..

George Leon Staphos - Bank of America Merrill Lynch Mark William Wilde - BMO Capital Markets (United States) Ashish Gupta - Stephens, Inc. Anthony Pettinari - Citigroup Global Markets, Inc. Ghansham Panjabi - Robert W. Baird & Co., Inc. Chip Dillon - Vertical Research Partners LLC Brian Maguire - Goldman Sachs & Co. LLC Debbie A.

Jones - Deutsche Bank Securities, Inc. Tom Narayan - RBC Capital Markets LLC Adam Jesse Josephson - KeyBanc Capital Markets, Inc. Gail Glazerman - Roe Equity Research LLC.

Good morning. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Graphic Packaging quarterly earnings conference call. Alex Ovshey, Vice President, Investor Relations of Graphic Packaging, you may begin your conference..

Thanks, Denise. Good morning and welcome to Graphic Packaging Holding Company's conference call to discuss our fourth quarter and full year 2017 results. Speaking on the call will be Mike Doss, the company's President and CEO, and Steve Scherger, Senior Vice President and CFO.

To help you follow along with today's call, we have provided a slide presentation which can be accessed by clicking on the webcast and presentations link on the Investors section of our website at www.graphicpkg.com.

I would like to remind everyone that statements of our expectations, plans, estimates and beliefs regarding future performance and events constitute forward-looking statements.

Such statements are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the company's present expectations. Information regarding these risks and uncertainties is contained in the company's periodic filings with the Securities and Exchange Commission.

Undue reliance should not be placed on forward-looking statements as such statements speak only as of the date on which they are made and the company undertakes no obligation to update such statements except as required by law. Mike, I'll turn it over to you..

Thank you, Alex. Good morning and thank you for joining us to discuss our fourth quarter and full year 2017 results. Fourth quarter adjusted EBITDA met our expectations at $192 million compared to $175 million in the prior year period. Net tons sold were up 1.9% driven by acquisitions and the continuation of modestly positive core volume.

Solid productivity, the benefits of acquisitions and positive core volume were partially offset by higher commodity input costs. While recycled fiber costs moderated significantly during the quarter, we incurred escalating logistics and chemical input costs.

We remain focused on offsetting our commodity input cost inflation with pricing initiatives over time. Full year 2017 adjusted EBITDA was down 6.8% as the benefits from acquisitions, modestly positive core volume and productivity were offset by significantly higher commodity input costs and lower pricing.

In 2017, our pricing to commodity input cost relationship was a $98 million headwind reflecting lower pricing and significant commodity input cost inflation. Pricing was negatively impacted by 2016 reductions in the RISI CRB price index partially offset by the realization of our CUK and CRB price increases in 2017.

Commodity input costs were significantly impacted by escalating recycled fiber costs in the first three quarters of 2017 and higher logistics and chemical input costs in the second half of the year. We remain committed to recovering our negative pricing to commodity input cost relationship which impacted the 2017 results.

The recently announced price increases for CRB, CUK and SBS are an important step in the recovery process. The supply/demand dynamics across our paperboard grades are healthy. In 2017, the AF&PA [American Forest & Paper Association] reported the average industry operating rate for CRB was 95% and for CUK and SBS, it was 96%.

Cash flow was solid as we generated $365 million in 2017. Our focus on growing our cash flow and allocating it effectively is unchanged. We continue to make progress on all our key strategic capital allocation priorities.

Before I discuss the progress we're making across our key strategic priorities and the details of the quarter, I would like to provide high level 2018 financial guidance. We closed the transformative combination with International Paper's North America Consumer Packaging business on January 1.

And our 2018 guidance reflects the expected full-year benefits from the transaction. We expect to generate approximately $1 billion of EBITDA in 2018. Steve will provide more details in his remarks.

But our 2018 guidance reflects $235 million of EBITDA from the IP transaction including the first year synergies, a relatively neutral pricing to commodity input cost relationship, strong productivity and the benefits of three tuck-under acquisitions we completed in 2017.

We expect 2018 cash flow to increase significantly to approximately $475 million. Now let me provide more detail on the key operational trends from the fourth quarter and discuss our three strategic capital allocation priorities and how we executed CSM in 2017.

Core organic volume in our global paperboard business was up 0.7% in the fourth quarter and has been positive for three consecutive quarters. Our core organic volume was up 0.5% for the full year in 2017 outperforming the market trends as reported by A.C. Nielsen, reflecting the continued success of our new product development pipeline.

Our global beverage market remained relatively healthy in the fourth quarter. Our global volume was up low single digits in the quarter and for the full year despite the softness in the North American mega beer market.

As we've discussed in the past, we expect our new product development efforts to drive about 100 basis points of organic volume growth per annum. Let me highlight one important new product commercialization in the quarter.

We have partnered with JBS Foods, one of the largest protein processors in the world, to introduce our patented microwavable tray and bowl technology, MicroRite into Brazil. As a reminder, the technology enables traditional oven-bake quality to be achieved in the microwave while maintaining reduced microwave cooking time.

The product is produced at our Wausau, Wisconsin, facility and is exported to Brazil. The product was launched in Brazil in late 2017 and will generate several million dollars of annualized revenue with significant potential for growth in 2019 and beyond. The tray and bowl both utilize our SBS paperboard. Turning to operations.

We closed our Santa Clara, California, coated recycled paperboard mill as planned on December 1, 2017. This action was enabled by strategic capital investments at our Midwest coated recycled paperboard mills as well as our West Monroe, Louisiana, and Macon, Georgia, coated unbleached craft paperboard mills over the last several years.

