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Good morning. My name is Shane, and I will be your conference operator. At this time, I would like to welcome everyone to the Berry Global Earnings Call. All lines have been placed on mute to prevent any additional noise. After the speakers' remarks, there will be a question-and-answer session. Thank you.
I would now like to turn the call over to Mr. Dustin Stilwell. You may begin the conference.
Thank you, and good morning everyone. Welcome to Berry's third fiscal quarter 2018 earnings call. Throughout this call we will refer to the third fiscal quarter as the June 2018 quarter. Before we begin our call, I would like to mention that on our website, we have provided a slide presentation to help guide our discussion this morning. After today's call, a replay will also be available on our website at berryglobal.com under our Investor Relations section.
Joining me from the company, I have Berry's Chief Executive Officer, Tom Salmon; and Chief Financial Officer, Mark Miles. Following Tom and Mark's comments today, we will have a question-and-answer session. In order to allow everyone the opportunity to participate, we do ask that you limit yourself to one question at a time with a related follow-up and then fall back into the queue for any additional questions.
As referenced on slide 2, during this call we will be discussing some non-GAAP financial measures. The most directly comparable GAAP financial measures and a reconciliation of the differences between the GAAP and non-GAAP financial measures are available in our earnings release and investor presentation on our website.
Finally, I remind you that certain statements made today may be forward-looking statements. These statements are made based upon management's expectations and beliefs concerning future events impacting the company and, therefore, involve a number of uncertainties and risks including, but not limited to those described in our earnings release, Annual Report on Form 10-K, and other filings with the SEC. Therefore, the actual results of operations or financial condition of the company could differ materially from those expressed or implied in our forward-looking statements.
Now, I would like to turn the call over to Berry's CEO, Tom Salmon.
Thank you, Dustin, and good morning everyone. This morning we'll be discussing several topics, including an update on the Clopay acquisition completed last quarter, fiscal third quarter results, highlights from our three operating segments including investments in both organic growth and cost reduction, our expectations for the remainder of fiscal 2018, and an announcement related to a return of capital back to our shareholders via the company's first share repurchase authorization program. Afterwards, Mark and I will be happy to answer any questions you may have.
First, I'm excited to announce another new chapter in Berry's rich history as today we announced the company's first ever $500 million share repurchase authorization program which will provide us the ability to return capital to our shareholders. This new share repurchase authorization demonstrates the board and management's confidence in the company's future and its ability to generate consistent and dependable free cash flow.
Our financial performance and balance sheet have strengthened considerably over the past several years. We're now in a solid position to return cash to our shareholders while still maintaining financial flexibility to execute our strategic plan, further strengthen our balance sheet, and invest in future growth. As we've stated on previous calls, we are committed to a balanced capital allocation strategy to maximize shareholder value which will thoughtfully include continued investment to grow our business organically, growth through strategic acquisitions, debt reduction, and returning cash to shareholders. We have a high confidence in our ability to generate significant shareholder value based on our historic track record and future growth prospects.
Now, turning to Berry's overall financial results for the June 2018 quarter on slide 3. I'm proud to report that we had another quarter of solid financial result delivering growth in revenue, earnings, organic volumes, as well as operating cash flows. These achievements were led by synergistic acquisitions along with a 1% overall organic volume growth. Revenue was a quarterly record for any period at $2.1 billion increasing by 9% over the prior year quarter highlighted by strong organic volume growth of 4% in our Consumer Packaging segment as well as strong growth in our tape, flexible packaging and non-woven specialties products.
Operating EBITDA, which was also a record for any period, was $374 million or a 3% improvement compared to fiscal Q3 2017. Our quarterly adjusted earnings per share represent a 7% improvement over last year and an impressive 5-year compounded annual growth rate of 20%. In a period of unprecedented inflation, we were able to largely offset significant cost inflation with a combination of price increases and cost reductions including our continued commitment to reduce the timing lag of passing through raw material cost changes.
Looking at our highlights specifically by segment, our Consumer Packaging business reported strong revenue and organic volume growth in the quarter of 7% and 4%, respectfully, led by our foodservice products driven by stronger demand at quick service restaurants and convenience stores. As communicated on prior calls, we are partnering with large multinational customers within our core foodservice product portfolio to address unmet needs in growing markets and have made significant investments introducing a new proprietary technologically advanced solution to the market at a lower cost with improved functionality and sustainability.
These next generation products provide a new consumer experience through premium design and sustainability offering a clear or white cup that is fully recyclable and at a lighter material weight. I'm happy to say that this project began its roll-out during the quarter as anticipated and we expect growth to continue to ramp in future quarters.
