Graphic Packaging Holding Company (GPK) Q3 2021 Earnings Report, Transcript and Summary

Hello everyone. And welcome to the Graphic Packaging Third Quarter 2021 Earnings Call. My name is Harry, and I'll be your operator today. [Operator Instructions] I'll now hand the call over to your host, Vice President of Investor Relations, Melanie Skijus. Melanie, please go ahead.

Good morning and welcome to Graphic Packaging Holding Company’s third quarter 2021 earnings call. Joining us on our call today are Mike Doss, the company's President and CEO; and Steve Scherger, Executive Vice President and CFO. To help you follow along with today's call, we will be referencing our third quarter earnings presentation which can be accessed through the webcast via self-directed slides and also in the Investors section of our website at www.graphicpkg.com. Before I turn the call over to Mike, let me remind you that today’s press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties and include, but are not limited to the factors identified in the belief and in our filings with the securities and exchange commission. Now, let me turn the call over to Mike.

Thank you, Melanie. Good morning to everyone joining us on the call and webcast this morning, our performance in the quarter was strong. We successfully navigated a complex supply chain and labor environment. We raised prices where necessary to offset accelerated commodity input cost inflation. We received the required regulatory approvals, for our AR Packaging acquisition and made significant strides towards completion of our transformational CRB platform optimization project. All of these accomplishments are aligned with the goals that we establish with vision 2025 and have us on track to meet or exceed our long-term aspirations for the business. Demand for more sustainable and circular packaging options continues to accelerate globally. The ongoing evolution to practice and promote more environmentally responsible behaviors is evidenced by the increasing number of new pledges made by global corporations to eliminate waste and increase the focus on recyclability, all supportive of commitments to lowering carbon footprints. The examples include proactive announcements by retailers around the world. Moving to minimize the impact that packaging has on our planet. Consumers are making their preferences known and companies that are serving them are responding to fiber-based packaging solutions we are developing, and the role we play in providing consumers with packaging choices to promote a more sustainable and circular economy, provide our employees with an immense sense of pride. This shows through our continued innovation in new product development initiatives. Along with service levels, we provide our customers in today's very challenging supply and labor environment. We established Vision 2025 in September of 2019, and they've demonstrated a very real pivot to organic growth since that time. While Q3 organic sales declined slightly. We still expect deliver organic sales growth in 2021 at the high end of our 100, 200 basis points annual target on top of the 4% organic growth we generated in 2020. On Slide 3, let me cover additional highlights from the third quarter, we've been successful in positioning the company to capture growth opportunities in this very strong demand environment we are growing with existing customers. We're ramping up with new ones in new markets. Momentum for fiber-based consumer packaging solutions is materializing at a time when we are experiencing unprecedented inflation, supply chain bottlenecks and labor market challenges. We estimate that the constraints in supply and labor markets resulted in approximately $25 million in delayed sales in the third quarter. We delivered strong adjusted EBITDA growth of $284 million, up 14% year-over-year. EBITDA growth was driven by positive price realization of $53 million and favorable net performance of $79 million, which offset unprecedented commodity input costs inflation of $88 million experienced in the quarter. The current environment with all those twists and turns is not deterring us from the focus on meeting or exceeding our Vision 2025 goals and capturing global demand for sustainable packaging solutions. Our dedicated teams are working tirelessly to keep customers in supply or backlogs remain elevated across all our paperboard substrates. As a result of the continued inflation and commodity input costs, we have taken swift pricing actions to recover the price cost dislocation we are experiencing this year. We committed to you that price would offset commodity input costs over time, and that any dislocation would be short-lived. We are delivering on that promise. As we have discussed with you over the past several quarters, we have implemented a number of initiatives to reduce pricing recovery legs, the customers, and have been negotiating positive modifications of other business terms. By the inflation we were experiencing this year as one for the history books, we are doing what we said we would do. Approximately $650 million in pricing initiatives had been implemented and will be recognized over the 2021 and 2022 time horizon. We recently published our latest, comprehensive ESG report and we outline the many initiatives underway to further drive sustainability across operations and innovation and product development with the end customer in mind. We intend to continue to invest in innovation and promote progress in sustainability to support the migration to a more circular economy. Just little earlier, we have been pursuing the required regulatory approvals for the AR Packaging acquisition we announced in may of this year. I'm pleased to report that we have received the final necessarily regulatory approvals this month. And we are working towards the November 1st close. In addition, our CRB platform optimization project remains on track for a startup of coated recycled paperboard production on our K2 machine in the fourth quarter. Turning now to Slide 4, you will see the innovation powerhouse that the combination of AR Packaging will create, large distributed footprint of AR Packaging is twenty-five converting facilities across Eastern and Western Europe at significant scale and cost efficiency benefits. The completion of this transformational acquisition extends our global reach, expands our service offerings and advances our commitment to sustainable packaging solutions for customers around the world. We intend to share our growth plans and milestones for the integration of AR Packaging along with an update on Vision 2025. When we report our fourth quarter and full year 2021 results, we will do this at an investor meeting on February 17th in New York City, where we look forward to hosting many of you in person and also providing a webcast for those of you who will need to attend remotely. Turning to Slide 5 and a second, extremely impactful, and well-timed strategic initiative. You can see the picture of our new state-of-the-art K2 CRB machine. Our team is executing a significant investment in our paperwork capabilities, the build-out and startup of the K2 machine in Kalamazoo, Michigan is the largest component of our CRB platform optimization project. And we are on track for paperwork production to begin in the fourth quarter. We are well into the operational readiness phase. We have our teams in place and we're completing the most extensive training effort in our company's history. We look forward to bringing this world-class lower cost, higher quality CRB platform, investments like over the coming quarters, working with our customers to grow their commitment to the recycled fiber-based solutions will generating the returns. We're committed to achieving. Turning to Slide 6. I will provide a few additional remarks on the current environment for pricing and the positive momentum we have to offset historically high commodity input cost inflation. We have executed $63 million of positive price that has flowed through the business over the first nine months of 2021. And we expect to realize that probably $77 million of positive pricing during the fourth quarter, we're currently targeting $510 of pricing in 2022, based on implemented and recognized pricing initiatives. The price actions are intended to fully offset the inflation we are experiencing across a wide array of commodity input costs. In total at this point, we expect to execute approximately $650 million in price actions over the 2021 and 2022 time horizon. As I’ve share today, global demand for fiber-based packaging solutions continues to grow. On Slide 7, let me touch on the steady and consistent nature of the value paperboard substrates have earned over time. Over the 15 year period captured here, you can see the steady, but increasing pricing for our paperboard substrates. This can be attributed to a healthy underlying demand for paperboard solutions, supply at levels required to meet customer demand and the introduction of new packaging solutions, driving growth in existing and new addressable markets. Before I turn the call over to Steve for a more in-depth discussion of our financials and guidance, I’d like to take a minute on Slide 8 to reflect on the organic growth we’ve generated since 2019. We surpassed our net organic sales growth goal in 2020, delivering 4% growth and we expect to deliver at the high end of our targeted 100 to 200 basis points goal this year. Notably, this year’s expected net organic growth of approximately 200 basis points reflects growth on top of the very strong growth we drove in 2020. The year-to-date picture on the slide tells the same story. Net organic sales have experienced growth of 2% compared to the same period in 2020 and the two year compounded annual growth rate for organic sales since 2019 is 3%. This trajectory is consistent with our organic growth expectations for the business as we continue to see conversions to fiber-based packaging solutions. We have positioned the company to capture growth opportunities in the years ahead, and we have accomplished a great deal so far this year. We look forward to closing the acquisition of AR Packaging in the next week and the start-up of our K2 machine in the fourth quarter. Simply put, we’re running a different race. The strategic priorities we are focused on and executing are redefining our leadership in the industry. With that, I will now turn the call over to Steve.

