Sonoco Products Company (SON) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q2 2017 Sonoco Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would like to introduce your host for today’s conference, Mr. Roger Schrum, Vice President of Investor Relations. Sir?

Thank you, Vince. Good morning and welcome to Sonoco’s investor conference call to discuss our 2017 second quarter financial results and outlook. Joining me today are Jack Sanders, President and Chief Executive Officer; Rob Tiede, Executive Vice President and Chief Operating Officer; and Barry Saunders, Senior Vice President and Chief Financial Officer. A news release reporting our financial results was issued before the market opened today and is available on the Investor Relations section of our website at sonoco.com. In addition, we will reference a presentation on the second quarter’s results, which also was posted on our Investor Relations website. Before we go further, let me remind you that today’s call and presentation contain a number of forward-looking statements based on current expectations, estimates and projections. These statements are not guarantees of future performance and are subject to certain risks and uncertainties; therefore, actual results may differ materially. Furthermore, today’s presentation includes the use of non-GAAP financial measures, which management believes provides useful information to investors about the Company’s financial condition and results of operations. Further information about the Company’s use of non-GAAP financial measures, including definitions, as well as reconciliations of those measures to the most closely related GAAP measure, is also available in the Investor Relations section of our website. Now, with that, let me turn it over to Barry.

Thank you, Roger. I’ll begin on slide three where you see that earlier this morning we reported second quarter earnings per share on GAAP basis of $0.43 per diluted share and base earnings of $0.71, which is just over the midpoint of our guidance of $0.67 to $0.73 and compares to base earnings of $0.73 for the same period last year. The differences between GAAP and base earnings are summarized on this slide. The most significant driver is the impact of recording a $31 million pretax pension settlement charge or $0.19 per share after tax related to lump sum payouts for certain vested participants in our defined benefit plan who elected to accept the offer made as part of our pension derisking strategy. We also incurred $0.06 in restructuring charges, $0.05 in acquisition-related expenses, all then partially offset by $0.02 of net favorable non-base tax items. Looking briefly at our base income statement on slide four, you see sales were $1,241 million, up $35 million or 3% from the prior year. And you will see the key drivers and the sales bridge in just a moment, but in summary, higher selling prices and the impact of acquisitions more than offset a slight decline in volume. Gross profit was $235.9 million, right $6 million below the prior year due to the lower volume while the gross profit margin percent was 19% versus a very strong 20.1% at this point last year. Selling, general and administrative and other income and expense items were $120.9 million which were down $4.9 million from last year, primarily due to lower accruals for management incentive plans and other year-over-year cost reductions, all of which more than offset normal wage and other S&A type inflation, all then resulting in base EBIT of $115 million, down $1.3 million from the prior year and you’ll see all the drivers of the change in the EBIT bridge in just a moment. Below EBIT, interest of $12.8 million was essentially in line with last year. Income taxes of $32.7 million were higher than last year due to a higher effective tax rate of 32%. Equity and affiliates when combined with minority interest was $2.3 million, not notably different from last year, thus ending up with base earnings of $71.8 million or $0.71 per diluted share. Looking at the sales bridge on slide five, you see volume when combined with mix was negative by $23 million or 1.9% for the Company as a whole for the quarter. I will mention that this year’s second quarter had one fewer business day due to have that Easter holiday fell into the second quarter this year, which could have theoretically negatively impacted volume by just over 1% for those businesses that don’t run 24/7. But none of the volume numbers that I’ll discuss today are adjusted to reflect the difference in business days, given the uncertainty of what that adjustment should be. To provide some details by segment. Consumer volume was down just under 1% driven by 3.2% shortfall in rigid paper containers where within that business composite can sales in North America were relatively flat, but the business was impacted by lower metal end sales. And European composite can volume was off 5%, once again most notably due to lower tobacco can sales. Flexible packaging was essentially flat for the quarter while we experienced about a 3% growth in our rigid plastics business driven by very solid growth in food related thermoforming. Display and Packaging segment volume was down 9% due most notably to lower component re-sales internationally and lower fulfillment activity in the U.S. Volume in the Paper and Industrial Converted Products segment was down 1% for the segment as a whole. Volume was off 3.6% in the U.S. and Canada tube and core business but in contrast European core volume was up the similar amount, 3.6% due to continued growth in the frontier east region and Eastern Europe but also what was considered to be some economically driven pickup in Western Europe as well. Protective packaging volume was down 2% as a 5% decline in foam component sold into automotive transportation and a 9% decline in temperature-assured packaging was largely offset by strong 5% increase in the consumer related protective packaging, most notably associated with appliance packaging. So, moving on down the bridge to price, you see that prices were higher year-over-year by 51 million, driven by the Paper and Industrial Converted Products segment associated with higher OCC prices, were based on prices in the Southeast, averaged a $165 per ton versus $87 in the same quarter last year. And I’ll speak more to OCC pricing when discussing price/cost in a few minutes. Selling prices whilst of higher in Consumer Packaging but to a much lower extent due to higher prices for paper, steel and resins. Moving down to acquisitions and divestitures, you see the net impact was favorable by $16 million this quarter due most notably to sales and plastics being favorable with Peninsula sales being greater than the impact of the blow molding divestiture as well as the benefit in flexibles of last year’s Plastic Packaging, Inc. acquisition. And finally, exchange and other was negative to the topline business only by $8 million as foreign exchange rate variances were not that significant on average for the full quarter year-over-year. Moving on to the EBIT bridge on slide six. You see the lower volume when combined with mix was negative by about $5 million. As expected, price/cost including the benefit of procurement productivity moved back to the positive this quarter, favorable by $2 million, mostly due to the Paper and Industrial Converted Products segment. And that’s even with price/cost in Europe being negative by almost 2 million as we’ve not yet fully recovered higher cost in that region. To provide a little more color around price/cost in the industrial businesses in North America, you find a summary of OCC price movement on page 14 of this presentation. You might recall that we ended the first quarter with OCC on $185 per ton, based on prices in the Southeast which represented the reset point for much of the business with contractual pass-throughs, while OCC price has been dropped in the second quarter averaging a $165 per ton. Unfortunately for the third quarter, pricing for those same contracts will be based on the June