Alex Ovshey – Vice President-Investor Relations Mike Doss – President and Chief Executive Officer Steve Scherger – Executive Vice President and Chief Financial Officer.

Anthony Pettinari – Citibank George Staphos – Bank of America Merrill Lynch Ghansham Panjabi – Baird Mark Connelly – Stephens Chip Dillon – Vertical Research Mark Wilde – BMO Capital Markets Brian Maguire – Goldman Sachs Debbie Jones – Deutsche Bank Adam Josephson – KeyBanc Capital Markets Gail Glazerman – Roe Equity Research Arun Viswanathan – RBC Capital Markets Daniel Rizzo – Jefferies Steve Chercover – Davidson.

Good morning. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the Graphic Package Earnings Call. Alex Ovshey, Vice President of Investor Relations, you may begin your conference..

Thanks, Tiffany. Good morning, and welcome to Graphic Packaging Holding Company’s conference call to discuss our second quarter 2018 results. Speaking on the call will be Mike Doss, 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 Webcasts 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..

freight, chemicals, purchased external paper and pulp substitute recycled fiber costs have continued to move higher. As a result, we estimate we will experience an incremental $25 million in commodity input cost inflation for the balance of 2018, more than offsetting the benefits of lower OCC costs.

Now let me provide more detail on key operational trends from the second quarter. Organic volume in our global paperboard packaging business was flat in the second quarter. Modestly improved demand for the frozen food and dry goods categories was offset by weakness in big beer brands in North America.

Our organic converting volume trend continues to outperform the market trends as reported by A.C. Nielsen, reflecting the ongoing success of our new product development pipeline. Our organic global beverage volume was flat in the second quarter, despite continued pressure on big beer brands in North America.

We continue to benefit from growth in craft beer and flavored and sparkling water categories in North America as well as beer in our international markets. As we have discussed in the past, we expect our new product development efforts will drive approximately 100 basis points organic volume growth per annum.

Let me highlight one new product commercialization in the quarter. In the second quarter, we commercialized our pressed bowl technology with ConAgra and are also far along on this opportunity with several other large consumer package goods companies around the world.

The main application is the frozen and microwave food categories where the crystallizable polyethylene or CPET plastic tray is currently the most commonly used solution. Our press paperboard pulp solution is made from a renewable and sustainable SFI certified SBS paperboard.

The technology enables traditional oven baked quality to be achieved in a microwave, while maintaining reduced microwave cooking time. We see significant runway to grow our pressed bowl offering over the coming years, given our small current footprint in the context of large frozen and microwavable food end markets. Turning to operations.

With the exception of the unplanned Augusta outages, our mills ran well. Backlogs remained healthy, five-plus weeks for CRB, CUK and SBS, reflecting a 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 platform, consuming approximately 80% of all the paperboard we produce for these grades. Industry operating of rates, according to the American Forest and Paper Association across the three boxboard grades, were north of 95% year-to-date through June.

Our Augusta mill experienced two significant unplanned outages in late June, which caused the mill to lose all power. When an event like this occurs, we complete a very comprehensive and rigorous start-up procedure to power the mill back up and get everything stabilized.

The outages resulted in 6,000 tons of lost production and lost fixed costs absorption. In total, these events impacted our June results by $6 million. While we occasionally experience these types of issues at our other virgin paperboard mills, they are very infrequent and we are usually able to recover much faster.

The previously announced and planned recovery boiler rebuild at Augusta in the fourth quarter will reduce the likelihood of power outages we experienced in the second quarter moving forward and allow us to recover from such interruptions much faster.

The rebuild recovery boiler and upgraded electrical system will be much more robust and stable than our current operating environment. Continued emphasis on improvement initiatives, variable costs and operating efficiencies contributed to majority of our cost savings this quarter.

We operated well and generated $19 million of net performance in the second quarter. Moving to costs. While we benefited from lower OCC input costs, we incurred elevated freight, chemical, external purchased paperboard and pulp substitute recycled fiber costs, resulting in $12 million of commodity input cost inflation during the quarter.

We expect elevated costs from these categories will continue for the balance of the year. Now let me briefly touch on the PFP acquisition, which we completed in June. We paid $34 million for two converting plants located in Tennessee and Texas.

The acquisition expands our leading position in the growing paperboard-based air filter frame market, which we entered with our acquisition of Carton Craft in July of 2017. The business converted approximately 18,000 tons of paperboard, primarily CUK, and generated strong EBITDA margins on an LTM basis.

Synergies from the acquisition will be driven by the integration of additional CUK paperboard tons and cost efficiencies. On a post-synergy basis, we expect the enterprise value to EBITDA multiple to be less than six times. Lastly, let me now discuss how we are progressing on integrating our new SBS mill and foodservice converting assets.