Thanks, Mike and good morning. Moving to Slide 9 focused on key financial highlights. Net sales increased 5% or $84 million from the prior year period to $1.8 billion. The year-over-year increase in sales was driven by higher pricing flowing through the business and acquisitions. Adjusted EBITDA increased 14% to $284 million resulting in improved adjusted EBITDA margin of 15.9%. Adjusted earnings per share grew 31% to $0.34 a share. Finally, our integration rate increased to 73% as we continue to internalize all paperboard into our converting operations. On Slides 10 and 11, you’ll see our revenue and EBITDA waterfalls. The drivers of the 5% year-over-year increase in sales were $53 million in pricing, $20 million of higher volume mix and $11 million of favorable foreign exchange. Adjusted EBITDA increased $34 million or 14% year-over-year to $284 million in third quarter versus the prior year period. The increase is notable, given accelerated commodity input cost inflation and materialized in the quarter. Adjusted EBITDA growth was driven by $53 million in price, $3 million in volume mix and $79 million in improved net productivity. Adjusted EBITDA was unfavorably impacted by $88 million of commodity input cost inflation and $13 million of labor, additional financial and market detail. Our Food Service business continued to recover from last year, growing 11% year-over-year, while food, beverage and consumer sales improved 3% including acquisitions. Mike pointed to $25 million in delayed sales resulting from supply chain and labor market constraints during the quarter. All the supply chain bottlenecks impacted all areas of our business, labor availability challenges were more specific to our Food Service business as we continued to ramp up production from the declines experienced in 2020. Without these delayed sales, none of any sales growth would have been flat for the quarter in line with our expectations. AF&PA industry operating rates were strong again in the third quarter. CRB was 95%, while SBS improved sequentially, and it was 96% at the end of the quarter. Our CUK operating rates continued to be well above 95%. These operating rates reflect the strong demand environment for paperboard. AF&PA third quarter data also showed continued declines in industry inventory levels with balances at multi-year lows. Backlogs are elevated at eight plus weeks across the UK and CRB and a six plus weeks in SBS. We ended the quarter with net leverage of 3.97x. I will discuss our cash generation expectations with you shortly. We have clear line of sight to bring leverage down to 3.5x or lower at the end of 2022, after leverage peaks in the fourth quarter, due to the financing for AR Packaging acquisition. Global liquidity was $1.8 billion at the end of the third quarter. Importantly, after we fund and complete the AR Packaging acquisition, our global liquidity will remain substantial with approximately $1 billion available. Turning now to full year 2021 guidance on Slide 13. We’ve updated guidance to reflect additional price actions, higher commodity input cost inflation, higher net performance and the assumption AR Packaging as part of our business effective November 1. 2021 adjusted EBITDA is projected to be in a range of $1.04 billion to $1.06 billion. The component and the EBITDA guidance change is the accelerated commodity input cost inflation occurring in the second half 2021. As Mike mentioned, we are actively taking the price actions necessary to offset this increased level of inflation. We anticipate cash flow will be in a range of $100 million to $150 million for the year. Capital spending has increased modestly driven by inflation across raw materials and the labor required to complete critical strategic projects on time. On Slide 15, I will wrap up my prepared remarks with a look into 2022. We continue to be very confident in the guardrails we provided last quarter for adjusted EBITDA in the $1.4 billion plus range. Importantly, on this slide, you can see the components and the walk to the substantial estimated EBITDA growth we will be driving next year. AR Packaging and Americraft are expected to contribute $160 million and $30 million before synergies respectively. For the base business it is reasonable to assume at least $20 million from our traditional EBITDA drivers of volume mix and net performance more than offsetting labor, benefits, other inflation and FX. The first $50 million of incremental EBITDA from our Kalamazoo project and a minimum recovery of $170 million of 2021 price cost dislocation provides a clear step change hire to adjusted EBITDA of $1.4 billion plus in 2022. The significant expected growth in EBITDA coupled with our commitment to meaningfully lower capital expenditures to next year, following the large capital project at Kalamazoo results in significant cash flow generation. The material EBITDA growth and cash flow generation projections give us line of sight to year end 2022 leverage at 3.5x or lower. We look forward to provide you with more detailed 2022 guidance when we meet with you in February. Thank you for your time this morning. I’ll now turn the call back to the operator for questions.