price of a $165 which has already moved up to a $185 in July and could be higher in August with price/cost again turning negative. Price/cost was only marginally positive in the consumer segment, even with procurement productivity, due most notably to negative price/cost in plastics where contractual pass-throughs have not yet but will catch up with rising resin costs. Price/cost was also negative in Protective Solutions due to some unrecovered higher material cost from both paper and resins. On the next slide down, you see that there was essentially no net impact when considering acquisitions net of divestitures where the loss of earnings from blow molding have been more -- or essentially offset by the combined impact of last year’s flexibles acquisition and Peninsula, which was now in for the full quarter. Moving down to manufacturing productivity, you see it was once again light at only about $2 million. Before getting into the specifics, it is fair to say that notable productivity is much harder to drive in a no growth environment, but it should have been better than it was. In the Paper and Industrial Converted Products segment, manufacturing productivity was actually quite solid and in line with our overall target including much improvement with the number 10 corrugating medium machine. Consumer Packaging productivity was weak due to some operational issues in plastics, where we had right at $1 million in quality claims and we also had some startup costs in our flexibles business. Display and Packaging productivity was negative almost entirely due to issues in our retail security Packaging business associated with the influx of new business. And Protective Solutions had a difficult quarter due to deleveraging associated with the lower volume, and particularly in the transportation component plant and some material inefficiencies. Moving down to the change in all other, which is the catchall category was essentially flat where normal non-material inflation of $12 million was offset by lower fixed cost spending including lower management incentive accruals. This is also the line where you would see the impact of any differences due to exchange rates on the translation of earnings and foreign currencies, but again had essentially no year-over-year impact on earnings for the quarter. And finally, there was essentially no difference in year-over-year pension cost as well. Moving on to the segment analysis, on slide seven. You see that Consumer Packaging sales were up 2% do most notably to acquisitions, while EBIT was essentially unchanged, thus the margin dropping slightly to still a very solid 11.3%. Display and Packaging sales were off 12% due to the lower volume, as previously described, but profits off 71% due most notably to the lower volume and negative manufacturing productivity with the EBIT margin being only 1.2% for the segment as a whole. As mentioned before, given some of the activity in the segment is service-related as well as the resale of purchase goods, we would not expect the margin to be equal to our other businesses, but it is fair to say there is certainly opportunity for improvement. Paper and Industrial Converted Products sales were up 8% do most notably to the higher selling prices associated with higher OCC prices with the EBIT improving 16% due to price/cost and where manufacturing productivity and favorable fixed costs more than offset all other non-material inflation, resulting in a very solid EBIT margin of 9.3% for the segment versus 8.6% for the same quarter last year. Protective Solutions sales were up 3%, but EBIT was off 23% due to negative price/cost and negative manufacturing productivity with the resulting EBIT margin of 8.1% versus the 10.9% last year, all thus ending with total Company margins of 9.3% as compared to 9.6% for the same quarter last year. On slide eight, you find our outlook for the third quarter where we are targeting to drive base earnings of $0.71 to $0.77 per share which compares to $0.72 in the same period last year. The outlook for the quarter assumes no significant step change in volume other than normal seasonality and certainly takes into consideration higher OCC prices, as I previously mentioned. Our outlook for the full year is essentially unchanged, which of course now includes $0.07 for the impact of acquisitions, just over half which will come from the Peninsula acquisition and the balance expected to come from the recently announced Clear Lam acquisition which we expect to close shortly. Moving from earnings to year-to-date cash flows on slide nine. You see that cash from operations is a $104 million versus a $186 million last year, a decrease of $82 million. Since this is such a significant change, I wanted to provide some additional detail this quarter. So, let me spend just a few more minutes than usual, walking through the individual line items. As a starting point, you see net income is $19 million lower due most notably to the pension settlement charge I mentioned earlier, which really has no impact on cash flow, as you move through the balance of the cash flow statement. Specifically related to pension activity, you can see that the year-over-year change on the cash flow statement between the positive this year and the negative last year is a net positive change of $20 million, despite higher pension contributions in 2017 of $13 million. In the first half of 2017, the use of working capital has been slightly lower than last year but there are many moving pieces within those numbers. Year-over-year, cash flow from accounts receivable is worse by $15 million with $25 million associated with higher selling prices. This was then partially offset by good January collections of pass-through account at year-end 2016. This weakened cash flow from receivables was more than offset by year-to-date changes in payables, which was $17 million more positive in 2017 than in 2016. The first half of 2016 was negatively impacted by the timing of payments while this year’s trend is a little bit more typical. One of the biggest drivers of the year-over-year change is tax related accounts which were negative this year by $22 million versus an add-back of $16 million last year, a net change of $38 million. This is essentially due to two major drivers. The primary driver’s the fact that we paid $25 million more of taxes during the period including $12 million related to the 2016 disposal of the blow molding division and we had an increase this quarter due to an $8 million prepayment for federal taxes. The second driver of the change in taxes is the pension settlement tax impact which was booked only and had no impact on our taxes payable but rather only reduction in our deferred tax liability, which accounted for $13 million of the change. The final year-over-year difference driving the -- variance is the all other line item, which accounts for about $35 million of the change, $10 million of which is associated with lower expense accruals, including lower management incentive accruals; another $20 million of this change is associated with various other assets and liabilities, this includes $4 million received in 2016, related to the relocation of a facility from a customer payment, $4 million reduction related to some non-trade receivables that were collected in 2016, a $4 million reduction in non-cash share compensation and several smaller other miscellaneous changes. Although there are many moving pieces that have impacted us year-to-date, for the full year, we’ve reduced our outlook for free cash flow from $125 million to a $100 million. This change is driven by the step change in receivables associated with our selling prices, which are now expected to remain near these elevated levels for longer than previously forecasted. Otherwise, the year-to-date changes were either anticipated in our original forecast or offset in some way as we move through the balance of the year. That completes my financial review for the quarter. And we’ll now turn it over to Jack for some additional comments.