In addition, we continue to innovate and provide premier healthcare packaging for a wide range of solutions for blood diagnostic vials to unique senior-friendly closures. We're also launching an innovative range of personal care products with a minimum of 25% post-consumer recycled content delivering on both aesthetics and sustainability. We continue to look for opportunities where we can provide advantaged products in targeted markets and I'm pleased to report that we are continuing to see a stronger pipeline and improved hit rate across the business and most pronounced in our healthcare and specialty rigid packaging products.
Our Health, Hygiene, and Specialties division recorded strong revenue growth of 20% as well as an 11% improvement in operating EBITDA including the impact of the recently completed acquisition of Clopay. We believe that with the ensuing rise of middle class and higher GDP growth rate in developing countries, demand will grow in the high value-added healthcare and hygiene markets. Specifically, our Asia nonwovens business, over the past two years, has grown over 6% with high utilization rates supporting our investment decision in a state-of-the-art nonwoven line in China. Our new $70 million asset will be the first of its kind in the region and will provide significant incremental capacity for Berry serving the Asian market. This investment is on-target to meet forecasted market and customer growth and will be focused on premium applications in the hygiene and healthcare markets. We're pleased to report that the project is progressing as expected.
Additionally, our previously announced $50 million investment in North America for our proprietary Spinlace technology has begun construction in our Mooresville, North Carolina location. This capacity expansion, I'll remind you, supports our customers and our growing wipes business for the consumer, health, and industrial markets. The unique capability of Spinlace combines flexibility and material inputs with our Apex imaging using three-dimensional technology to provide both superior product performance and custom branding at competitive costs. This investment and this technology supports our leading market position and is progressing as we expected. We remain focused on high growth markets and applications where we are partnering with our customers in the commercialization of products and feel confident these investments will promote longer-term growth expectations within our nonwoven business.
The acquisition and integration of Clopay that closed in early February continues to progress on schedule. Combination of Clopay with Berry's Health, Hygiene, and Specialties division has strengthened our position within the attractive health and hygiene markets and broadened our presence as a global supplier to many of the leading consumer and industrial product manufacturers. As we stated on our last quarterly call, we're accomplishing our objectives of reducing material and operating cost and remain confident in our ability to achieve $40 million of annual cost synergies and continue to work on identifying new cost reduction and growth opportunities.
Inside our Engineered Materials division, we recorded modest organic volume growth in our legacy business for the quarter led by our tapes and flexible packaging products. Our legacy tapes business had another strong quarter with growth in organic volume and earnings, which was supplemented by our acquisition of Adchem last year, which has provided new sales channels and product offerings in the growing specialty tapes market. Utilizing our new film technology and flexible packaging, our recent investments in value-add and multi-layer film to support growth in e-commerce provides an opportunity for our customers to have a more cost competitive packaging solution.
In April, we secured a multi-year supply agreement with our packaging converter partner that specializes in the manufacturing of protective packaging solutions for the e-commerce, courier fulfillment and distribution market. In order to support their expected growth, we'll be investing over $20 million to add capacity for value-added films in multiple Berry facilities throughout the next nine months.
Additionally, we're investing in our innovative protection solution product offerings, which provide enhanced load containment, ultimately reducing the breakage, damage and loss incurred in the transportation of goods. Specifically, we continue to see opportunities with our food and beverage customers to take share from other substrates with improved film performance eliminating the need for additional packaging. The fundamentals of our Engineered Materials segment remain positive as reflected by another solid quarter.
Now, I'll turn the call over to Mark who will review Berry's financial results in more details and then I'll come back and summarize our strategy and open the call for questions. Mark?
Thank you, Tom, and good morning, everyone. I would like to refer everyone to slide 4 now. As Tom referenced, Berry posted a quarterly record net sales of $2.072 billion, which was up $166 million or 9% over the prior year quarter, primarily attributed to incremental sales in the Clopay acquisition along with selling price increases to pass through higher costs as well as 1% organic volume growth. From an earnings perspective, we achieved a quarterly operating EBITDA record of $374 million, an increase of $10 million over the prior year.
The addition of the Clopay business along with cost reduction efforts and price increases were partially offset by higher raw materials, manufacturing and transportation costs. During a period of significant inflation, we made progress during the quarter and we'll continue to work diligently within all three segments to pass through these increased costs related to raw materials and transportation. And we remain committed to offsetting in a productive manner. Pricing remains a core focus where we are also working with our customers to shorten the timing lag of raw material pass-through and I'm pleased to report that these efforts showed continued progress as well.
Looking at the results of each operating segment starting on slide 5, net sales for our Engineered Materials division for the quarter was $687 million, flat compared to the prior year quarter. An increase in selling prices as well as a modest increase in organic volumes in the legacy Berry operations was partially offset by lower revenue in the legacy AEP facilities.