Thank you. [Operator Instructions] And our first question comes from Mark Wilde of Bank of Montreal. Mark, your line is open now if you’d like to proceed with your question. Mark your line is now open, if you’d like to proceed with your question. We are having some connection issues with Mark Wilde there. I’ll move on to our next question, which is from Mark Weintraub from Seaport Research Partners. Mark, your line is now open if you’d like to proceed with your question.

Thank you. Last quarter I believe you had indicated that the rollover impact from inflation at that point in time to 2022, you would have gauged at roughly $50 million to $75 million if I remember correctly. If you were to update that number today where would it stand?

Hey, Mark its Steve. Good morning. Yes, we’ve updated obviously for this year, the inflation now midpoint of $310 million and the rollover effect is in the $100 million to $125 million range, assuming everything stays as is. So the cumulative two year inflation right now is in the $400 million to $425 million range. Obviously we shared with you today that our cumulative price activity over that same period of time is the $650 million that we shared with you today.

Okay, great. And so just to make sure I fully understand that. So I think you had – just trying to get to side, here we go. So you talked about $510 million on the pricing side for 2022 recognizing that there certainly can be a lot more inflation or not from where we are today. So if we think about the price cost, if things were to be fixed today, can we take the $510 million and subtract the $100 million to $125 million and that would be a starting number for 2022, again, recognizing that we can get more inflation here. Is that fair? Or am I missing something?

Well, I think the way you want to make sure you think about it Mark is we have very clear line of sight to $510 million of pricing next year based upon known and recognized activities. That’s roughly $250 million a ton across the three primary substrate along with our cost models. And so then if you compare that, of course, to the flow-through on inflation, you’ve got $310 million this year, another $100 million to $125 million next year leading into the low 4s. So we need to, and all we committed to on the slide with the – to the $1.4 billion plus is that we’ll first recover the $170 million of dislocation this year and then whatever inflation comes next year, obviously we have plans in place to recover that as well. The $100 million to $125 million is what would be known carry over today. Does that give it to you specifically?

That does. Thank you. Thank you very much. Okay, great. And just lastly if I could. Level of confidence in getting that $510 million on pricing, is that pretty contractually established? How much work is needed to achieve bringing those numbers to the bottom line? What level of confidence should investors have about that at this point?

Yes. Good morning, Mark. It’s Mike. They should have a high level of confidence and this is contractually driven. These are multi-year contracts, so it’s flowing through an execution of the contractual terms of those agreements.

Super. Appreciate it.

Thanks, Mark.

Thank you, Mark. And our next question will be coming from Ghansham Panjabi [Baird]. Ghansham your line is open now, if you’d like to proceed with your question.