We have quickly and successfully integrated these mills into our West Coast supply chain. Our mills ran well and our backlogs improved to 5 plus weeks for CUK and CRB reflecting modestly improved demand and the closure of our Santa Clara mill.

As a reminder, our CUK and CRB mill operations are highly integrated with our converting platforms consuming approximately 86% of all the paperboard we produce for these grades. Shifting to performance. Continued emphasis on improvement initiatives, variable costs and operating efficiencies contributed the majority of the cost savings in the quarter.

We operated well and generated $24 million of net performance in the fourth quarter. We generated $57 million of net performance in 2017. Our performance was solid in 2017 but was negatively impacted by a significantly planned maintenance downtime at our West Monroe mill in Q1, the hurricanes in Q3 and the closure of Santa Clara in Q4. Moving to costs.

While recycled fiber input costs moderated significantly in the quarter, we incurred escalating logistics and chemical input costs. In 2017, we incurred $71 million of commodity input cost inflation. More than half the inflation was driven by higher recycled fiber input costs in the first three quarters of 2017.

The remaining was driven by higher logistics and chemical input costs which accelerated in the second half of the year. We expect to incur elevated logistics, chemical and resin input costs in 2018. As we've stated previously, we remain focused on offsetting our commodity input cost inflation with pricing over a reasonable timeframe.

We recently announced a $50 per ton price increase for our CRB, CUK and SBS to our open market paperboard customers, an important step in the process to recover and offset our commodity input cost inflation. I will now review our three strategic capital allocation priorities and how we executed against them in 2017.

Our first strategic priority is to reinvest in our business where we can generate compelling rates of return on capital projects across our mill and converting systems. We invested $260 million in capital expenditures in 2017, which will drive a significant portion of our 2018 productivity.

In the first quarter of 2017, we invested $40 million to upgrade two headboxes on our number six CUK paper machine in West Monroe, Louisiana. The project has lowered variable costs at the mill and has resulted in improved sheet quality, which is driving lower costs in our downstream converting operations.

Looking ahead to 2018, we expect our capital expenditures will be approximately $380 million. In 2018, we will install a curtain coater on the number two paper machine at our Macon, Georgia, CUK mill. We added a curtain coater on the Macon number one paper machine in 2016.

The curtain coater enables a significantly more efficient application of coating chemicals to the paperboard. As a result, we will continue to materially reduce our consumption of TiO2, the price of which has significantly escalated since 2016.

We expect to invest about $30 million in the project and generate approximately $10 million of EBITDA on an annualized basis. We will also invest about $30 million to rebuild a recovery boiler at the new Augusta, Georgia, SBS mill. This is an extensive project that was driven by the need to rebuild critical parts of the boiler.

The project will drive significantly improved reliability at the mill. The project will require approximately 40 days of planned maintenance downtime, which will take place in late October through the end of this year.

International Paper began the planning and engineering of this project in 2017, and we were fully aware of the investment when we were evaluating the combination. We will also continue to invest behind our food and beverage converting plants in 2018 to drive lower costs.

We will provide more details on those projects as we execute against our internal plans.

We expect the capital investments related to these projects will allow us to continue to deliver productivity benefits in the mid to high end of our targeted $60 million to $80 million range separate from the $25 million in synergies we will capture from the IP integration.

Our second strategic priority is to execute on acquisitions at post-synergy multiples that are well below our trading multiple. We had a busy second half of the year. We closed the Carton Craft, Norgraft, and Seydaco acquisitions.

The acquisitions we closed in 2017 met key strategic priorities we look for in potential opportunities, specifically an enhanced product, customer, and geographic profile and further run rate to reduce our costs. The integration of these acquisitions is on plan. We spent $203 million on these acquisitions in 2017.

And we estimate that we paid approximately 6.5 times forward EBITDA, taking into account the synergies we expect to achieve. Now let me briefly discuss our acquisition strategy in the context of the transformative combination with International Paper's North American Consumer Packaging business.

The combination creates a compelling platform for Graphic Packaging to grow in SBS foodservice and folding carton converting organically and through acquisitions.

Looking ahead to 2018, we see a solid pipeline of acquisition opportunities that will allow us to further integrate our SBS mills and increase our scale in SBS foodservice and folding carton converting. Our focus is on acquisition opportunities in North America and in Europe.

Our third strategic priority is to return capital to shareholders to drive long-term shareholder value. We returned $156 million in cash to shareholders in 2017 through $93 million in dividends and $62 million in share repurchases. And with that, I'll turn the call over to Steve Scherger, our Chief Financial Officer.

Steve?.

Thanks, Mike, and good morning. We reported fourth quarter earnings per share of $0.56 per diluted share, up compared to $0.11 in the fourth quarter of 2016. Fourth quarter 2017 net income was negatively impacted by an after-tax charge of $14.9 million for business combinations and other special charges.

The quarter was positively impacted by a $136 million benefit related to the Tax Cuts and Jobs Act 2017. The $136 million benefit is primarily related to a reduction in our deferred tax liability, reflecting the impact of the tax reform legislation.

When adjusting for these charges, adjusted net income for the fourth quarter was $52.8 million or $0.17 per diluted share. This compares to fourth quarter 2016 adjusted net income of $44.7 million or $0.14 per diluted share. For full year 2017, we reported earnings per share of $0.96 per diluted share, up compared to $0.71 in 2016.

Full year 2017 net income was negatively impacted by an after-tax charge of $32.5 million for business combinations and other special charges. The full year was positively impacted by the $136 million tax benefit recorded in the fourth quarter.