Thanks, Barry. Let me spend a few moments talking about our first half performance and then address some of the key issues we see for the rest of the year and the actions we are taking to address opportunities and challenges. Let me start by thanking our team for delivering first half results, which met the midpoint of our guidance as well as analyst consensus estimates. Collectively, we did a very good job of managing our businesses and moving the Company toward our 2017 goals, despite generally weak market demand and fluctuating raw material costs. You’ve heard me say this before, we believe there is strength in the diversity of our portfolio. If you look at our performance in the first half of 2017, you can see why. In the first quarter, when rising OCC prices impacted our global paper businesses, we were able to offset some of that impact with continued strong results in our consumer related businesses. In the second quarter, our industrial businesses had their best results in nearly three years, which help -- I’m sorry, our industrial businesses had the best results in nearly three years, which helped offset weaker results in other areas of the Company. One of our toughest challenges right now is dealing with generally weak demand from many of our consumer packaging customers; this isn’t new. Consumer packing volumes have been flat to down since the end of 2014, as consumers preference for packaged food is clearly being impacted by changing taste for more fresh and natural products. We see this challenge as an opportunity. We’ve been focused on gaining new thermoforming and flexible packaging capabilities to serve the growing consumer demand for products on the perimeter of the store. Our recent acquisitions of Peninsula and Clear Lam are examples of how we are changing our business mix to capture this new growth. Peninsula, which we’ve had for the entire second quarter, performed well in meeting our targets and essentially offset prior year results from our divested blow molding operations. Peninsula and Clear Lam are expected to produce about $0.07 of earnings accretion in 2017 and will have additional accretion in 2018 and beyond. We plan to grow these businesses and recently approved capital to put a new thermoforming line in our plant in Guadalajara, Mexico. One of the key attractions of Clear Lam is the ability to leverage their expertise in modified atmosphere packaging to drive additional growth to our existing flexible and thermoforming customers who require improved shelf life. We expect to close this acquisition by the end of July and then work diligently to meet our accretion target and internalize much of our needs for multilayer barrier films. Of course, our call wouldn’t be complete without a discussion of recovered paper prices which continued to confound most of the experts including us. As most of you know, Sonoco is a significant recycler and consumer of OCC. The cost of OCC reached historic levels in March, then declined in April and May but is now pushed back to record levels of $185 a ton in the Southeast. Because we collect approximately twice the amount of recovered paper we consume through our recycling operations, we have a partial hedge against rising OCC prices. Furthermore, we have in place quarterly OCC contract pass-through mechanisms in about half our customers with the remaining half subject to announced price increases, which we are currently implementing in all geographies. I will remind you that over the past 10 years, we have had only two years where we have experienced a slightly negative price/cost relationship and we fully expect to recover rising raw material costs through the rest of 2017. However, with OCC prices rising now, we will face challenges in the third quarter. Our expectation is prices could rise again in August before stabilizing and then declining somewhat in the fourth quarter. In closing, we are cautious entering the second half of the year and have lowered the top end of our guidance and expect to be range of $2.73 to $2.80 per share, which includes the targeted $0.07 per share coming from acquisition. However, personally, I am still targeting $2.78 per share. Our three critical focus areas for the remainder of the year are driving growth, both organic and through acquisition; recovering raw material inflation; and we must do a better job reducing our unit cost to produce to manufacturing productivity. Finally, while we’ve been very effective adjusting to the current environment, we’ve realized we must continue to improve our operating structure. In order to do so, we are taking a more holistic look at each business to ensure we’re serving the right customers with the right cost structure to ensure we improve our competitiveness and drive long-term margin improvement. So, with that, operator, I’d ask that you please review the question-and-answer session procedure.

Thank you. [Operator Instructions] Our first question is from Ghansham Panjabi of Robert W. Baird. Your line is open.

Hi. Good morning. This is actually Matt Krueger sitting in for Ghansham Panjabi. Howe are you doing today?

Good morning Matt.

So, first question, can you expand on the plans to review each business and then streamline the operating structure? And then can you possibly quantify the savings potential from these actions, even if it’s on kind of a broad basis?