Yes. Thank you. Good morning, everybody. Just as a follow-up to Mark’s question, can you comment on the velocity of inflation that you’re seeing at current versus as you kind of get granular with the various constituents? I know there’s a lot going on with OCC for labor and random shots like the China curtailments that are impacting other industries. But at this point, are you starting to see a plateauing sequentially?

Yes. Good morning, Ghansham. I’ll start. This is Steve and Mike can add on. I think certainly what we saw throughout the quarter was an acceleration of inflation. And as we talked during the quarter on the occasions where we had the opportunity to do so when we saw more inflation, we took a more pricing action and it kind of flowed through in the incremental $100 million of inflation from the last time that we spoke. And it was pretty widespread, I mean about $100 million, half of it is well chronicled relative to chemicals, energy, resin all moving up. We also saw OCC move up. That was another significant part of the $100 million. And then of course, the ongoing challenges on the logistics front just in terms of rates for truck, rail as well as ocean. So it kind of all moved through the $120 million that we’re guiding for Q4 is representative of what we’re seeing at today. And obviously we don’t try to hypothesize whether they’ll move up or down from here. Mike, anything you want to add to that?

No. I think what you’ve seen Ghansham is that like an OCC it’s kind of went up 11 months in a row and in the last couple of months it’s kind of peaked. And so we watched those kinds of things. But as Steve said, it’s pretty difficult to try to forecast out what inflation is going to do. As you know, it seems like every month there’s a new commodity that somehow gets challenged. And so we’re dealing with those things. And I think the point that investors should look at here as Steve outlined is with pricing actions we’ve taken, we’re in a really good spot relative to how inflation develops as we go into next year, both in terms of the carry over and additional inflation that we could incur. And as we’ve demonstrated here since our second quarter call, when we see more inflation, we will take more pricing actions, we’ll offset that.

Okay. That’s very helpful. Thank you for that. And then for my second question, every inflation cycle customers trying to mitigate price increases to consumers by reducing packaging size and also decontenting material to some extent. How do you see that dynamic playing out in the current inflation cycle, which is much more severe in the magnitude? And do you see the lightweighting and packaging size shift as a volume risk for you in 2022? Thanks so much.

Yes. Thanks for that question. I appreciate it. I think if you look at packaging in general across a wide swath of different packaging mediums, they’re all inflating at relatively similar rates. And so, the substitution piece of that is going to be pretty minimal based on how we see it. In terms of lightweighting and packaging optimization those are the things that we deal with our customers all the time. And it actually creates some opportunities for us, particularly on the fiber-based side. So we would actually see that probably as more of an opportunity than a threat going forward.

Okay, great. Thanks so much.

Thanks, Ghansham.

Thank you, Ghansham. Our next question comes from George Staphos from Bank of America. George, your line will be open now, if you would like to proceed with your question.

Thanks very much. Hi, guys. Good morning. Thanks for all the details. I wanted to hit some – two questions, generally one on volume and then the other on Kalamazoo. So in terms of volume, you documented pretty well in terms of what was affecting you in the third quarter, the lost revenue. A lot of that effect hitting you in food service. What comfort do you have that the supply chain issues and labor issues that were affecting you will moderate here such that volume should be as expected in the fourth quarter? And aside from food service, can you talk a bit about where you’re seeing particular strength for your products, especially the new products, Mike. And I ask that partly with some content recently that I’ve seen where one of the major QSR changes is moving from a poly coated paper cup back to plastic. So, where do you stand with your defense of that with a PLA coated cup?

Yes. So thanks for that, George. I think if you kind of take a step back and we’d kind of outlined this a little bit in our prepared comments, but it’s good to spend a little bit of time on it too. Year-to-date through the second quarter, we saw our volumes up 3% across the board. And as you recall, we reiterated at that point in time that we’d be at the high end of our 100 to 200 basis points. So as Steve mentioned in his comments, we actually saw a little bit of this coming in Q3 and anticipated relative to the guide that we gave on the second quarter. There are really four things that hit us in the quarter relative to the organic volumes being down 1%. First and you’ve seen this from a number of our customers that have already released, our customers were having some challenges with their supply chains. And obviously if they don’t make a package, we don’t sell a box. And so there was some of that going on. Some labor availability on the food service side of our end use markets as well. That’s been pretty well chronicled. And in our case, the ramp of food service is just a – we had to add over 200 people back. And if you think about when the pandemic hit, we actually had to right-size that business real quick and we did it. But then as the volumes comes back in a strong way like we saw them happen here in the second and third quarter, adding that many people in a rapid fire fashion just isn’t easy in this environment. So our labor issues are fairly discreet in our food service business. Yes, we see it really across our platform. But in terms of the impact on volumes, it would have been in the food service business. So we have the demand, the issue is getting the people there so we can actually execute. And we’ve made some progress in our third quarter as we go into the fourth quarter. So that’s part of the comfort that you hear from me. We also lost the facility for about two months in the Northeast as part of Hurricane Ida. It just got flooded out and so we had to move all that volume around, and that costs us a little bit of sales in the quarter. And then lastly, some of the open market paperboard that we buy in Europe just became difficult to get in some cases. And so that slowed us down a little bit in the European platform. Again, we have plenty of demand. The issue is getting the materials that we need in order to process them and actually get them out the door. So when you put that all together we see some of those things debating as I mentioned is, we’re in the fourth quarter here and we expect to return more towards that higher part of that 100 to 200 basis points and finish the year strong.