When adjusted for these charges, adjusted net income for full year 2017 was $196.7 million or $0.63 per diluted share. This compares to the full year 2016 adjusted net income of $233.4 million or $0.73 per diluted share.

Focusing on fourth quarter net sales, revenue increased 5%, driven primarily by $37 million of volume from our acquired business, modestly positive core volume, and a $16 million benefit from foreign exchange. Price turned slightly positive in Q4.

Turning to fourth quarter EBITDA, the $17 million increase to $192 million was driven by solid performance of $24 million, positive volume from acquisitions and core volume of $7 million, slightly positive pricing, and a $3 million foreign exchange benefit.

These benefits were partially offset by $11 million of commodity input cost inflation and $6 million of labor and benefits inflation. We ended 2017 with over $1.1 billion global liquidity and $2.2 billion of net debt. Total net debt decreased $51 million during the quarter.

During the quarter we contributed an incremental $82 million to our pension plans, which I will elaborate on shortly. We generated $365 million of cash flow in 2017 before the additional $82 million pension contribution.

We invested $260 million in capital, completed $203 million in acquisitions, and returned $156 million to shareholders via dividends and share repurchases. The year-end 2017 net leverage ratio was 3.1 times adjusted EBTIDA compared to 2.76 times at the end of 2016.

In conjunction with the combination on January 1, we assumed $660 million of International Paper debt and concurrently amended and extended our senior secured credit agreement to 2023. We remain committed to our long-term net leverage target of 2.5 to 3 times.

Before I provide more detail on our 2018 guidance, I'd like to briefly discuss the impact of the recent tax reform legislation and our pensions, starting with tax reform. Graphic Packaging is a significant beneficiary of tax reform, with approximately 85% of our earnings generated in the U.S.

We expect our effective tax rate will be reduced to the 24% to 27% range from the 35% to 37% range previously. Prior to tax reform, we expect that our NOLs would allow us to be a minimal U.S. federal cash taxpayer through year-end 2019. We'll continue to assess the overall impact of tax reforms. Currently, we expect that we'll not be a material U.S.

federal cash taxpayer through 2020. We expect total cash taxes will be in the $20 million to $40 million range per year between 2018 to 2020. The key driver in the extension of the NOLs is the 100% expensing provision for capital expenditures in the legislation, which reduces taxable income and extends utilization of the NOLs.

Turning to pensions, our aggregate funded status improved significantly in 2017. The improvement reflects continued strong performance of the plan assets and an additional $82 million contribution we made to the plans in the fourth quarter.

In 2017, we contributed $119 million to our plans, significantly above the $30 million to $40 million we initially communicated. The $82 million contribution was made given the opportunity to de-risk the U.S. plan and significantly reduce our expected pension contributions on a go-forward basis.

Post the $82 million contribution, we further shifted the U.S. plan away from risk-seeking assets. We continue on a path to de-risk the plan. We expect our pension contributions to decline to the $5 million to $10 million per year range on a go-forward basis, compared to $40 million to $60 million per year over the last seven years.

Turning to full year 2018 guidance, as Mike referenced, we expect our EBITDA will be in the $1 billion range in 2018, excluding approximately $25 million of one-time costs associated with the planned Augusta recovery boiler rebuild. We expect the pricing to commodity cost inflation relationship to be relatively flat in 2018.

Pricing will be roughly a $20 million positive as we benefit from previously realized CRB and CUK price increases during 2018 and the flow-through of higher prices for business ties to cost models. We expect commodity input costs will offset known pricing based on current inflationary trends.

We've factored in a modest tailwind from lower recycled fiber input costs. We expect OCC prices in our Midwest OCC fiber basket will average $15 per ton to $20 per ton lower in 2018 versus the 2017 average level. Given the inflation we experienced in Q4, we've factored in higher logistics, chemical and resin input costs into our 2018 guidance.

We expect our labor benefits inflation to be $25 million to $30 million in 2018. On performance, we're well-positioned to achieve at least the midpoint of our targeted $60 million to $80 million range excluding the expected $25 million in synergies from the IP combination.

Shifting to volume, we expect core volume to again be relatively flat consistent with our performance over the last several years. We remain focused on outperforming the market through new product development, customer and geographic expansion and substrate substitution; also all consistent with prior years.

We expect $235 million of EBITDA from the International Paper combination including the targeted $25 million in year one synergies. As we manage through the January cold weather and ramp up the synergies, we expect first quarter EBITDA would be in the $225 million to $235 million range. Finally, turning to cash flow.

We expect cash flow will be in the $475 million range, a bridge from approximately $1 billion of EBITDA reflects interest expense of $125 million to $135 million, cash taxes of $20 million to $30 million, pension contributions of $5 million to $10 million, capital expenditures of $380 million and positive working capital of $15 million to $20 million.

The remainder of our guidance is contained on the last page of the presentation on our website. Thanks for your time this morning. I'll now turn the call back to Mike..

Thanks, Steve. While we incurred significant pricing to commodity input cost inflation headwind in 2017, we executed on our key capital allocation priorities and announced the combination with International Paper's North American Consumer Packaging business, which closed on January 1.

In 2018, we are keenly focused on recovering commodity input cost inflation through pricing. We have planned for flat volumes and have targeted plans in place to outperform the markets with our new product development and substrate substitution consistent with previous years.

We will continue to be well-positioned to generate productivity that is well in excess of our labor and benefit cost inflation.

And the transformative International Paper transaction significantly increases the opportunities set we have to deploy capital across our three strategic capital allocation priorities to drive shareholder value in 2018 and beyond. I'll now turn the call back to the operator for questions..