Yes. I want to do this on a real broad basis because we’ve just started the process. But, when I mean holistic look, we’re really taking a very deep dive, now that we have an Oracle system that’s capable of giving us very, very granular data, of looking at what are the customers that we service the best, the processes and procedures we have in place, what are the products and the customers that are best served by Sonoco as opposed to looking and say, we’ll serve everybody. We’re beginning to focus on those customers where we can deliver the most value and consequently extract the most value from our perspective. In looking at that, then you’d rescale the entire operations to really build it around those customers. The margin impact and the EBIT impact of doing that across our business model could be anywhere from three to five points of margin. So, we are just beginning, but we think it’s an excellent way to look at the business. It’s a part of our grow and optimize strategy, because optimize means optimizing your customer base as well and understanding your value proposition. So, I do think it will have a strong impact. It’s going to take several years to roll out. So, I don’t want to create an expectation that next quarter we’ll be talking about how successful it was, it will not be that way. It will take a while, but it’s a very disciplined process and we’ve just begun.

Okay. That’s helpful. And then can you provide some added detail on what specifically drove the volume shortfall for the protective segment? And what are your expectations for the segment throughout the remainder for the year? I know you gave the volume numbers, but if you could kind of provide some detail on those specific end markets, that would be helpful.

Yes. If you look at the market and it’s three segments. We had shortfall of course in automotive that we knew was coming that should not have surprised us and did not surprise us. We had actual growth in our consumer segment, which is really built around appliances mostly. I believe that was up some 5%. But then, we had a shortfall in that ThermoSafe business. And that’s a bit of surprise to a degree and that that business has a strong growth profile and we continue to have one. Right now, however, some of our customers are late launching new drug trials, the number of drug trials or new launches are down on a year-over-year basis. And that’s been kind of delayed and pushback for the latter half of the year. So looking forward, I certainly expect us to continue strong in consumer; I expect us to see a rebound on the ThermoSafe side of the business. We already have new volume one, we’ll be launching that in the second half of the year. We’re going to continue to struggle with volumes in automotive; I don’t see any improvement in that. And quite frankly, we are little late to the table in rationalizing our cost structure around servicing that industry, but you can bet, we’re going to be very aggressive doing so in the third and fourth quarter to match our capacity to demand on the automotive side of that business.

Thank you. Our next question is from George Staphos of Bank of America Merrill Lynch. Your line is open.

Hi, guys. Thanks for the details. Congratulation on the progress so far this year. Barry, maybe a question to start on the working capital. I think you mentioned that receivables were $15 million or $25 million more negative this year in terms of your projection and that’s the primary reason why working capital comes down. I assume that’s just going to be meaning you get that much benefit in 2018, that should be a positive for you, it’s just a timing issue. Would that be fair?

Well, actually, George, to clarify, if prices remained at these current elevated levels, and definitely it would really be a $25 million step change just in our base receivables. Obviously, if prices come back down, then certainly would recover that whenever that might happen. All else being equal, it would be a one-time step change this year. And again, if everything was completely unchanged year-over-year, would be back up to another $125 million in free cash flow next year, again if everything was consistent.

I got you. I assume because what’s been happening with input costs, obviously you’re now following with your own selling price increases by the time you get those implemented; there is a lag effect. But I see what you’re saying right now in terms of that component. Thank you. You already covered a little bit in answering Matt’s question, but on productivity, can you answer a little bit more, provide a bit more color in terms of what you’re doing in the segment to improve productivity? It was obviously a good quarter year-on-year and certainly versus our model, anymore color there would be very helpful.

Well, productivity is a pretty wide area. You have purchasing productivity; we have manufacturing productivity; and we have fixed cost productivity. When you aggregate it all, we’re doing quite well. But specifically in manufacturing productivity, in the plants that have SPS we just have stellar results that have fully implemented, you see very strong progress. Flexibles is a division that volume up or down, they continue drive productivity. I think North America, RP had some solid numbers, so did our tube and core business as well. But day in and day out, paper drives SPS, the paper division had very strong productivity. And SPS is a key part of driving productivity for us in those businesses that really embrace it and drive it, you can see the consistent results in that part of productivity, manufacturing productivity.

Okay. Thanks for that Jack. I want to turn, next question, I got one after then, I’ll turn it over to volume. So, tube and core volume North America was down 3.5%. We obviously having tracked the Company for a while, know that a lot of that business is driven by the containerboard business, which I thought would have been relatively strong, correct me if I’m wrong on that. It would mean that your graphic paper, tube and core and other markets for that matter were obviously that much weaker. But was there anything surprising in the volume number in the second quarter for tube and core North America? And then in display, are you beginning to see -- I think this question has come up in the past, any effect from the purchase from the consumer occurring now direct and through e-commerce as opposed to at the store front and what effect that’s having on your display business?

Okay. First to tube and core volumes. Certainly, what you say, we are seeing increased demand for kraft or corrugated liner cores that’s certainly there. During the course of the year or during the course of the quarter, I believe we saw some weakness and it’s more of a timing issue for film cores as kind of waiting to see and resin coming down, they experienced that. That certainly was part of that weakness as well. Half the weakness, George, is really volume loss or share loss as we have pushed price pretty hard. Some of that is coming from this holistic look I talked about, about looking at the business in a more holistic way and using price to sort through that is driving some of that share loss. So, I suspect that you’re going to see an improvement in those relative numbers in the third quarter because I think films are going to be somewhat stronger as we move in the third quarter than it was in the second quarter.

Okay. Any effect of e-com on your Display and Packaging business? And I’ll turn it over with that.

For me to quantify that would be extremely difficult. I will tell you, I think this is a slower period of the year in Display and Packaging and this appears to be pretty slow as far as demand in D&P right now. So, is e-commerce having an effect that I don’t know; it’s hard to me to quantify, but it’s certainly volume in D&P is down, in the display end of the business as well.