The integration is going very well. Organic volume in the foodservice converting business was up 2.4% year-over-year in the quarter, consistent with the trend in the first quarter. We are executing on the $75 million in synergies that we expect to achieve by the end of year three.

Specifically in the quarter, we have made further progress on SG&A reduction and paperboard integration initiatives. As I noted earlier, adjusted EBITDA from the SBS mill and foodservice converting assets is tracking in line with our $230 million – $235 million outlook for the full year in 2018, despite the impact from the unplanned outages in June.

We are continuing to actively look at acquisition opportunities in North America and Europe to further increase our SBS mill converting plant integration levels. And with that, I’ll turn the call over to Steve Scherger, our Chief Financial Officer.

Steve?.

Thanks, Mike, and good morning. We reported second quarter earnings per share of $0.16 per diluted share, up compared to $0.14 in the second quarter of 2017.

Second quarter 2018 net income was negatively impacted by a net $5.1 million of special charges that are detailed in the reconciliation of non-GAAP financial measures table included in our earnings release. When adjusting for these charges, adjusted net income for the second quarter was $54.5 million, or $0.18 per diluted share.

This compares to second quarter 2017 adjusted net income of $46.4 million or $0.15 per diluted share. Focusing on second quarter net sales.

Revenue increased 38%, driven primarily by $360 million of revenue from the SBS mill and foodservice converting assets, $37 million of volume related primarily to other acquisitions and $10 million benefit from foreign exchange. Price was an $8 million positive in the quarter. Turning to second quarter adjusted EBITDA.

The $65 million increase to $236 million was driven by $55 million of EBITDA from the SBS mill and foodservice converting assets, solid performance of $19 million and an $8 million of positive pricing. These benefits were partially offset by $12 million commodity input cost inflation and $6 million of other inflation, primarily labor and benefits.

We ended the second quarter 2018 with over $1 billion of global liquidity and $2.9 billion of net debt. Total net debt decreased $122 million, reflecting solid cash flow generation in the quarter.

Adjusted for the GAAP classification change, related to our receivables securitization on sale programs that we previously discussed in Q1, cash flow from operations was a positive $226 million in the quarter. We invested $81 million in capital and returned $23 million to shareholders via dividends.

The second quarter pro forma net leverage ratio was three times adjusted EBITDA, compared to 3.3 times at the end of first quarter. We remain committed to our long-term net leverage target of 2.5 to 3 times and expect to be in this range by year-end, reflecting our strong cash flow generation. Turning to full year 2018 guidance.

As Mike referenced, we continue to expect our adjusted EBITDA will be at least $1 billion. On performance, we’re well positioned to achieve our targeted $60 million to $80 million, excluding the expected synergies from the SBS mill and foodservice converting assets.

We continue to expect our labor and benefits inflation will be in the $25 million to $30 million range. Shifting to volume. We expect organic volume to, again, be relatively flat in 2018, 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, again, all consistent with prior years. We expect $235 million of adjusted EBITDA from the new SBS mill and foodservice converting assets, including the targeted year-one synergies.

We expect third quarter EBITDA will be in the $265 million to $275 million range. Finally, turning to cash flow. We continue to expect cash flow will be at least $475 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.

Mike?.

Thanks, Steve. As we move through the second half of 2018, we are keenly focused on recovering commodity input cost inflation through pricing and executing and integrating and generating the targeted synergies from the SBS mill and foodservice assets.

We continue to plan for flat organic volume and have targeted plans in place to outperform the market through new product development and substrate substitution, consistent with prior years. We continue to be well positioned to generate productivity that is well in excess of our labor and benefits cost inflation.

I will now turn the call back to the operator for questions..

[Operator Instructions] Your first question comes from the line of Anthony Pettinari with Citibank. Your line is open..

Good morning. Last quarter, you talked about $100 million of costs that you were going to recover.

Given the incremental cost inflation you saw in 2Q, when you think about recovering these $100 million plus, is the time frame just kind of pushed back a quarter, or some of these incremental costs, you’re just not going to be able to recover? In understanding, you’re not giving 2019 guidance, can you kind of bridge roughly how price-cost recovery might play out next year?.

Good morning, Anthony, it’s Steve. I think just a couple of things, as you mentioned we have seen inflation coming to the business as we articulated here in our comments. And our commitment to, over time, recovering that $100 million is still absolute and it’s what we’re targeting.

And I think you’re seeing us be quite assertive with now five announced price increases in total to pursue that. And you’ve seen good price execution from us here in the first half of this year, and it will accelerate as we move into the second half of 2018. So our commitment to offsetting that over time remains intact.