Continuing to impact our business in the quarter was the steps we took to rationalize the business associated with the acquisition of AEP. And as communicated previously, we expect this June quarter to be the last quarter where the year-over-year volume comparison will be materially impacted by these decisions.
Operating EBITDA in our Engineered Materials division was $129 million and down slightly compared to the prior year quarter as a result of the AEP business rationalization. Increased selling prices in the legacy Berry business along with cost reductions and synergy realization offset cost increases in the quarter.
Next on slide 6, our Health, Hygiene, and Specialties division generated net sales of $726 million in the quarter compared to $606 million in the prior year quarter. The increase of $120 million or 20% was primarily attributed to the Clopay acquisition, a favorable currency impact and an increase in selling prices due to the pass-through of higher raw material costs. Base organic volumes declined 3% primarily due to weakness in global hygiene sales. Operating EBITDA increased 11% in the quarter to $123 million. This $12 million increase in operating EBITDA was primarily a result of the Clopay acquisition, cost reduction initiatives, and the favorable impact of currency partially offset by the under recovery of higher costs.
Turning to slide 7, net sale for our Consumer Packaging division was $659 million in the quarter, which was $45 million higher than the June 2017 quarter. The 7% increase was a result of higher selling prices and an organic base volume growth of 4% driven by the strong growth from our foodservice products that Tom referenced earlier. Operating EBITDA for Consumer Packaging in the quarter was $122 million compared to $121 million in the prior year quarter. Cost reduction activities along with the 4% organic base volume growth was partially offset by higher material, transportation, and manufacturing costs in the quarter. Our results also included increased costs related to facility consolidation as well as scrap and inefficiencies from the start-up of new capital expenditures.
We are pleased with the hard work and accomplishments of our team in working through these equipment startups in addition to handling raw material supply chain disruptions while providing high quality and service to our customers' increased demand.
Slide 8 provides a summary of our income statement for our fiscal third quarter. Overall, operating income increased by $4 million or 2% over the prior year quarter. This increase was due to the items previously discussed that drove the $12 million operating EBITDA improvement, partially offset by higher depreciation and amortization expense in the quarter related to the Clopay acquisition.
Interest expense was $67 million compared to the prior year expense of $68 million. This decrease is primarily a result of interest rate reductions we have achieved from proactive actions to lower our interest cost from completed refinancings, partially offset by higher market interest rates and the new debt financing associated with the Clopay acquisition. We have continued our efforts to refinance our debt and reduce interest expense when opportunities are available to lower our interest cost and strengthen our balance sheet. We are pleased with our progress and have increased our interest coverage ratio, calculated as operating EBITDA divided by annual interest expense to 5.3 times from 2.4 times at IPO.
Additionally, we have continued to strengthen our balance sheet over the same time period by reducing our leverage ratio of net debt divided by adjusted EBITDA from 5.2 times to now 3.9 times. We have made early principal payments of $200 million on our debt through the first three quarters of fiscal 2018 and made an additional $100 million early term loan principal payment after quarter end and anticipate further reducing our debt leverage ratio by fiscal year-end.
In wrapping up the income statement, our net income for the quarter increased 3% to $110 million compared to the prior year quarter. Basic earnings per diluted share increased to $0.81 and adjusted earnings per diluted share increased to $0.96 in the current quarter, a 7% improvement from the June 2017 comparable quarter of $0.90.
Next on slide 9. The company generated a June quarterly record of $271 million of cash flow from operations in the quarter. Net capital expenditures in the quarter were $86 million as we incurred spending on cost reduction initiatives, as well as the growth projects Tom referenced.
During the first three fiscal quarters of 2018, we have invested a record level of capital to support the organic and new product growth initiatives that we have discussed the past few quarters and we're starting to see and look forward to the continued sales and earnings growth from these projects in future quarters. Our adjusted free cash flow defined as cash flow from operations less capital expenditures and payments made under the tax receivable agreement was $185 million and $530 million for the quarter and four quarter ended June 2018, respectively.
Our consistently increasing and dependable free cash flow provides us the opportunity to return capital to our shareholders with the new $500 million share repurchase program Tom referenced earlier. The new authorization allows for the repurchase of shares from time to time through open market purchases, privately negotiated transactions and Rule 10b5-1 plans in accordance with applicable securities laws. The timing of these purchases will depend on market conditions. The new share repurchase program also has no expiration date.