And George, just add to Mike’s point around the momentum on the innovation front. I mean, overall our momentum for fiber-based convergence, whether it’s foam cups continuing to convert over to fiber-based solutions or KeelClip solutions in Europe, expanding globally or PaperSeal solution gaining significant traction around meats and cheeses and other perimeter of the store activities. Those items, as we’ve talked quite a bit give us kind confidence that the 100 to 200 basis points of organic growth that we’ve experienced over the last two years will continue as we move into 2022.

Okay. I guess, Steve, I was hoping maybe if you had a quick update on PLA coded cups. If you have, well, maybe you’ll save it for the analyst presentation in February. And then my second question just quickly, with Kalamazoo coming up quickly, congratulations on that being on track and earlier, frankly, than your initial budgeting and guidance. There’s been some reports about the reaction in the community to the growth of the Kalamazoo project. Can you comment how you’re being received in the community? There’s also been some discussion about your tax benefits that you’re getting the facility, anything that we should be aware of in terms of how that project will drive return and growth for Graphic going forward. Thank you, guys.

Yes. So thanks for the question. I’ll deal with – I’ll mention Kalamazoo here in terms of our project. Yes, we’re on – we’re actually on our original schedule. We expect to make paperboard here in the Q4 towards the end of the quarter. And it’s important that we do because we absolutely need that paperboard to operate our business. We’ve got a lot of demand for customers that we actually need that tonnage coming online. Relative to some of the reports in – come out around some of the odor complaints, I think is what you’re referencing. I’d characterize those as kind of normal course. We’re dealing with those through normal channels. And there’s really from a return standpoint on the project, we’re investing well over $600 million. As you know, it’s a state-of-the-art facility and have the capability to be a great citizen in that community. And ultimately drive the jobs and additional production that we committed to when we started.

And George, very briefly off the cycle, we like the customer trialing that’s going on. We’ve got good momentum that we’ll share more with you as we kind of embark around into 2022. I’m sure we’ll talk about that specifically when we describe our overall innovation efforts when we’re together at February 17.

Sounds good. Thanks guys. Good luck in the quarter.

Thank you, George.

Thank you, George. Our next question is from Mark Wilde from Bank of Montreal. Mark, your line is now open, if you’d like to proceed with your question.

Yes. Good morning, Mike. Good morning, Steve.

Hey Mark.

Mike, I just want to start, if you could help us just unpack what’s gone on here in the cardboard market over the last three to six months, because it’s really been a very sharp turn in the market. Just trying to get some sense of how you understand it, the pickup in domestic demand, perhaps, set against maybe some difficulties bringing imported bleach board or imported kind of CRB into the market.

Yes. Thanks for that, Mark. I think you’ve answered part of it. I would also add, as you know, in 2019 and early 2020, there was some capacity taken out of the market. One of our competitors shut an SPS mill down, another one shut a paper machine down. We obviously shut down a small recycled paperboard mill in conjunction with our project in Kalamazoo. And at the same time, you’ve got strong demand. I mean, take a look at our demand. We’re up compounded 3% on volumes over that two year period of time, we’ve got a high market share as you know, approaching 40%. And so when you look at some of the dislocations and shipping challenges that some of the importers have had to deal with that has created a real desire for domestic production and thus the operating rates being about 95% in some cases, 97%. Backlogs at multi-year highs and industry inventories, as Steve mentioned in his prepared comments really down across all three grades. And so that’s really the dynamic that is going on. And again, why our start-up of our mill in Kalamazoo is so strategic, the timing of it just couldn’t be better relative to the demand we see out there, because we’ll have tons that’ll be able to help our customers meet their objectives. And these will be some of the highest quality, lowest cost CRB tons in the world. So we like that project better today than we did when we announced it. We liked them when we announced it. So I think that gives you a little color on what we see here.

Okay. And then just a couple questions around Europe. Last year you had some delayed machine placements. So I’m curious about how you sit on that. And then the impact of these European energy price spikes either on your existing business, as well as on the AR business.

Yes. Thanks for that, Mark. In terms of our machine placements, they’re growing along well, we’re able to get our technicians in now, I think on the KeelClip side, we’re up to almost 60 machines that we’ve placed and are installed and operational. And that’s on top of other machines that do wraps and baskets just the general movement there on the beverage side, auto plastics and into paperboard. So that’s been a real source of growth for us this year. In regards to energy rates in Europe, as you know, we’re converting only over there, even with AR Packaging, they’re converting only. So the actual impact of nat gas on our direct operations is relatively small. Obviously, we buy the paperboard and you’ve seen kind of rapid fire bunch of increases in surcharges that have gone off by European producers on that material. And the way our contracts, those will be pass along that we take on to the increases. As we talked about when we announced the deal with AR, those tenders tend to be a shorter duration and have more frequent openers because the vast majority of people who make folding cartons in Europe are non-integrated.