Your first question comes from George Staphos with Bank of America. Your line is open..

Hi, everyone. Good morning. Thanks for all the details and congratulations on the year. My two questions will be as follows. First, in terms of new product introductions, where are you seeing the most benefit if you can specify by end market? You mentioned you have a new oven-ready microwavable bowl.

But are there other things like that? Is there any increase in volume and backlog because of pre-buying, do you think, if you can answer that question as well? And then separately, I just wanted to check, Steve.

The $475 million of free cash flow or cash flow as you're guiding it, just to be clear, does that include the payment that you'll be making to IP? My guess is they don't because it's not part of that bridge.

So whatever we come up within that number; ultimately, we should then back out the minority interest to get to our free cash flow versus your free cash flow. Thanks, I'll turn it over..

George, it's Mike. I'll take the first part of that question and then let Steve -.

Good morning, Mike..

Good morning. In regards to new product, I'd characterize that the real focus for us right now is on our strength packaging platform which is really again around eliminating tertiary packaging with many of our customer products. And those are the disappearing pallets, corrugated substitution, those types of products.

And we've seen a steady demand for those types of initiatives and new product development activities. And we've been pretty successful in bringing several of those to market here over the course of the last 12 months.

The other area where we're shifting gears and really amping up our efforts in conjunction with the new resources that joined our company on January 1 is on this whole area of what I'll call bowl pressing replacing traditional CPET bowls with paperboard bowls with various coatings that provides a grease and water barrier and yet tend to be more recyclable and compostable.

So those would be two real areas I'd point you to. I mentioned the microwave product. That's been an ongoing focus, as you know, for many, many years and will continue to be so as we go forward with an extended base. In regards to pre-buying, I'm assuming you're talking about paperboard..

Correct..

We don't see that right now in a material fashion at least. I'm sure there could be some minor amounts around the edges. But that's not something that I'd characterize as being anything we're seeing at this point. And I'll defer to Steve now on that..

Good morning, George. It's Steve. With regards to the $475 million of free cash flow, that's our traditional definition for 100% of the business. And you may recall the only cash that we'll be moving to International Paper this year would be the dividend equivalents from the partnership interest.

And there'll be three of those payments this year to them for the equivalent of the roughly $80 million share equivalents multiplied by our quarterly dividend and there'll be three of those. And that's within the context of what would be our overall dividend payments that you see for the year..

Okay. Thanks, Steve..

You bet..

Your next question comes from Mark Wilde with BMO Capital Markets. Your line is open..

Good morning, Steve. Good morning, Mike..

Good morning..

Hi..

Hi, Mark..

I'd like to just come back to sort of the guidance around price and just the EBITDA for the full year because it seems like you're not really recouping sort of the combination of kind of cost pass-through from last year plus price increases that were announced last year if we look at your kind of pricing guidance for 2018.

And at the same time and kind of related to that, it seems like all you're really doing in terms of the core EBITDA is getting back to kind of the 2016 level. And since then you've made acquisitions and you've invested a lot of capital. So I'm wondering if you can help us reconcile that..

Mark, it's Steve. I'll start and Mike can add in some context. So I think relative to the pricing guidance at $20 million, let me just take you through that. That has all known pricing activities in it. So that includes the net $15 per ton on CRB, the net $30 per ton on CUK from last year, as well as the cost model pass-throughs.

And it also has in it – as you know, we negotiate with customers on a multiyear basis throughout the year. And so it has some of the net impact of those negotiations in it. And so it has everything that's known.

What it doesn't have in it at this point is, of course, the price increase announcements that we've made, the $50 per ton on all three substrates. As you know, most of that will be a late 2018, early 2019 recognition, assuming that those are recognized.

And I think to your point around price/cost, we're keenly aware that we have, as Mike mentioned, about a $100 million price/cost headwind that we navigated through here over the last really 18 months.

And that's what we're obviously very focused on recovering to get back to the kind of margin profile that you were recognizing really 2016 and beyond in terms of what we're continuing to aspire to do with the recovery that needs to happen on price versus cost..

Yeah, Mark. Your comment is spot on. As I mentioned in my prepared remarks, we've got a $98 million price/cost spread. And right now, the guidance that we've provided here is that it's basically a neutral price/cost spread. So we've got to go initiate pricing activities and go recoup that over the next 12 months.

That's where we're going to be focused on going after it..

Okay. And if I could, for a follow-on, I'm just curious if you could talk a little bit about puts and takes in the packaging business because I notice over in Europe in particular, it seems like there are some good things and some potential challenges for you. We're seeing some stories about pressure on single-service cups.

But at the same time, we're also seeing a lot of stories about pressure on plastic consumer packaging. So I wondered, Mike, if you could help us talk a little bit about those cross-currents..

All that's very accurate and we see the same things and are heavily involved in many of those products, as you well know. We continue to believe that fiber-based products are actually a good story. They're made from renewable resource. They are recyclable and compostable, and that's obviously on the positive side.

On the other side of that ledger, we need to do a better job working with our customers to really close the loop in terms of our ability to capture some of that material and bring it back and get more of it recycled, so a two-part effort.

We want to do the new product development work, but we also need to make sure that we're advocating with our customers to figure out how we capture that material and get it back so that it can be reused again, Mark..

Okay, good enough. I'll turn it over..

Thank you..

Your next question comes from Mark Connelly with Stephens. Your line is open..

Hi, good morning. This is Ashish Gupta for Mark..

Good morning..

Good morning..

Good morning. Just the first question, so the modestly positive core volume sounds really positive to us, almost like a blowout level after the last couple of years.