The supply-demand environment is critical to that, as you know, and that is in an appropriate place as well. So I would agree with you that it isn’t the time to focus on 2019 guidance.

But if you look at pricing, as we mentioned last quarter, we had about $100 million of pricing in 2019 that we would see flow through based upon the previous announced increases. And with the CRB recognized $50 per ton increase, so that was recognized here in the quarter, that number moves to $125 million.

And then of course, there is the pending next $50 CUK, so all of that is in line with our commitment to recovering inflation over time..

Okay. That’s helpful. And then you called out the $6 million hit from Augusta in late June.

Apologies if I missed this, but is there any knock-on impact from that in start of 3Q?.

Yes, Anthony, it is Mike. No. It was – those were two discrete events that occurred the last two weeks of the month of June, no carryover into July..

Okay, that’s helpful. I’ll turn it over..

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

George?.

Can you hear me okay?.

Yes, we got you..

Okay. Maybe piggybacking on Anthony’s question. I had a question on Augusta and what actually drove the outages. And what in the outage that is planned for the third quarter will help to address and make more robust your manufacturing process at the mill? That’s question number one.

Question number two, as you think about these next price increases that are on the table and recognizing that you really can’t get into forward looks here, would you anticipate, based on your experience, any changes in the phasing, changes in the timing of when you would be able to implement relative to what your experience over the years has been? Thank you..

Thanks, George. I’ll take Augusta, and Steve, I’ll let you cover the question in regards to pricing. In terms of Augusta, what happened is we had two discrete events that knocked the mill down completely dark. One was caused by weather. One was caused by a system failure that we had at the Augusta mill.

And as we talked about when we announced the deal in Q1, we’ve known that we have a repair that we have to do there to get the Augusta recovery boiler back in the condition that we needed to be in from a reliability and stability point of view. So in that regard, we knew we had exposure there.

And of course, we don’t plan on having this thunderstorm knock the mill down, but that’s what happened in one of these cases. And what we’re going to do, George, in Q4 is rebuild that boiler floor. We’ve got some tube work we’re going to do.

And we’re also upgrading a fair amount of instrumentation and the electronics associated with our control system. And that will move that technology from 25-year-old technology to modern technology, consistent with what we have in Macon and West Monroe that will allow us to have a much more robust and reliable operation of our recovery boiler there.

And if we do have an interruption, it will allow us to recover much faster, consistent with what we could do at our other virgin mills. So that’s what we’re going to do in Augusta..

And, George, on pricing timing, really no change to our sequencing in terms of kind of full implementation after nine months. The CRB obviously just recently recognized. We’ll start to execute on that, and it will be fully in as you kind of round the corner into 2019.

The earliest conceivable recognition of the latest CUK is probably in August, September-type activity. Same scenario, that would start to then roll in over the next nine months and the vast majority of that would be a 2019 event.

I think what you – we tried to provide in some of the details on the website today was a little bit of showing the trajectory of how pricing is accelerating in the business. We’ll go from $8 million in Q2 to $20 million in Q3. That’s an important acceleration as we execute on previous price increases.

That same kind of trajectory is what we would expect to see on any current, recognized or future price increases..

Okay. Thank you. I’ll turn it, I’ll back..

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

Good morning.

I guess, first, just given the disruption you sort of saw on the SBS mill, does that change your view in terms of the time line of any other productivity or maintenance initiatives that you’re considering specific to the acquired SBS assets? Just trying to get a sense, Mike, whether the disruption was a true one-off or maybe a function of the assets perhaps being overdue for maintenance, just given the timing of the transaction? Thank you..

No, thanks for the question there, Ghansham. It really was – we knew this. It was disclosed during diligence. IP had already planned to do the repair in Q4. They started the inventory build as we headed into this year. And as we talked about at year-end and then on Q1, our Q4, we’ve got 42 days planned to do this outage.

It’s a $35 million capital project. It’s all in our guidance that we gave you. So we have planned to do this. It’s just between now and when we get the repair done. We’ve got some vulnerability there, and it hit us in June. So I treat it as a discrete event..

Okay. Understood. And then just as my second question, obviously, you’re seeing success in pricing from an open market standpoint.

Can you just update us on how contract discussions with the customers are progressing? Just trying to get a sense as to what would actually prevent you from being able to fully implement these price increases along your vertical footprint? Thanks so much..

So I’ll take that one, and Steve, you can sprinkle in any color. But look, as you see, we are getting the pricing. It’s coming through the business. We got $55 million worth of pricing that’s coming in this year.

Steve articulated, on a gross basis, the pricing for the announced pricing moves, that happened in Q1 as well as the subsequent second CRB increase. And those are contractually driven, and we’re implementing them.

Now having said that, implementing pricing is always difficult, but this is contractually driven, and we’re executing on those increases and plan to realize them..