Okay. That’s helpful. I’ll turn it over. Thanks, Mike.

Thanks, Mark.

Thanks, Mark.

Thank you very much, Mark. And our next question comes from Gabe Hajde from Wells Fargo. Gabe, your line will be open now, if you would like to proceed with your question.

All right. Good morning, Mike and Steve. Thank you. I hate to harp on the inflation point here, but – and to be clear, I guess, you are in industry efforts to maintain or – even enhance margins, price increases is pretty encouraging. But if I want to sort of stress test, the assumption that you gave us kind of for the fourth quarter in terms of inflation and then heading into 2022, even just in the fourth quarter or the second half, I want to say it's going to be around 120 million for the fourth quarter, 210 for the second half, but you're telling us 100 to 125 for next year. So I'm curious if there's timing and something related to the cadence of that that says, okay, maybe things taper off in the back half of 2022. And then on the labor and benefit bucket that was kind of consistently running that 50 million range, this maybe run a little bit harder next year and I appreciate the magnitude. It's not nearly as big as an input cost, but maybe 60 million just given more labor and benefit markets are today.

Yes, Gabe, it’s Steve. Just to answer the second question, almost as you did, I think we'll likely see our labor benefits inflation be at the higher end of our range next year. And that's kind of been the guardrails that we provided to just given some of the realities that we've been talking about relative to labor availability and some wage inflation. But to your commodity input cost inflation question, as we've talked, we're not forecasting 2022 inflation at this point, but what we are sharing is that if everything kind of stayed as is, and a lot of this acceleration here occurred in the second half, so you're right, you've got $200 million plus in the second half of the year, if things stay where they are and you compare that then to the prior year, the rollover is in that $100 million to $125 million range, mostly because most of the acceleration, true acceleration has occurred in the second half of the year. And so most of the inflation on the carryover would be occurring in the first half of next year. Again, that's not a forecast that's important but it is the carryover in terms of that as your pressure testing it.

Okay. And then, I guess, again, sticking with inflation and I apologize. To the extent that, I mean, I'm hearing food and beverage brand owners talk about potentially 20%, 25% inflation, as they roll this inflation through the grocery channel, et cetera. And how consumers might respond, when they're spending their dollars on this, what is your experience when they've seen this, this kind of inflation in terms of, I guess, demand elasticity for the products that you serve do you see any kind of potential that consumers trade down and is that a net positive for you or a potential risk as we head in the 2022?

Yes, Gabe. Thanks for the question. It's a great question. I think look, I can't tell you that we've seen this exact experience relative to the amount of inflation that's flowing through, at least not recently. This is a couple decades since we've seen this kind of input cost inflation, shocks. I mean, I think the thing that I point to for Graphic and what positions us uniquely in the marketplace is 95% of everything we do is food and beverage base. So you're right. There may be some trade downs, maybe instead of buying branded, I go to store brand, but it's a physiological human need that I have to eat and drink, and we make those kind of packages that go into those kind of products. So and we've got a diversified portfolio as you well know, relative to food service and the at-home consumption. So, to our revenue makeup, it's a nice balance and really gives us the ability to benefit regardless of how that develops in the environment there, but it's definitely going to be inflationary. Going forward, there's no doubt about it.

And Gabe, just to add on to that as the occasions where for whatever reason, the economy comes to a slower position to either due to inflation or other activities, our business has been very defensive in the past as Mike mentioned. And so yes, there may be – there could be some headwinds but overall the trading down actually can be sometimes net favorable. And even if there's large dislocation on true consumption, they tend to be quite modest on a percentage basis. That's right. Bottom line is I guess Gabe, to summarize that our confidence level and our Vision 2025 goal of growing a 100 to 200 basis points between now and 2025 is hot based on the projects we see and what our customers are telling us.

Thank you, guys. We're just trying to remain vigilant over here.

Yes, absolutely.

Thanks Gabe.

Thank you, Gabe. Our next question comes from Adam Samuelson from Goldman Sachs. Adam, your line will be open now, if you'd like to proceed with your question.

Yes. Thank you. Good morning, everyone.

Good morning, Adam.

So I guess, first I was hoping to get a little bit more color on the performance in the quarter, the net performance line which was a positive 79 million contribution in the third quarter. That as far as back as I can see one of the bigger quarterly results that you guys have posted, maybe if you could dissect that a little bit, because and I think through some of the repair remarks that you've made earlier, it's talking more about headway and challenges around labor, around you had the mill in, in the Northeast rather than productivity benefits. So I'm just hoping to get a little bit more color on kind how you've been able to mitigate kind of some of these cost headwinds operationally.