Looking aside from new product development, can you share some more details on what's going on in the processed food markets; how you think about soft drink demand as we look out a little bit further?.

I think when you look in the individual verticals, there's obviously some up and some down. And we've talked about some of the different verticals in the past, so I won't spend a bunch of time on that this morning. But what I will say we saw in 2017 was it seemed and felt more like we were able to bounce along the bottom in terms of our core volumes.

And our new product development activities really were accretive in that regard and really helped us drive that 100 basis points that you saw in terms of volume gain year over year, and that's how we started January as well. So look, every quarter is something that we watch very carefully.

We're working closely with our customers to help them win in the marketplace. It's a challenged marketplace, as you well know. But we expect that that trend will probably continue here in 2018, and that's how we're building our business and focusing our new product development efforts..

Okay, thanks. And just to follow-up on that, so is there a way to parse through what the acquisitions from the last couple of years have helped contribute to that organic volume growth versus – obviously, anything acquired recently isn't organic.

But looking further back, maybe anecdotally, how the acquisitions have contributed to this organic volume growth versus the new product development?.

This is Steve. I'll take a cut at that. As you see, when we portray our results, we always call out the acquisitions a bit separately from core volume. And then once we get into a full one-year overlap on those acquisitions; of course that becomes core.

What we've seen from that over the last three quarters and really through the year is we've had very modest net growth from that, 0.5% for this year.

Once we get into a full year of ownership for the acquisitions; yeah, they've played a good important role because we have been investing in markets and geographies with those acquisitions that have a little better growth profile.

So it's been part of the remixing of the portfolio towards businesses that are more local in orientation, regional businesses that are serving foodservice applications, that are serving craft beer, for example, that are winning in some of the applications that are that are better-for-you, good-for-you foods.

And so yes, it's played a role along with new product development..

Thanks a lot..

You bet..

Your next question comes from Anthony Pettinari with Citi. Your line is open..

Good morning. I had a follow-up question on the outstanding price hikes that aren't baked into the $1 billion guidance. Assuming they are successful, can you remind us how long you'd expect it to take for those to show up in earnings? I think CRB and CUK have taken up to nine months, but you've been trying to accelerate that.

Any comments you can give there? And then can you compare that to SBS or what you've seen from IP's history and your experience as an SBS buyer?.

Thanks, Anthony. It's Steve. Just to take you through that, you're right that nine months is still roughly right relative to CRB and CUK. About six months has been the norm for SBS. That's what we would have experienced previously and what we see with the team now relative to SBS, so a little bit of a combination of nine and six months.

Assuming some natural recognition here late Q1, we would see predominantly a 2019 positive impact. But we would estimate that we might see 25% of it rolling through 2018 coming out the back half of the year. And we'll obviously continue to keep you informed of how that plays out once there is recognition.

But that's how it would naturally play assuming some level of recognition..

Okay, that's very helpful. And then just on the performance improvements, I think you indicated the closure of Santa Clara impacted performance improvements in 4Q. I'm wondering how much of a hit that was.

Does any of it continue into 1Q? And then I think in the past you had talked about Santa Clara was maybe a $10 million benefit to performance improvements. So just wondering if that's still the case and what the kind of timing of the realization of the benefit for Santa Clara would be..

Yeah. Sure, Anthony. It's Mike. I think if you think about that, it was probably about a $5 million impact in Q4 in terms of EBITDA. We built about $10 million worth of inventory which we're now relieving and will be really fully relieved by the end of Q1. And the $10 million of EBITDA improvement is intact for 2018 and it's really already started..

Great. I'll turn it over..

Your next question comes from Ghansham Panjabi with Baird. Your line is open..

Hello.

Can you hear me?.

Hi. Yeah, we got you. Hi, Ghansham..

Hi, guys. Good morning.

So first up, back to the core volume growth of 0.7% in 4Q, did the quarter benefit, do you think, from some of the beverage customers having been disrupted during 3Q from the hurricanes and maybe kind of a normalization of production in 4Q? Maybe you can give us a sense as to how the beverage market specifically performed for you in the quarter..

Our global beverage business was actually pretty good. Our North American mega beer was actually down quite a bit consistent with the trends that were well chronicled and reported there, Ghansham. So I wouldn't say that we saw a big correction or – relative to what happened in Q3 relative to the hurricanes. It was kind of steady and as we expected..

Okay. And then just in terms of your projects to reduce the usage of chemicals such as TiO2 that you referenced, Mike. Was the timeline sort of accelerated given the increase in raw material costs or are these part of your normal productivity project pipeline? Thanks so much..

It's really all part of our ongoing productivity pipeline. We'll have to do that, as you know, during our annual outage in Macon, which will take place in September of this year. So we have to queue those projects up on a year-over-year basis to manage the downtime associated with the installation.

The good thing for us on this one is it's the second one we're doing at the Macon mill. So we understand how to do it and what it's going to take. And we expect it to go well..

Thank you..

You bet..

Your next question comes from Chip Dillon with Vertical Research. Your line is open..

Yes and good morning..

Hi, Chip..

First question is to do with the – hey there, is with – you mentioned the $1 billion EBITDA guide for the year.

And did you say that did not include about, what was it, $25 million or so for the impact of the outage at the Augusta mill? Is that right?.

That's right, Chip. It's Steve, yes..

Okay. And then the other thing is on the operating cash flow guidance. You mentioned the $380 million in CapEx. It looks like about every year you spend roughly $20 million on the packaging machine capital.

Is that sort of a good number to use?.

Yeah, that's a good number..

Okay. That's -.