Perfect. Thank you so much..

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

Thank you. Two questions.

First, are your customers doing or considering doing more switching between substrates with these price hikes? And are you at all concerned about shifting from paperboard to plastic as a result of these higher prices?.

Good morning, Mark. I’m going to take both of those. I think from a switching standpoint, yes, we always see some minor switching around the edges between more CRB and CUK, but it’s pretty small. Most of what we do is really, purpose-built specifications are dialed in for that application.

If you think about beverage and handle tears and frozen food where you need the stacking strength, these are very purpose-built specifications. Cups on SBS. So the amount of switching that actually occurs is very modest along those lines. In regards to substitution to plastic, we have not seen that.

As a matter of fact, we’ve actually seen a bit of the opposite effect to that where our new product development backlogs are actually growing. We profiled one of the products here where it’s a pressed paperboard bowl, it’s replacing the traditional CPET package. We’ve seen foam to paper conversions accelerate as another example.

And that really is what’s driven our SBS and foodservice growth 2.4% year-to-date. So in that regard, I think it’s actually more of a – that conversion is actually a little bit more of a tailwind for us as opposed to a headwind..

One more question. You talked about a robust M&A pipeline. We’ve been figuring you might do $250 million or more.

Is that still possible this year?.

Yes, it is still possible this year..

Yes, pipeline remains good, Mark. And you saw us transact one here in the quarter. And we’re certainly working on other options to drive exactly the kind of integration that we spoke of, both in terms of SBS and other substrates..

Thank you..

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

Do with the freight, the chemicals, the pulp substitutes, the non [Audio Dip] paper that is, is going to cost you $25 million more this year than maybe you had thought before.

How does the – how much of that could we see recovered next year, not through pricing but through just the way your contracts work? Because I understand you do have some that are cost-plus based, and that with some lag, you would tend to get some of that back..

Yes, Chip, it’s Steve. It’s well said on your part. Obviously, pricing comes in multiple forms for us, as you know. Obviously, these announced open market price increases drive that component of our model. Cost models are – do drive a pass-through as well, and we are seeing net inflation in the business, as you saw this quarter, at $12 million.

So our cost models will pass some of that through. In fact, if you look at this year’s $55 million, some of that is cost model-driven. Some of that is the passing through of paperboard where we buy paperboard externally, for example.

And also, in the area of freight, those oftentimes are also discussions we have with customers around the freight from us to them.

And there’s typically annual resets oftentimes associated with freight, particularly given the kind of now low double-digit freight inflation that’s very well chronicled and certainly impacting anyone who is moving product in a material way, much like us..

Okay. And then I had one follow-up. And that is if you look at the EBITDA guidance for the year and what you’re saying, it looks like the fourth quarter might be similar to last year, which was unusual in that you typically have a seasonal sequential drop from third to fourth.

But I guess with all these pricing initiatives and with maybe some of the catch-up on some of the cost modeling, it looks like you could have a better fourth than third if – depending how much of probably a billion you get to..

No, that’s right, Chip. There’s a little bit of seasonal slowdown that we do see at the volume level.

But the pricing movement through the business is pretty material as you start to move from – as you see from Q3 and Q4, which gives us confidence in kind of the sequence, if you will, the $265 million to $275 million this quarter and then the follow-on, which would be a good solid quarter both for our traditional core business as well as the SBS mill and foodservice assets, which are operating quite well relative to expectations, setting aside what we chatted about with regards to Augusta..

Yes, I’ll just add on to that, Steve. I think the other thing we have this year is obviously synergies that are coming in on Q3 and Q4 now that were well into this. So that helps explain that as well, Chip..

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

Thank you. Good morning, Mike. Good morning, Steve. I wondered if we could start off just talking about sort of capital allocation. I know you want to reduce debt. I know you want to increase SBS integration.

But with the stock at $14 today, is share repurchase also part of the equation?.

We have a share repurchase plan that’s out there. But as we said consistently here, our focus this year is primarily on debt reduction. We want to get our balance sheet in good shape. So we’ve talked about, Mark, to be prepared in the event that IP wanted to unwind our combination, which could happen as early as January 1, 2020, as you know.

Having said that, we will be opportunistic if there is a significant dislocation in the stock. We have the levers to pull to deal with that – take advantage of that, I should say..

Okay.

And then is it possible you could give us an update on both the Santa Clara proceeds and then any growing opportunities over in Europe because of this increased focus over there on reducing single-serve plastic?.

Yes. Just briefly on Santa Clara, we continue to market that facility and expect – we’re working towards a transaction this year. That’s what we’re targeting. There’s been no real change in that regard, and we’ll certainly continue to keep you updated, but no change in terms of our desire, the intent and the likely proceeds from a range perspective..