Yes, Adam, it’s Steve, be glad to. Most of the headwinds that we've talked about kind of rolled through in terms of the waterfall, they impacted volume mix because of the volume not necessarily being there. So that's where those headwinds showed up. We were very pleased with our overall productivity in the quarter and you're right. It was a very substantial number, two primary drivers there, one just very good core productivity in that 34 million range. That's kind of at our expectations. And then on a year, over year basis, we had significantly less maintenance downtime year over year. We had quite a bit last year, much less this year. And our team's executed against that exceptionally well, so that positive for us in the quarter. So those are the two big primary drivers of positive there. You'll see that return back to more normalized in Q4. And as we look out over time, our 50 million to 70 million of core productivity is the right kind of range for the business, but no, it was a very strong performance relative to overall productivity in the quarter.

Okay. That's really helpful. And there's been a lot of discussion on the price cost dynamic on the call, but maybe just as we sit here today and we're evaluating kind of the future progression of some of these commodity markets. Anything start to come down quickly from on the chemical side or are you seeing anything more plateau versus where are the specific pockets that have been much more challenging through the second half of the year?

Yes, Adam, it’s Mike. So I would comment as I mentioned earlier, we've seen at least the last couple of months that it would appear that secondary fiber has peaked a bit. We're not calling that it won't go up again, but you asked the questions, so that's a couple months on a row after seeing that March higher for 11 months straight on some of the polyethylenes like low density polyethylene, we've seen them move down slightly now materially are still elevated quite high on a year-over-year basis, almost 100% on some of the grades we buy. But they have gone down, they tick down just slightly. So we're watching those things. On the other side of things, we've seen some wood inflation, is growing particularly on hardwood and some of the baskets we're in, but that's all in the guide that Steve gave you. And it's all consistent with the inflationary expectations we outline for both Q4 and the carryover into 2022.

Okay. That color's really helpful. I'll pass it on. Thanks.

Thank you, Adam. Our next question is coming from [indiscernible] from Truist Bank. Michael, your line will be open now, if you would like to proceed with your question.

Thanks very much. Good morning, Mike, Steve, Melanie. I appreciate you taking my question.

Good morning, Michael.

Just quickly on – obviously lot discussion with input cost inflation. I want to touch just quickly on labor and Mike, you mentioned particularly being a headwind in food service, particularly as you had from layoffs. And you try to build now that business has recovered. You try to build that back up. Can you just talk a little more about what the company is doing to attract labor and have with the rollout of vaccine mandates, has that impacted the labor supply? Just wanted to try to get a sense of what the company's specifically doing and whether the vaccine mandates have actually impacted the attraction of labor as well.

Yes. Appreciate the question, Michael. So we're doing that in number of things to attract talent that we need to operate those facilities that I mentioned, and we're doing it differently than we've done it in the past. We've got some pretty big sign on bonuses that we put in place for people, employee referral type bonuses that we're offering folks because they know different people in the community and suggest them, hey, this is a place you take a hard look at given a track record. And those things are actually making a difference. And in some cases, we've had to look at wage rates, particularly for some of our entry level positions and we're doing those types of things to continue to take a look at how we are the employer of choice and the communities where we operate. So it will be a combination of all those things. We're staying very close to it and I'm confident that over the next quarter or two, we'll be able to get our staffing back to the levels we need it to be. But as a outline, the food service is really the most profound for us, just given the magnitude of the amount of people that we had to hire back after the layoffs, that ensued following the pandemic.

Got it. That’s helpful. And then just quickly on sustainable packaging solutions, office cycle, paper [indiscernible] other new product. I wonder if you could just talk about commercialization where those products stand from a commercialization at this point in terms maybe incremental revenue EBITDA. I think that the more you can share with respect to your focus on sustainable packaging, that's really what help us and help investors get their appreciation of how you guiding the business. So just any insights on those sustainable packaging would be helpful.

No, again, I appreciate that question, Michael. I think it all comes back to our three big growth platforms that we've talked about. So it's around plastic replacement opportunities, enhanced cooking solutions and strength packaging. We've got a big addressable market as we show you when we were together kind of pre-AR Packaging at $7.5 billion. And we'll update that for you when we're together, in February, in New York City kind of giving you an outline on what that looks like it's going to grow. We've seen more opportunities to actually go faster. And that gives Steve and I have a lot of confidence in our 100 to 200 basis points of true organic growth. And to your point, we'll be able to show additional examples and products that we've got there when we're together kind of giving you an update on our enhanced Vision 2025 goals.

Thanks. Good luck in the quarter.

You bet, Michael. Thank you.

Thank you, Michael. Our next question comes from Kyle White from Deutsche Bank. Kyle, your line will be open now if you'd like to proceed.

Hey, good morning. Thanks for taking my questions. Just wanted to go back to the 2022 bridge and ask is it possible to break out what you expect from your core productivity and that $20 million grouping that you have? I know you had some weather events this year that you should lap and then also how do outages next year compare to this year?