Thanks. The next question is from Philip Ng of Jefferies. Your line is open.

Hey, Jack. I know you said it was fairly in the process, but based on your analysis on servicing customers add most value, any color on whether it’s like larger CPG versus smaller upstarts, organic food and -- upstarts or organic food companies? And as part of this initiative, are you looking to kind of retool the resources your sales force allocate or based on the mix, some color on that would be helpful?

Yes. Let me -- again, I don’t want get too far down the line here. First of all, we are starting on the industrial side of our business.

Okay.

So, it’s not impacting consumer. But it’s really built around what do we best and what are the customers where we can create the most value. And then focusing on those customers and then working with the other customers to make sure that they’re serviced properly, either through an alliance or through setting up a different model to service them internally, but not trying to do all the same -- not try to feed everyone from the same spoon, from the same facility, if you will.

Got you. But to initiate this strategy -- the new approach, it’s not going to require a lot of capital, is that the right way to think about it?

Well, there’s going to be capital required as we upgrade equipment to the state-of-the-art status for the equipment that we’ll keep in place.

Okay.

And then there is going to be capital -- there is going to be cash required as we consolidate the footprint. That’s the big part of the entire process is really to consolidate.

Got you. That’s helpful. And I guess sticking with big picture, I know in terms of your M&A approach, I know for some time, you’re talking about doing something more sizable potentially in flexible packaging. But just looking at your more recent bolt-on acquisitions that you’ve done, it does seem like that you’re pivoting away from some of these markets. And it’s really more focused around the primitive stores. In years passed, you were very focused on big, large CPGs. Are you kind of reallocating on how you think about that and just resources going forward?

Well, again, we’ve been very specific. It’s thermoforming, it’s flexibles and it’s protective solutions and we are following that religiously and right down the line. I will tell you that -- and we’ve said this -- it’s capability focus, we want to add certain capabilities through our mix, we wanted to blow film, we now have it, we have 3, 5 and non-layer capability through Clear Lam. We wanted to get the of the perimeter of the store and certainly we knew that Peninsula would bring that to us. So, we are adding -- we are inside our focus areas and we are adding capability and that’s what’s driving this.

Okay. And just one last one for me. Your margins for protective was under pressure, part of that is volume, but price/cost is negative as well. Do you expect that to become positive or more mutual going forward through a combination of price increases or any view that you have on resin in the back half?

Absolutely.

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

Jack, Barry, Roger, good morning.

Good morning, Adam.

Jack, just one on volume and then a couple of obligatory ones on OCC. You started the year expecting around 2% volume growth and last quarter you said it’d be more like 1. What is your expectation now?

Well, I still think that by the time the end of the year gets here, overall, we say we’re going to be somewhat flat. So, what that means is for the second half of the year, we’re going to have to, say, a little bit of a pickup from where we are now, above even the seasonal pickup, but slight. So, I think by the time we get to the year-end, we’ll be flat to slightly up, we’ll be in that range.

For the year, you meant?

Yes.

Okay. And just a couple on OCC. Can you give us a sense, how much higher prices you’re expecting in August?

It could drift up another $10, but that’s just a best guess I’ve got.

Is this a less certain situation than normal because last quarter I think you said you thought it’d be down 10 to 20 in May, if I’m not mistaken and then stabilize thereafter. It sounds like you’re little less certain, this time around.

Well, it certainly did drop in April and May but then we got a fairly strong spike back up in, as we began the third -- as we began June. And so, we are less certain. And it’s much harder to predict now because normally we’d be going into -- this is a fairly improving -- this is a lower generation time. But as we move into the third quarter, you move into higher generation. That higher generation is important for OCC collection and it’s -- that’s a bit of unknown now. I don’t know what that generation is going to be, given the e-commerce impact, what’s going to be available behind the stores. That’s creating the uncertainty to me.

And just couple related to that point, Jack. You said, you expect a decline in the fourth quarter, which is historically what’s happened, but obviously last year OCC prices started spiking in the fourth quarter because of e-commerce. So, why do you expect OCC to go down in the fourth quarter, just given when we know about e-commerce growth.

Yes, I think that’s a solid question. I’m expecting it to follow more of a consistent pattern. One of the things that is still confusing me and I must say this is, e-commerce is new. It’s been here for some time. What’s so unique about this particular year? I think that we really need to get our hands around that. We’re working internally to better understand it. AF&PA is also working to understand how you improve recycling rates through the home -- through homes versus behind stores. I think we’re going to have a fairly strong holiday season. Consumers seem to be in a pretty good mood. So kind of predicting based on what is historically the case, not was the anomaly of last year.

And just this recent surge in OCC, Jack, compared to what’s historically happened. I mean, how unusual is it and how much do you think e-commerce, Chinese demand or recent recycle capacity additions in the U.S., et cetera, play into how different this last 10 months or so has been compared to historical?

Well, certainly, you can go back in time and you can find where OCC has risen during the summer months. It has happened, it’s usually situational. I certainly think a combination of factors, e-commerce is driving more demand domestically, I think that that’s fairly obvious. I think China is in the market right now, filling their pipelines and other things. And they’re probably experiencing a lot of what we are experiencing with e-commerce in China. So, as you -- as the market figures out how to get more OCC back from the homes, I think it will begin to level out over time. I think there’s going to be a big push on how you do that. The corrugated is still there, you just have to go get it differently.

And just last on China, Jack. The National Sword inspection program, I mean that’s eliminating their imports of mix paper. What impact do you think that will have on their demand for U.S. OCC in the next couple of months or longer for that matter?