And Chip, it's Steve. Just kind of going back to your question on the Augusta recovery boiler rebuild at $25 million won't be a negative to our net cash flows. As a corporation, we've got, as you know, a fair number of moving parts this year also on the closure of the Santa Clara mill. That's real estate that has some inherent value.

So we've tried to look through that for you and so that the $475 million kind of takes the net impact of some of those one-time expenditures into consideration..

Got you. And then as we look at the pricing for – let's just, for instance, say the SBS initiative is successful because that's a business you haven't really been in up till now.

Is it fairly safe to say that very little of that would be subject to what I'll call a cost-plus model that would maybe limit that impact?.

That's accurate, Chip. It would be predominantly driven off of the RISI index for pricing..

And is this probably still fair to say that of the other two substrates, that it's kind of a good guess that 50-50 is subject to the pricing and 50% might be more tied to costs?.

Yeah, it's actually not a guess. You're accurate in your assessment on that..

Yeah, Chip. There's about 2.5 million tons that are kind of linked more towards RISI if you look at the total versus the 3.7 million tons of overall production capability..

I see, I got you. And then just for our modeling to make sure we're right on this.

It sounds to me since you will recognize the minority interest being half of your after-tax income – I'm sorry, that made no sense – 20.5% of your after-tax income, there's no reflection of any share issuance unless and until they decide to sell their interest in two years..

That's correct, Chip. Everything that we'll do when you see us reporting will be based upon roughly the 310 million shares that we have as GPK. They'll have, as you rightly said, a 20.5% interest in the partnership that'll be recognized in terms of minority interest after tax on the P&L, which you'll see in Q1..

Terrific. Thank you..

You bet..

Your next question comes from Brian Maguire with Goldman Sachs. Your line is open..

Hey. Good morning, guys..

Good morning..

...a question on the $1 billion EBITDA guidance. I know in the past you've given a range, sometimes maybe $20 million range. And this time, I recognize $1 billion is a nice round number to use as a point estimate.

But as you're thinking about it internally, when you communicate to the troops, would you say $1 billion is more at the low end of what you kind of view as a positive year for you guys this year or is that truly the midpoint? And then if it was to slip a little bit below the $1 billion number, what sort of factors would you think would drive that?.

Well, Brian, it's the first week of February. And so as we're kind of looking at that from $1 billion, we think that's the right number to put out there right now given some of the various puts and takes that are there. As you know, right now in terms of some numbers for you, OCC is at $94 per ton. Our guidance we gave you is at $115 per ton.

Last year, it was $130 per ton. So there's different continuums along those lines. The dollar is a little weaker now than it was last year. But what's that going to be when we finish the year? Those are all things that can move it, to your point, $10 million or $20 million kind of around that $1 billion number.

So that's why we did it the way that we did it and tried to waterfall it so you could kind of see how it was coming together..

Okay, thanks. And then just a question on the price increase announcements that are out there. I guess that both the SBS and the CUK ones, it seems like last year there was good support for that.

CRB, I guess the question is what's sort of different now versus November when RISI sort of surprised people with the $35 coming out there that gives you confidence you can think you can get some of the $50 increase through now. Maybe just summarize what you think has changed in the market since November..

So what I think has changed in the market really over the last year – if you think about it, Brian – is 260,000 tons of capacity have come out. And as we think about that capacity, I would kind of lump CRB and CUK together. So you got 4.5 million tons between those two grades that were made.

And you take 260,000 tons out against that, it's about 5.7% of capacity that's been essentially removed. You're starting to see that in the CUK operating statistics. Both November and December, you saw, were quite strong year-over-year.

I expect that trend to continue as we go into 2018 given the fact that we shifted 75,000 tons from our mill in Santa Clara into our CUK system. So really if you think about it, it's really supply and demand and relative to how those substrates will actually perform.

And that's really how we're looking at it as we enter 2018 and why we made the decision to implement pricing announcements..

Okay. Just one last one for Steve for modeling. Is $380 million a good number for CapEx going forward? And is there any – you mentioned the Augusta spending this year.

Is there anything temporarily boosting it this year or is that a good number to use going forward?.

Yeah. Thanks, Brian. I think the way to think about that going forward if you kind of take the new enterprise – I think baseline CapEx, we used to be kind of in that $200 million range pre the combination.

And I think if you look at kind of baseline now and given the acquisitions that we've done and probably used in the $320 million range as kind of baseline CapEx; any time we spend above that, we'll continue to do what we've done in the past which is to lay it out for you very specifically relative to those investments just like we're doing this year, curtain coater, Augusta recovery rebuild, et cetera.

So $320 million is probably baseline. I think you've seen from us that we always do have good solid projects that we would tend to bring forward. They tend to be in that $30 million to $50 million range on a go-forward. So I wouldn't use $320 million necessarily. I'd step it up a little bit for the investments we're likely to make.

But this year we do have a little bit of the unique investment on the Augusta recovery rebuild at roughly $30 million..

Okay, thanks very much..

You bet..

Your next question comes from Debbie Jones with Deutsche Bank. Your line is open..

Hey, good morning..

Hi, Debbie..

My first question is on volume. Second just on the cost guidance. If you look kind of historically at the rate of shift from boxboard to plastic packaging, I know there's no precise answer for you. But do you think that that's exciting? Is there an argument to be made we're kind of plateaued here? And then a second question on volumes.

Do you notice historically a change in consumer behavior when OCC prices stay materially lower over a period of time? Do you see customers maybe increasing their order volumes when they have that visibility?.