Yes, Kyle, it’s Steve. Obviously in February, we'll provide you with the details. I think what's there is, we talked about in the prepared remarks, we've got a long history of our productivity and the organic sales growth that we were just talking about that those items will more than offset the labor and benefits inflation that we're experiencing, obviously any FX headwinds. And also there'll be synergy capture that will be in there. So current line of sight to $20 million-plus feels clear to us, obviously will provide more details on that in February. I think the intent here is good long history of synergy capture, overall performance, organic sales growth, more than offsetting those other items and our confidence as we head into 2022 that that will occur is high.

Got it. And then on the Kalamazoo project, are there any startup costs associated with bringing that up and should we expect the $50 million benefit to begin rolling through in 1Q on kind of a flat line basis, or really take some time to kind of ramp up?

There will be a little bit of ramping Kyle. I think modest benefits in Q1, and then we would expect to see more as we kind of roll in the one-time cost or redundancy costs or relatively modest. And we'll call those out if there are any substance, but we're looking forward to starting up here in Q4 and be making product in Q1. But I think the benefits themselves will be a little more weighted Q2 and beyond as production and then high quality production ramps up.

Appreciate it. I'll turn it over.

Thanks, Kyle.

Thank you, Kyle. Our next question is from Anthony Pettinari from Citi. Anthony, your line will be open if you would like to proceed.

Good morning. On capital allocation, you're closing AR soon and you have a CapEx cycle that rolls off next year. I'm just wondering if you could talk about either the appetite or the ability to pursue additional acquisitions as you integrate AR or is now sort of time for kind of a natural pause and then just kind of remind us where you'd like to be from a leverage perspective maybe next year?

Yes. So I'll take a shot at that and let Steve provide a little color too, Anthony. Thanks for the question. From our standpoint, we love the setup we've got going into 2022, look at the catalyst we've got in front of us, between AR Packaging, timing that looks excellent with the growth of consumer fiber-based packaging, we've got Kalamazoo starting up, we've got to deliver on $100 million of EBITDA growth there, 50 and 50 over the next couple of years. When you look at all that our leverage is going to be elevated here at year end, we'll take the debt on, AR Packaging. So I think what you should think about us in 2022, it's a heads down year for us focused on kind of taking advantage of the investments we've made and delivering on those. We've got clear line of sight in terms of what needs to happen. As Steve mentioned in his prepared comments, we feel confident we'll be at 3.5 times levered at year end on 2022 are lower. And when we did AR, we told you that by 2023, we want to be at three times. So that's kind of where we're focused on. It's not to say that we wouldn't look at something if it came up, but our CapEx is going to go back to a more normalized rate, but we've got the projects that I've outlined in front of you that give us good synergy things to work on and value creation for shareholders. And we want to stay focused on that stuff at least into 2022.

Okay. Okay. That's helpful. And then just following up on Mark Wilde’s question on the global box board market, assuming freight rates or ocean freight rates kind of improve or normalize at some point next year, do you think it's the case that significant import pressure could come back in SBS and maybe CRB, or do you think it's more the case that some of this capacity, either no longer running or maybe not in the cost position to impact the U.S. market. And I guess I'm thinking about the Chinese shutting down some capacity and the Europeans dealing with some of these cost issues. Just kind of curious what your take is?

Yes, I guess as I said here today, first off, I don't see ocean rates coming down materially, so maybe some of the congestion will clean up, but we expect freight, as we've told you, for several quarters now to be structural in nature, both in terms of ship rail and truck and that really move to our benefit, given the wide platform that we operate and how we built the company. So that, I'd start with that point. And then in terms of what's happening in Europe as I mentioned with what we're seeing on the beverage side, there's even more growth of consumer fiber-based packaging in Europe, replacing single use plastics in that market. So those producers over there, particularly with higher freight and dislocation on shipping costs, they're going to want to service that market first. And you answered part of that question. You think about what's happening with GD board in that market compared to their version of recycled versus some of the virgin grades. You've got natural gas prices approaching $30 in MMBTUs. So there's going to be a lot of demand for fiber in that market. And to degree of those producers can move it into that market. I'm sure they'd want to just like, we would want to do that here domestically. So we're in that market now in a material way, as I mentioned to you where the packaging will be the largest purchaser of paper board. So we've got good knowledge of what's going on. And that's going to help us drive our agenda going forward here. And we like the position that we brought established for the company on a combined basis.

Okay. That's very helpful. I'll turn it over.

Thank you very much, Anthony.

Thank you, Anthony. And that concludes today's Q&A session, I'll hand back to Mike Doss for any closing remarks.

Okay. Thank you for everyone for joining us today, we look forward to seeing many of you on February 17th in New York City, where we will outline our fourth quarter results and full year results, provide a detailed outlook for 2022 and update you on AR Packaging integration and growth opportunities. Finally, we want to be able to spend some time talking about our updated Vision 2025 milestones incorporating the catalyst that we discussed today. With that, hope you have a great day, and we look forward to talking to you again soon.

Thank you to everyone, who has joined us today, this concludes the call and you may now disconnect your lines.