Adam, right now, first of all, we need to really understand the definition that they are applying to mixed wastepaper. There is a -- that needs to be defined clearly. If it’s a very, very restrictive decision and it really limits mixed wastepaper, it’ll have an impact on OCC and will drive demand for OCC. It’s a fairly liberal interpretation of loose paper, not like we use here in the U.S. I don’t think it will have much impact at all. They just need to clarify exactly what they mean by wastepaper -- mixed waste paper.

Your next question is from Chris Manuel of Wells Fargo. Your line is open.

Good morning, gentlemen and thank you for the color. I just had a couple of questions. If I could start with Clear Lam, can you give us a sense as to what specifically there got you excited about this particular property? I know that, being able to blow some of your own films instead of purchasing from the outside. But what -- are you able to shift some of what you are buying over towards them or where are they at with utilization et cetera? And are there very specific areas within the barrier component that they are particularly good at? Whether that’s, I don’t know, if dairy, if it’s meat, what areas that you feel they got an opportunity and how you can overlap?

Chris, this is Rob. Let me answer it multiple ways. Not only do they blow film, but they also extrude thermoforming sheet that we could internalize inside our system. Jack talked about the multilayer. So, is it barrier constructs that they are making and today they do participate in the cheese and dairy, as well the other real application for us is the marriage of our portion pack thermoform cups that we make where they are our living stock partners. So, we now have the ability to go to market, no different than BMS and Winpak with a total solution as it relates to sauces that we see growing, not just in quick serve restaurant, but going outside of quick serve restaurants as well.

And they’ve got the capacity to service your existing business, you don’t have to add more barrier blowing capability?

No, they’ve got some available capacity on the sheet side of things and there is some equipment coming in as well.

Okay. That’s helpful. And then, Jack, back to kind of recovered fiber and some of the impacts through the system, a couple of different directions here. One, I know what some of your consumer businesses and you’ve got resets, particularly with certain stat chips, different areas that they are kind of once a year. Are you able to go out when you have such big movements like this and recover extra pieces? Part one. And then part two is, I’ve been reading about a number of surcharges and elements on OCC recovery as well, how does that work through your system? I mean, I know your net collect kind of 2 to 1 but how does that get reflected into your contracts?

I guess that if it got just too onerous, we certainly would move forward with trying an out of market increase. But for the most part, it is annual contract adjustments and they occur, some in the beginning of the year, some in the middle part of the year. So, we’re usually able to be fairly good at recovering what those costs might be on the paper side of the business.

Okay. And then, with respect to the premium and the things. So, when you have pass-thoughs or different mechanism in your contracts, are the premiums also -- do they fall underneath that and are pass-throughable, if that’s a word, or are you kind of stuck with this? How does that work?

I’m not sure what the premium is.

It’s different times that we’ve seen published OCC price, but there have also been some premium numbers we’ve seen attached to in a few places.

Well, again, I think that there are premiums. It’s usually based upon the market price for the products. Most of these contracts do have phrases for extraordinary increases in costs. And if we can deem it as extraordinary, we can go in to negotiate it. But the premium that you might read about that somebody’s paying a $20 premium that we wouldn’t be able to really affix to. It’s going to have to be based upon the published indices for the product, if that’s what you’re asking me.

Yes. Thank you. And then, just last question along these lines, I think you’re out with a number of price increases across products, tubes and cores in Europe, URB in different locations and as well a supplemental medium increase here in North America. Can you give us a sense as to how those are going today or efficacy of those? I know at different times you’ve got more or less of some of the tube and cores. But if you could kind of run through maybe what’s here in the market with and give us a sense as to how they’re going thus far will be helpful.

Well, Chris, I’d say, it’s real early in the process; effective date really was July. We are raising prices tube and core globally because of the domestic situation of OCC. As you know, some markets are going to do better than others, depending upon just how that market kind of reacts to those types of things. But, we’re going to push hard. We’re going to go for recovery. These are real increases. Every one of our competitors; no one is not receiving these costs increases. I remain fairly confident that our competition understands the magnitude of the increase that’s hitting them and will react accordingly. I’ll be able to update you better in the third quarter or at the end of this quarter or at the end of this month. But right now, I’d say, I just don’t have a window to it, other than we’re pushing hard.

Thank you. Our next question is from Scott Gaffner of Barclays. Your line is open.

Hey, Jack. I just want to talk about protective solutions for a second and I think you said 5% decline in the automotive business. Is that specific to a certain customer or a platform loss, or what is driving the minus 5% within the automotive business in protective?

Yes. There may be a couple of other factors to influence this, but primarily the parts that we manufacture, go into automobiles, not SUVs and trucks. Now, that doesn’t mean we don’t have parts in SUVs and trucks. It just means, there have been more opportunities in automobiles like truck liners and those types of things that are molded from this polypropylene for cars. So, what we are experiencing really is across the board decreases and the customers where we supply parts, we’re just seeing volume in cars are down. So consequently, our volume in EPP or the molded parts are down.

Okay. And then, within that business, I think you mentioned as part of this holistic cost approach, really seemed like cost to serve within that segment of the business was relatively high, meaning maybe your customer has a lot of, just in time demands, et cetera. Is that maybe an example of where you’ve over-served the customer or is that how we should think about it?

Yes. Well, first of all, we haven’t taken the process to -- it’s not made it to protective yet. We’re just now piloting it in the tube and core business here in North America. But specifically, what we have to do is to match demand to our production capability. So, that’s what we are looking at right now, specifically in tube and cores to make sure that demand and production are matched, based upon what we see going forward.