Okay, Debbie. Let me just take – I'm going to just take these in sequence and how you asked them. In terms of shifts from cartons into plastic, as we've talked in the past, we see there is some natural migration that occurs around specifications around all the different types of packaging substrates.

But relative to our share on the folding carton side – and Alex tracks this pretty carefully – against all the industry statistics, we do not see fundamental shifts out of paperboard and into plastic or vice versa. So we see that as kind of a steady march and that's reflected in our overall volume guidance that we just gave you.

In regards to kind of pre-buying when OCC is lower, that'd be primarily on the open market paperboard side. Again, we're 86% vertically integrated on that grade within CUK. So even if they did, it would be a small portion of our sales. And as I mentioned earlier on one of the questions, we just have not seen that so far this year..

Okay. And I guess I'm just also asking about customers who are buying the folding cartons.

If the price of that product was actually moving down materially, does that tend to have an impact just because these tend to be rolled through on an index and it has actually reduced those costs?.

It tends to be very small. Again, they've got finite areas to store this material. Most of our supply chains now tend to be just in time. So it's not like they want to buy forward, buy and fill a warehouse full of cartons so that graphics change and the labeling changes, so they need to keep that pretty real time..

And, Debbie, it's Steve. We also don't tend to see movements among substrates either. And as we've talked in the past, most products are in the substrate that they should naturally be in..

Okay, that's helpful. And just a quick question on the $30 million to $40 million in higher costs.

Can you just give me an order of magnitude of where the pressure is coming from on the items that you called out?.

Yes, I'd be glad to. The net of it, as we mentioned, we've made what we think is a prudent assumption around OCC that Mike just said a moment ago at $94 per ton, we've assumed $115 per ton for net OCC. And that compares to $130 per ton last year. So that will be deflationary inside of the assumptions $15 million to $20 million.

And then what we've really seen is we've seen it on chemical costs, logistics very specifically, as well as resin. We saw in Q4 on our core business about $10 million of inflation from those items specifically.

And so if we trend line those out, that's the $30 million to $40 million of inflation very specifically from those items, logistics, chemicals, and resin. And that nets to the assumption and we think a good prudent assumption around some net inflation in the business with some deflation on OCC, net inflation on those other costs..

Okay, that's helpful. Thank you..

You bet..

You got it..

Your next question comes from Arun Viswanathan with RBC Capital Markets. Your line is open..

Hi, yeah. Thanks for taking the questions. It's actually Tom for Arun.

On the guidance, what would the hypothetical EBITDA contribution be if you were 100% successful on all three substrate price increases?.

I think the theory of the case if you just go to just what we chatted about earlier over time would be the $50 times the 2.5 million tons that has some attachment to that. So you're in the $125 million range if you just do theory of the case. Obviously, we wouldn't encourage you to do theories.

But in theory the case that would be the math, roughly the 2.5 million tons times the $50 across all three substrates..

Got it, understood.

And then my follow-up, in the event you guys do buy back the IT stake, to what extent would that limit your ability from doing other M&A in the interim in terms of financial flexibility?.

I think the way to think about that, Tom, is we're two years out and that's really their call. They make a decision on that and would talk to us at that point in time.

And when you look at the free cash flow that we're generating, you'll see us pay down our debt this year and next year and get ourselves positioned there, where if that was something that they wanted to do, we'd be well positioned to be able to do it and still have flexibility to continue to grow our business and drive our strategic priorities that we've outlined..

Okay.

And then actually lastly on volumes, is there a reason why your guidance doesn't include any volume growth if you've certainly outperformed the market?.

What we tend to do, Tom, is plan for what we see as the base case scenario. It forces us to be very prudent around spending and treat every dollar like a prisoner when it comes to cost reduction, and we think it just drives a better business. If we build volume growth into our forwards and then it doesn't happen, then we have an issue.

So we plan for flat volumes and try to outperform that, which we did in 2017..

Great, thanks. I'll turn it over..

You bet..

Your next question comes from Adam Josephson with KeyBanc. Your line is open..

Hi, Steve, Mike, good morning..

Hi, Adam..

A couple of clarifications on the guidance, if you don't mind. The $50 across all three grades, you mentioned earlier the 2.5 million, not the 3.7 million tons. I just want to make sure I understand what the sensitivity is. I know you said you're 50% cost pass-through.

I am just trying to understand what the ultimate benefit could be if all three go through, you get 25% of it this year.

Should I apply it to the 2.5 million or the 3.7 million tons?.

Adam, it's Steve. I'd apply to the 2.5 million tons, but the other roughly 1.2 million tons is what tends to flow through on cost models. Obviously, that would be matched up more with cost models. I think if you're doing the math you just did, you'd do it off the 2.5 million tons..

So if you got – if all three were recognized, you got 25% of it this year, you're talking maybe $15 million of potential upside to EBITDA.

Is that about, right?.

Yes, that's in range. That would be right..

And then just on OCC. I know what your OCC assumptions are.

Should we assume that the 1.2 million tons of recycled fiber you're buying that would also mix paper as comparable to the OCC in terms of your assuming a $20 move higher on average for the full year relative to where we are now?.

It's a basket and that's a good assumption. The only point of clarification I'd make for you on that, Adam, is it's actually about 1.1 million tons now with the closure of the Santa Clara facility, and OCC would be about 500,000 of that..

Okay. So maybe – if OCC and mix stay exactly where they are, you're talking, call it $20 million of upside to EBITDA.

Is that in the ballpark?.

It's in the ballpark and that's a good number..

Thanks so much, I appreciate it..

You bet, Adam..

Your next question comes from Gail Glazerman with Roe Equity Research. Your line is open..