And in regards to Europe, Mark, in addition to some of the similar CPET tray substitution opportunities we’re seeing, as we’ve talked about in the past, we see an acceleration of replacing shrink film, particularly for our beverage application.

So we’ve got a growing backlog there relative to NPD activity, new product development activity, focused on those initiatives as well..

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

Good morning, guys. It’s been a couple of quarters in a row where we see the cost inflation, including freight, be a bit of a headwind. And I know you guys, the goal is to offset that over time with pricing.

But some of the others in the industry have a little bit of a shorter lag on those implementations and more of an ability to kind of keep it contained within the calendar or fiscal year.

Given the strength in the industry and we’ve all seen that the boxboard data has been solid, why not try and work your relationships with customers to shorten those lags as opposed to pushing these open market increases that we’re seeing now? Do you think you could use the power – relative power that you’ve got in negotiating more for shortening those lags as opposed to just raising pricing?.

Thanks for the question, Brian. I guess I’m going to take a little different tack. I think to your point, the favorable supply and demand balance that we have right now has allowed us to really drive five price increase announcements. So far this year, we’ve got four of them have been recognized, one of them is pending, to your point.

And that’s all focused at recovering that price/cost spread that you’re speaking to. Having said that, what is really more important for us is to stay out in front of this inflation recovery and have more frequent increases that will allow us to recover and recapture that inflation that occurs.

I think what we’re doing this year is really showing you how we’re planning to deal with that. And I understand the question around the nine months versus shortening it. But the real issue here is if we can get pricing on an annual basis that continues to flow through the business, that becomes a little bit less of an issue..

Okay. Great. And just a follow-up, could you maybe just comment on what the multiples you’re seeing in the M&A environment? I mean, the deal you closed recently seemed like it was still done at a pretty attractive multiple.

But we’ve been hearing more and more about private equity being more interested in the space in general and multiples coming up a little bit. Just kind of comment on your thoughts for the deal that you’ve gotten, the pipeline, if you can continue to do them at the historical multiples that you’ve done deals at..

Yes, thank you, Brian, for raising that. Certainly saw with PFP that, that is a multiple quite consistent with what we’ve seen in the past, kind of that eight plus or minus, kind of on the way in multiple, maybe slightly higher if there’s a growth trajectory there. But we haven’t seen anything that indicates that, that’s going to move materially.

Now that being said, we’re early in some of what we’re trying to do on the SBS side throughout its integration.

But so far, we haven’t seen anything that would indicate that we’re in a different environment relative to both the multiple on the way in and, most importantly, the post-synergy multiple that we can get to with the kind of capture that we talk about pretty consistently on driving integration, taking out costs and SG&A and the like.

So no real material change based upon what we completed and what we’re assessing..

Okay, thanks very much..

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

So on SBS, you’re – if I add back the $6 million, you’re actually tracking ahead of the $235 million that you pointed to for the acquired business. And I just wanted to see if there’s anything you could call out that’s going a bit better. Just if I add that back, you were performing better than we thought in the quarter.

And just could you comment on your volume outlook in that business for the back half of the year?.

Yes, thanks, Debbie. I guess what I’d point out is, to your point, if you add it back, we’re at – if you add that $6 million back, we’re at $220 million through six months. So to your point, slightly ahead of the $235 million. Volumes have held up very well in that business.

As I mentioned, year-to-date, we’re up 2.4%, and that was consistent Q1 into Q2. So we’re very encouraged about that. I talked about some of the substitution opportunities that we’re seeing there, foam to paper cups and some of these CPET replacement for both.

So I think that’s some upside as we round the corner out of 2018 into 2019, too, from a volume standpoint. In regards to what’s going better, I would point to the SG&A reductions that we talked about. We’ve been able to integrate the business quite quickly in that regard.

And we’re also slightly ahead of our schedule in terms of our paperboard integration of our external purchases of SBS into our own assets. So those will be a couple of things that I’d point to..

And, Debbie, this is Steve. Just on Mike’s point there, the integration of paperboard in-house, if you will, is going very well. And I think for a lot of folks following our top line, I think it may have been one of the reasons that it appeared we were a little short on the top line.

As we integrate those tons in, it’s actually – of course, that sale gets eliminated because we’re utilizing that in-house. We’re also – as Mike mentioned, we’re building a little bit of inventory in preparation for the SBS downtime that we’ll be taking in Q4. So I think relative to the top line, it actually met our expectations for the quarter.

I think one of the things that’s happening is an internalization of tons, 100,000 plus, that we’re bringing in-house that actually – that’s not a top line, if you will, because we’re utilizing it internally and it’s driving EBITDA and cash flow value..