Okay. And last one for me just in paper and industrial converted, I think you said Europe, sub 3.6%, despite maybe some negative tobacco trends. So, can you talk about where you’re seeing, especially in Western Europe where you’re seeing areas of strength?

Yes. Scott, that’s two different areas. The negative tobacco trends impacting composite cans, tubes and cores are strong in what we call the frontier, but also domestic demand of Western Europe as we call it, just the more developed market has improved a little bit. So, it’s better Western European demand and then what we call the frontier Poland, Turkey, et cetera volume growth into those markets has been good.

Thanks. Our next question is from Mark Wilde of BMO. Your line is open.

I wanted to come back to the display business, just briefly. Any thoughts kind of in the near-term about just whether the consumer products companies are allocating their promotional spend any different way and whether that might be affecting the display business?

Well, I certainly think they’re probably evaluating a lot of things, Mark, on -- certainly in the process food area about what they need to do. What we do see is that we see a lot of what, we call, I guess industry calls ready pack, in a move to ready pack where it’s in some sort of case display and it’s easily put on to the shelf. So, a lot of the business is may be moving in that direction. We’re certainly participating in some of that. But, this is traditionally a slow time for our display business. So, we are experiencing that as well.

Okay.

But I’m sure, they’re rethinking everything inside the CPGs.

Yes. And then, just kind of staying on the theme a little bit, just with this growth in e-commerce. Is this creating sort of situations where you need to evaluate particular packages that you produce or you need to think about sort of alternative formats?

Well, I certainly think that inside the protective packaging arena, we’re looking at opportunities and options about how do we participate in e-commerce. I also think that there is opportunities for us to think about the basic packages for products. One of the things, if you buy stuff over the internet, you may get a large container of dishwashing soap along with a light bulb. And if it’s wrapped around in the box, it may damage the light bulb.

Damage the light bulb.

I mean, those are the types of things that we’re thinking about as if how do we adapt to the growth of e-commerce and what are the products that we need to kind of have in our offering that would create value for our customers.

Okay. And the last question I had, we have been talking for several quarters about just options for the medium machine. and I wondered given the uptick we’re seeing in the containerboard market and particularly over in the medium business, whether this is perhaps accelerating some discussions?

Well, certainly the medium machine is performing extremely well on a year-over-year basis. We still are looking to resolve this issue. And I would say, nothing is changed from that perspective. We want a long-term resolution to number 10 and continue to look forward.

And would you think we might get one this year?

I would hope so.

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

I just wanted to come back to the discussion about the holistic view. And it seems like it’s really focused on tubes and cores. I mean, what we are really talking about here is some -- our URB capacity closures sort of on the table. And is that something that you guys are kind a contemplating -- is that at all tied into the conversation around OCC prices and maybe we’re kind of in a little bit of a different paradigm there? And if there are any comments about kind of the long range profitability for some of your URB operations?

I would tell you that we’re not that far along yet in the process. I will tell you that when you look at the mix of business and the number of SKUs, you can simplify the business a good bit and not really have a significant impact on your URB demand, nothing major. So, we’re not that far down the line in that process.

Okay, thanks. And then just maybe for Berry, the free cash flow guide, I understand that the reduction was more driven by receivables. But it does seem like the seasonal cadence is a bit different. I think you provided some color to walk through it. But it seems like an awful big step up in the second half. Just wondering if you could remind us big picture, what’s driving what seems like about $170 million of free cash flow, your guidance for in the second half and typically it looks like it would be more like $50 million to $100 million range, just what are some of the kind of factors that would drive that?

You’re certainly right. There are many moving pieces to that, but just some things, obviously receivables used a little bit more cash than we expected in the quarter. Our compliance percentage dropped a little bit just due to a couple of customer specifics that we clearly expect to get back on track. We had some prepaid taxes that I mentioned that we’ll recover and use effectively through the balance of the year and that there are just a lot of fits starts to the way payments and accruals, the timing of all that falls. But again, at this point we are comfortable in saying that the only change in our free cash flow forecast is really the impact of the onetime step change in receivables.

Okay. Just one last one, if I could on the working capital front. As we are thinking about OCC and where it might end the year and it sounds like expecting to be maybe a bit lower by the end of the year. Maybe you can give us just size of like what a $10 a ton move in OCC price would have on your inventories or your working capital as you settle it up into yearend?

I don’t have that readily available, but just think of it in terms we ended last year of 120 and we are expecting that to be notably higher than that, even if it goes down some de minimis amount. So, it’s the magnitude of the year-over-year change that we we’re really talking about.

Thanks. Your next question is from Steve Chercover of D.A. Davidson. Your line is open.

Thanks. Good morning. Just a couple of quick questions, first on Clear Lam. It sounds like its sales and the purchase price are both about 75%, as large as Peninsula. So, is it fair to say that the earnings contribution is also 75%, because it sounds from Barry’s comments like it might be a little more profitable?

Yes. Not having done that math, it’s hard for me to kind of get to that conclusion…

Are you able to maybe give us…

…mathematically run through my head.

…an EBITDA multiple what you paid?

Yes. No, we don’t do that. I will tell you that in the final analysis with Clear Lam, we expect that multiple to be below 7 with all the synergies that we believe comes along with it.

Okay. That’s helpful. Thanks. And then secondly, the poor performance in paper and industrial was really a substantial recovery from Q1. So, I’m wondering, was there a lot of maintenance in Q1, much more than the prior periods, year ago or Q2?