Hey, good morning. Going back to inflation, I appreciate your commenting about the fourth quarter run rate. I'm just wondering.

Have you seen material incremental inflation carry into the first quarter, and have you seen any kind of negative weather impact on operations in the quarter?.

Gail, it's Mike. I'll take that. We really did see freight escalate in January, but I would characterize it, we had about a week and a half period of time where, as you well know, there was some very extreme cold weather in the Gulf and Southeast of the United States, where our large virgin mills are located.

And that really impacted freight, both trucking and rail, for that period of time. There was a point in time in the middle of all that where there were 11 truckloads for every one truck that was available. Now that since improved since then. I think the last numbers I saw earlier this week were around 6-to-1 truckloads as we went into February.

We expect that to get a little bit better here as we wind through first quarter, but that was really what we saw. We did have one of our mills impacted by that cold weather, where we lost some production for a period of time. And again, that's all reflected in the outlook that we gave for the quarter..

Okay, that's helpful.

And thinking about the M&A pipeline moving forward, can you just give some color on what you're seeing? Obviously, integrating the SBS is a top priority, I'm just wondering geographically where you see the best opportunities at this point or if you're seeing any different?.

So the focus and our efforts will be aimed in both Europe and North America. We remained very focused on building out a converting business in Europe that is a $1 billion plus as we've talked about in the past.

We now have another leg of that stool to work on with SBS, as we just closed during our last call around 22% of our sales is now on that Food Service side of the business, which is growing a little faster the perimeter of the store. And you know, our track record it being aggressive and tuck-in acquisitions is pretty well chronicled.

And as you can expect, as we now have these new assets, you know that our pipeline is growing and people are talking to us and we're looking at the right fits and valuation and all the things you'd expect us to do, as we look to build out that integration level, which we said would be around 80% over the next three to five years is our target for SBS..

Okay, thank you..

You bet..

Your next question comes from George Staphos with Bank of America. Your line is open..

Hi, guys, just some follow-ons here. So, back to the inflation question, I was just doing some rough math.

So you're basically implying that in your non-fiber based materials and/or variable cost, including chem, including freight that you're assuming more or less an average 30%, 35% increase in cost from what the fourth quarter average was and that seems to be blended across chemicals, freight and so on.

Is that an accurate figure? If not, if you could provide a little bit more color there? And then on the question of perimeter of store, Mike, are you seeing more opportunity in terms of brown or you're seeing more opportunity now with bleached in the toolbox, bleached cartons having more opportunity versus UK in terms of perimeter store and convenience? And then, I had a couple of other follow-ons..

Yeah, George. It's Steve. I probably want to work with you a little bit on that 30% number that you said.

I think what we were trying to convey is, when we look at the actual costs we were incurring in Q4, we saw about $10 million of inflation in those categories and we've assumed kind of a continuation of that year-over-year, that what's drive that assumption.

There are some things that are up in that zone, into that 30%, but I don't know that I would necessarily assume that as a number if you will. So, I would – I'm going to defer a little bit to you on that in terms of, let me do a little bit of work, to make sure that you understand the cost base, which you're referring to.

But it was really trend line Q4 into – in the 2018..

That's fine. We'll talk about it offline. I was just reverse engineering, you gave us the goal for the year or the expected negative, I took out or swung the fiber-based positive and divided by 4 and then compared that to the $10 million, that's how I got to the number. But, that may be – it's a change in the rate of change, not the absolute level.

So I think that's where we may be offer the percentage now as I think about it.

In terms of perimeter of store, Mike any thoughts on that?.

Yeah. I think it's a great question. Though the thing we have now with the company with all three substrates, as you know, is we're agnostic whether the customer wants brown and some do. And now we also have the capability of supplying them SBS.

And as I mentioned, we're seeing a lot of traction on your pressed bowls in provisioning around the perimeter of the store. These stores continue to build out the selection that they have for consumers, as they come in and grab meals that are ready whether that's for lunch or dinner.

So, we've got lot of our new product development activity focused in that regard. So, I won't really say it's one versus the other and I think that's the great part of the product offering that we now have is that we can provide them all those products, George..

Is there a way to quantify what perimeter stores growing for you overall Mike at this juncture, recognizing it's not the majority of your business, but it's meaningful now?.

Yeah, I'd say the number is 1% to 1.5% in that particular category as we defined it..

All right. (00:59:40).

...on a bigger base for us..

Okay. My last question, I'll turn it over. One, if I saw it correctly and advise me if I'm incorrect here. You have a working capital benefit in your free cash flow bridge, but obviously you're guiding input costs higher, so I'm assuming that's on the fiber-based.

Said differently, if price are going up and variable costs are going up, I would expect working capital to be a negative, not a positive. Explain to me, why it's a positive in the cash flow? And then with PM2, did I hear correctly, making PM2, that the current quarter goes in, in October? Thank you. I'll turn it over..

I'll take a crack at both of those and then, Steve, you can speculate in the color. I think the current coater actually goes in, in September, so we'll be starting it up in October, George. And then in regards to working capital, it's really relieving that paperboard that we built for the Santa Clara closure....

Right, right, right..

...and also a little bit of the build that IP started and we will continue on the SBS side to take care of the outage at the Augusta mill when we do the recovery of the boilers, so it's those two things, volume of inventory are related George..

Okay. Thank you, very helpful. I'll turn it over..

That concludes today's Q&A session. I'll turn the call back over to Mike Doss for closing remarks..

Thank you for joining our earnings call today. We look forward to speaking with you again in April. Have a great day..

This concludes today's conference call. You may now disconnect..