Okay.

And if I would clarify on the incremental $25 million in inflation that you’re calling out, is that assuming sequential uptick in some of the headwinds that you experienced in Q2? And then what is the OCC assumption for that?.

Yes, thanks, Debbie. Just relative to that, on OCC specifically, so OCC and DLK, it’s relatively flat to where we’re at today with a small uptick of about $10 as we kind of roll into the fourth quarter. So a modest uptick in there, and that’s a couple million dollars inherent in terms of some inflation that we would see.

For the most part with regards to the others and that $50 million of total inflation, $30 million of that is freight alone. And what we’re really seeing that’s causing some of what the $10 million uptick is we don’t really see a subsiding of that in the fourth quarter.

We’re assuming that we’ll continue to see some inflation quarter-to-quarter in Q4, specifically about $4 million in the assumption that we’ve laid out for you in the material. So for the most part, it’s a continuation of what we’re seeing today, unless we have very clear knowledge that something is going to move a little bit higher.

But for the most part, assume it that what’s were seeing today, we don’t necessarily – and then freight would probably be the only one where – we don’t really see freight not having – we see freight having inflation in Q4. That’s probably a little different view than we would have had 90 days ago..

Your next question comes from the line of Adam Josephson with KeyBanc Capital Markets. Your line is open..

Mike and Steve, good morning. One on the price/cost next year. Steve, I think you talked about $125 million of additional gross pricing in 2019 before the CUK increase. So let’s say bit of kind of timing of that increase, assuming it’s successful, you got another $20 million or so.

So let’s say, you have an additional $150 million of gross pricing next year, you talk about labor and benefits inflation of $25 million to $30 million, can you give us a sense for what your average input inflation has been over the past several years [Audio Dip] of what the inflation offset could be for that additional pricing next year?.

Yes. Maybe just to put it into context now with who we are today, obviously, with the SBS mill and foodservice assets. Our commodity spend is about $2 billion. It’s a little over $2 billion, Adam. So I think that will help you put into context what kind of potential inflation scenarios could play out next year.

Cumulatively this year with what we’re talking about, but certainly with several movements of material dollars, for example, of that $2 billion, just under $0.5 billion is freight for the total company, assuming the inflation we’re seeing this year. And it’s actually our largest single spend in that commodity bucket of a couple billion dollars.

So this year, we’re actually seeing net – even with OCC down, we’re seeing a net 3%, 4% type inflation across that basket of costs, certainly driven by chemicals, freight and some of the higher-end pulp substitutes for recycled products that we use in our CRB mill. So that just – again, try to give you some sense for that.

Obviously, labor and benefits, $25 million to $30 million, that will actually move up next year because, keep in mind, next year, we’ll have the team, the SBS and foodservice team in that calculation. Today, they’re just in the $235 million.

So we’ll come back to you and that number will move up $5 million to $10 million, and we’ll bring that forward, when we eventually discuss guidance for 2019..

Thanks, Steve. And just one on SBS.

Why didn’t you announce a second SBS price increase along with the second CRB and CUK price increases, particularly considering that you announced an increase that is on all three in the winter or spring, and it sounds like there’s some SBS demand remains pretty healthy?.

Hey, Adam. It’s Mike. I mean, the overall dynamics of that market are good. The operating rate, your data as you’re pointing out, is over 95%. Actually, it’s closer to 97%. Having said that, we’re not going to talk about forward pricing actions that we would do that just wouldn’t be appropriate for us to do.

We continue to assess supply and demand dynamics. As Steve mentioned, we’re building a little inventory right now because we’ve got an outage that’s going to take place in Q4 of this year. So we’re balancing through all that. But we’re looking at what that looks like, and we will continue to keep you posted on what we end up doing with our pricing..

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

Good morning.

Can you offer some perspective on the mounting of assumptions and just what you’re hearing from your customers in how new addition [Audio Dip] in the business you had and how you think that might play out for you?.

Yes, Gail. In regards to the direct impact for Graphic in terms of revenue, it’s measured in approximately $20 million of our total revenue out of $6 billion. So it’s pretty small in that regard. There’s certainly some impact on some of the commodities that are out there that we buy, and we talked a little bit about some of those.

But in terms of what it is directly for Graphic, it’s pretty small right now. And having said that, many of our customers are talking to us about some of the concerns that they have around that. But it isn’t right now a direct impact on our business per se..

Okay. And then switching gears. Steve, I’m just looking at possibly converting paper [Audio Dip] or paper mills to paperboard, including the CUK. And I’m just wondering how you think about the global dynamics kind of incremental like 400,000, 500,000 tons [indiscernible] plastic..