No. I think that Q1 to Q2 was a little bit about price cost, a little bit about runability and certainly number 10 was a positive impact as well. But, the business ran very, very well in Q2.

All right. Yes. I mean, it really stands out. Okay. Thank you.

This is what I’d expect it to do, to tell you the truth.

So, then, Q1 was disappointing in the mid 20s for EBIT?

Yes, absolutely.

Got it. Okay. Thanks.

Thank you. Our next question is from Debbie Jones of Deutsche Bank. Your line is open.

Hi. Thanks for taking my question. I just have two, another one on e-commerce and one on resin procurement. The first question on e-commerce, if you could just focus on your consumer business, have you identified, what percentage of your business would really be or has been impacted by the shift in distribution? And then, two, could you just give us a sense of what your customers are talking about, if it’s kind of stepped up, they need to kind of switch formats and whether or not you think that it could be margin enhancing for you?

Well, it’d be very difficult for us to give you some idea of the impact of e-commerce, because we sell it to our customers and then how they distribute it, we don’t know. So, we can’t help you with that. I will tell you, we’re having conversations with certainly large customers as well as e-commerce providers about what type of packaging do we need to solve our problems. Anytime there is an opportunity to redesign a package or be a part of the solution, yes, I believe margins can be enhanced to the process.

Okay. And then, second question on resin procurement. You’ve done a number of bolt-on deals in plastics oriented company. And I’m just wondering, you’ve talked in the past about wanting to kind of increase your resin buy, but at the same time you’ve also had some divestments. So, I wondered if you’re happy with your current level or you think there is a need to kind of increase your competitiveness by increasing your overall resin buy through acquisitions.

I would tell you, yes, we’re pleased with our -- the way we procure resin and the formulas that we have in place. We think we do a very solid job there. Debbie, I’ll tell you, clearly, we would not buy something to increase the amount of resin we buy. That’s not the format that we would use. We would only buy something because we think it adds capability to our mix and it improves our ability to serve the customer. Having said that, there are clearly opportunities to increase our footprint in thermoforming and that would bring additional capabilities, and we are focused on doing just that.

Thank you. Your next question is from Chip Dillon from Vertical. Your line is open.

Jack, I had a question about the refrigerated temperature assured business. I know you’ve added a couple of pieces to that in recent years and you mentioned a volume decline in the quarter. Maybe you could talk a little bit about maybe what caused that, is the business -- is that just sort of a hiccup or is the business maybe not expanding at the rate you thought it might be?

Chip, it’s Rob. It’s actually a tale of two cities. We did see some volume decline. So, let me give you some color on that. If I go back to 2015, there were directionally 45 launches of new drugs that took place. You see that sort of flow through the next 12 months. And we picked up our proportionate share. So, we saw a significant growth in 2016. In 2016, there were 25 -- or I’m sorry 22 new product launches. So, we see that decline take place this month. First half of this year, there were 24. And Jack mentioned earlier that we have been awarded a number of these projects. So, we’re going to see that start to roll through the second half of the year. If I take a look at the sales for the quarter, the businesses that we acquired actually offset the volume decline that experienced in the legacy business. So that is just ramping up. So, if I look at it just in dollar terms, our ThermoSafe business is flat year-over-year with the acquisition offsetting the volume decline. I think the volume decline that we’ve experienced is one of timing, and that timing is related to the launch of the new projects that we’ve been awarded.

Got you and that’s really helpful. And then just real quickly, on the Clear Lam packaging acquisition, did you -- I know it’s really helpful, I see you gave some sales guidance. Can you give us some rough EBITDA guidance as we think about you owning it and what synergy possibilities there might be?

Not yet.

Okay, understood. And would you say...

The synergies are substantial from internalizing supply to blending with thermoforming and offering a complete solution as well as with both Peninsula and our portion control. So, see there are significant synergies here.

Got you. And I would imagine all of this will fold into the consumer segment. Correct?

Correct.

Our next question is from George Staphos of Bank of America Merrill Lynch. Your line is open.

Hi, guys. Thanks for taking my follow-on. I know it’s late in the, I’ll be quick. Jack, just want to come back. The cautious view you have on the back half of the year as you said in the press release, is that more just driven by the volatility in OCC and inputs and the unpredictability there or is it sort of the lingering volume weakness you’re seeing at the consumer company level that’s driving that statement?

Yes. It’s more around the OCC, George, and how does that actually turn out.

Okay. That’s fair. And then my last question. A number of years ago, I don’t know, four, five years ago, Sonoco had talked more and more about getting into the waste streams so to speak with your existing capabilities obviously and offering that creating a more commercial business entities from that with MRFs and helping your customers source and procure and reclaim material more effectively and obviously getting paid for that service. That ultimately I think faded away, in part as input costs declined. With OCC now rising again, do you see an opportunity to turn that into more of a profit center and a bigger business over time or not really? Thanks and good luck in the quarter.

George, certainly, there is an opportunity that’s there but it’s not really for us and it has to be around purpose. We are in the OCC or we are in the recycling business to paper our mills and to assure we have the absolute lowest cost of supply. I think that was a realization we came to. Business is complicated enough, we don’t need to complicate it more. So, we just retrench and sit. Our purpose is to paper our mills at the lowest cost -- lowest possible cost and that’s kind of the way we run the business today.

Thank you. At this time there’s no other questions in queue. I’ll turn to Mr. Schrum for closing remarks.

Thank you again, Vince. In closing, let me again thank each of you for joining us today, and we appreciate your interest in the Company. And as always, if you have further questions, please don’t hesitate to contact us. Thank you, again.

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Everyone, have a great day.