Yes. I guess that’s a hard question for me to answer right now because I don’t – when they say packaging grades, I don’t know exactly what they’re talking about actually producing. Historically, that’s tended to be more liquid packaging than beverage packaging, which, as you know, is what we tend to focus on in our business..

I’m calling it CUK. I don’t know if that’s – their definition is different than yours, but that’s what they’re calling it..

I guess we’d have to see what end use applications they’re looking at. I mean, we’ll look to continue to monitor that situation. But as I mentioned, they’re – or as you said, they’re in the preliminary evaluation stage. So by the time they got something approved and built and converted, we’re talking a couple of years down the road.

And again, one of the things that we do, we’re not selling open market CUK in Europe. We’re exporting our CUK and converting it at our own converting facilities directly for our customers. So it’s not like we don’t have downstream demand for what we’re doing..

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

Hi, thanks. Good morning. So just wanted to ask again about the outlook a little bit.

What’s the likelihood or confidence that you have in fully offsetting all this inflation in 2019? To your earlier point of getting ahead of these inflationary pressures, I mean, would you see the requirement of another round of price increases across all three grades to make that happen? Thanks..

Arun, it’s Mike. I guess in regards – Steve did a pretty good job of modeling out what the gross pricing looks like into 2019, and it’s significant. We are not in a position right now today where we can forecast what inflation will be in 2019. But we explained that we’ve got about a $2 billion spend in that regard.

And so you can model a little bit based on what that looks like today and historically and take a look at that from your perspective. In regards to additional pricing, as inflation continues to increase, we will seek to recover it. And I think our actions so far this year have demonstrated that in a favorable supply and demand dynamic..

Okay.

And just as a follow-up, do you think there’s any receptiveness amongst your customer base or competitors for surcharge or any kind of mechanisms to offset the freight inflation that you see and some of the others as well?.

We have pricing mechanisms that actually capture that freight for customer deliveries, if you will. You have to remember, of that $500 million of freight that Steve talked about, over half of that is shipped to ourselves. So that’s recovered with some of the actual pricing that we got on the open market paperboard.

And then beyond that, some customers actually pick up the material themselves, and some, we deliver. Those who we deliver, we have mechanisms that will reset over time, usually on an annual basis..

And just the last one is, any thoughts, future thoughts on potentially buying out the IP stake when it becomes available? Is that still something you consider or not?.

Well, again, Arun, that’s really their decision. They have the decision to make if and when they decide to do that. It’s not a Graphic Packaging decision. If they decide to do it, we’re getting our balance sheet in a position that would allow us to do it if they put the shares to us..

And, Arun, it’s Steve. Just if they do take that decision, contractually, the way that we establish that process is the actual put, if you will, of their decision to sell the stake, it occurs contractually in $250 million share equivalents every six months.

And so it’s a sequenced process that would be a two or three-year stress the balance sheet in any material way. Now we could choose to go faster. As we’ve talked, if the balance sheet was in a place that we wanted to do so, we could probably advocate that.

But contractually, it’s a very thoughtful exit relative to it being, over time, in kind of tranches of twice a year, if you will, specifically every six months, $250 million at a tranche, which is important relative to the balance sheet flexibility that we’re working to maintain to also give ourselves the flexibility on the tuck-unders and the ongoing integration options available to us..

Your next question comes from the line of Daniel Rizzo with Jefferies. Your line is open..

Good morning. You mentioned that the backlog is at five-plus weeks and you termed that as healthy.

I was just wondering, just probably speaking, what average – what backlog average is?.

I guess what I’d point to, Daniel, in that regard is the better way probably to look at that, we’re talking – that’s our internal demand. And again, we’ve got a lot of – 86% of the paperboard we manufacture at our CRB and CUK mills is internally integrated.

If you’re looking for a gauge of strength, I’d point you to the AF&PA operating rates, which, as we talked about, are all above 95% year-to-date..

Okay.

And then I guess, what I also was looking for is if there’s been significant prebuying, just in anticipation of what’s going to occur in the second half of the year?.

We’ve not seen that..

Your next question comes from the line of Steve Chercover with Davidson. Your line is open..

Good morning. Little bit of late in the session, but thanks for taking my question. So first of all, I was wondering if you could be a little more specific about what pulp substitute have actually moved higher because I guess we were looking – we look generically at OCC and whatnot..

Yes, it’s a really good question. I think that’s one of the challenges we have. We – what we buy isn’t all OCC. We’ve talked a little bit about this in the past. We buy probably 950,000 tons. We probably buy about 1 million tons of total fiber. Half of that is OCC and half of it is other grades that go into making CRB.

In the very top layer, the top 10% to 15% of CRB sheet tends to be high grades and pulp subs because the trade-off is you don’t have to use as much coating if you are using something that’s a little cleaner, a little whiter, Steve. And so those have inflated so far this year by about $40 a ton, and we buy in the neighborhood of 200,000 tons.

So you can get the math on that..

Yes, I thought that might be the case because intuitively, everyone focuses on OCC….

And as you know, I mean, the demand for that is pretty strong because with pulp prices going up as they’ve done on a global basis, people who are making tissue in particular are substituting a lot of that for some of their pulp purchases..

Yes, just repeating what Mike said, 200,000 of the roughly million, so 20%, kind of fall into that high-grade category where we’ve seen that $40 move, from a year-over-year basis, up. And that’s what driven that – what we recognized as $5 million beyond our expectations, but it’s actually inflation that’s closer to $10 million in total..

Yes, I thought that might be the case, and I just thought it was maybe worth flushing it out because I don’t sort of think it’s intuitive.

And then I would then take the opposite track perhaps to Mark Connelly and say, in addition to coffee cups and the SBS pressed bowls, can you give us other examples of where you might benefit from what I’m going to call a war on plastic?.

Well, I think just in general, we’ve – it’s always been a highly competitive market, and we expect it to continue to be that way, Steve, going forward. We’re not suggesting that paperboard is just massively replacing flexible applications. We’re not seeing that. There are some discrete areas where we’ve seen more momentum. We’ve profiled a few of them.

Foam, some of the shrinkwrap on beverage are two great examples for us. But we are seeing more wraps, too, around products like frozen food products and that type of stuff as opposed to a flexible film. That can now be a small paperboard sleeve, if you will, that kind of stuff.

And that’s why I’m saying treat it a little bit as a tailwind is how we’re looking at it. And I think that’s appropriate given what we’ve seen at least year-to-date..

Okay. And one last odd ball one.

If IP were to trigger the put in 2020 and given that it’s a lengthy process, can they reverse course?.

It’s a decision that’s made tranches at a time. And so we had actually made with each of the decision points are up to $250 million. And so it’s not an all-or-nothing decision. It’s a decision to exercise, if you will, the first $250 million. That would get done and then potentially the next.

Now again, we could go to them and advocate something different, but contractually, it’s a sequenced series and it is a series of decisions..

Okay. Thank you both..

You bet, Steve..

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

Thanks for taking my follow on. Steve kind of stole one of my last ones, but I’ll ask it a little bit differently.

In the 2.4% growth that you say you’re seeing in foodservice, is there anything that is one-off, relatively sizable, et cetera, such that next year’s growth in foodservice would be below the 2.4%? Or do you think you can maintain this level of growth into 2019? My other two questions, one, just remind us if it’s possible and if we exclude Augusta from the discussion, is there anything year-on-year in third quarter or fourth quarter from a maintenance standpoint that we should be thinking about as we go through our own EBITDA bridges? And in inflation this year, there’s been a lot of discussion obviously about freight.

Recognizing there’s been significant inflation here and in other commodities, was there anything like out-of-pattern freight or anything in terms of your usage that would correct from an operational standpoint in 2019 versus 2018. Thank you, guys. Good luck in the quarter..

Thank you, George. In regards to growth around the SBS assets at 2.4%, again, we’ve been able to drive that down two quarters in a row. Admittedly, we’re early on in those assets, but based on what we’re seeing, it’s a pretty balanced growth. It’s not one particular thing that’s driving all that growth. It’s really around the perimeter of the store.

It’s foam conversions, those types of things that we’ve been talking about. And again, in the context of our organic growth in our legacy or core business, we’ve now seen six quarters in a row where we’ve seen some modest growth.

This quarter was a little bit muted because of some of the mega beer in North America, but we were still able to play to a draw even with a pretty sizable headwind on that. So we think that, that growth profile is intact, George. In regards to maintenance implications for Q3 or Q4, Q3 is the same as it has been from a scheduled standpoint.

We’ve got our Macon annual outage in Q3, but the duration of that is consistent with what we’ve seen other years. In Q4, we had the big Augusta outage, which is 42 days, as I mentioned earlier. But as we’ve talked about, that will be taken below the line, so that will be normalized out.

And in regards to freight, any potential pickup we could see going into next year, there is a little bit of pickup that we will see in Q1 and Q2 of next year from a mode standpoint where we ended up tracking a little bit more of our paperboard, given the tightness.

And it was really driven by the closure of the Santa Clara mill and getting our logistical lines all lined out as we shut that mill down in the end of Q4 of last year, as you know, and had to reload that inventory back into the supply chain.

So there’ll be a little pickup in that regard, but it’s measured in several million dollars as opposed to tens of millions of dollars..

I will now turn the call back over to the CEO, Mike Doss..

Thank you for joining us on our earnings call. We look forward to speaking with you again in October..

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