And finally on slide 10, we have a proven track record of generating growth in annual free cash flow through various economic cycles and market conditions, and have achieved or exceeded our annual cash flows every year since our IPO. With respect to fiscal 2018, we remain committed to achieving our fiscal 2000 (sic) [fiscal 2018] adjusted free cash flow target of $630 million. Our guidance includes $987 million of cash flow from operations, partially offset by net capital expenditures of $320 million and the $37 million tax receivable payment that was made in the first fiscal quarter. This guidance includes a reduction to our capital spending of $20 million, along with $30 million of lower cash, taxes and other cash costs.
Earnings reduction is being driven by ongoing cost inflation versus the timing lag of passing along these cost increases. Specifically, excluding recent acquisitions, through the first three fiscal quarters of 2018 our cost to manufacture products have increased approximately $160 million. And thus far, we have been able to offset $100 million through selling price increases.
Our primary cost is plastic resin which has been extremely volatile from a pricing perspective in addition to numerous supply disruption throughout the supply chain in fiscal 2018. Polypropylene which constitutes almost 25% of our cost of goods sold has increased 20% in the months of May and June combined and is up more than 40% for the year. This increase, as we expect, will create headwinds in our Consumer Packaging and Health, Hygiene, and Specialties results in the September quarter because of the timing lag in passing through these cost increases. We are actively working with our customers to not only shorten our pass-through mechanisms to match the timing of these costs in our supply chain, but also recover other inflationary costs that are not covered by our pricing catch-up mechanism.
This concludes my financial review, and now I'll turn it back to Tom.
Thank you, Mark. As mentioned, in the face of continued cost increases we've reaffirmed our 2018 adjusted free cash flow target of $630 million, which represents an adjusted free cash flow yield of over 10% when using our market capitalization as of the end of the June quarter. We will continue to work diligently to offset inflation with increased selling prices, driving earnings growth through a focus on our reduction initiatives as well as grow our business organically and through strategic acquisitions.
We're extremely proud of our history and predictability as we've grown our free cash flow and exceeded our target every single year as a publicly traded company. We are taking proactive measures within each of our businesses to improve efficiency and profitability that will better position the company for continued success. These actions include reducing material usage, increasing our use of automation throughout our facilities, lowering our power consumption as well as improving how we logistically transport our products to our customers.
Through a comprehensive review of our cost saving efforts, we'll focus our future cost reduction and capital spending to explore ways to offset these inflationary headwinds while reshaping our go-to-market strategy to align with the evolving packaging and distribution preferences. These initiatives will assist us in remaining the low-cost manufacturer of choice while maintaining our high quality products and top tier service to our customers. We believe our scale provides us the opportunity to source low-cost materials and reduce the transportation and supply chain cost for our customers. We're excited about these projects and we'll continue to keep you posted on our progress in future calls.
Through our strategic decisions on capital deployment, we've been able to demonstrate organic volume growth by providing advantaged products in targeted markets. We'll also generate stronger revenue pipeline and increase win rates in each of our three businesses. With this robust pipeline of organic growth initiatives, we are in various stages of the commercialization process to continue to deliver these advantaged products in targeted markets for unmet needs. Let me again highlight several that are further along in the process. Within Consumer Packaging we are seeing firsthand the benefit of investing in targeted markets with advantaged products with our recent drink cup investment. The Consumer Packaging division through the strategic investments grew 4% in the quarter, and anticipate continued positive volumes in future quarters. We continue to invest in premier healthcare packaging for a wide-range of solutions as well as an innovative range of personal care products with a minimum of 25% post-consumer recycled content.
Within our Engineered Materials segment, we successfully completed the integration of the AEP acquisition and continue to utilize our new film technology through material science to produce value added multilayer films used to support the fast growing e-commerce space, specifically investing approximately $20 million with our packaging and converter partner that specializes in the manufacturing of protected packaging for e-commerce and distribution markets.
In our HHS segment we've committed to align our assets within the faster growing regions of the world and have invested $70 million in a state-of-the-art nonwoven line in China to support our customers' expected growth in the region. Additionally, we plan to add another $50 million investment using our Spinlace technology here in North America in support of the growing wipes market. Lastly, we've initiated evaluations of future global investments supporting the expansion of the innovative film technology brought by the Clopay acquisition to support growth in healthcare, next generation adult incontinence and feminine care applications.
These exciting efforts by our teams will lead our organic investment plan over the next several years, augmenting our disciplined and proven acquisition growth strategy. So far, in fiscal 2018 we've completed the strategic acquisition of Clopay and look forward to continue on our successful track record. Our pipeline continues to be very robust with global opportunities in each of our three segments.
The overall global packaging space remains fragmented where Berry, over $8 billion in pro forma annual revenue, is one of the largest in the world. With our leading portfolio of products touching consumer and industrial markets, we feel there is and will be many opportunities to continue to find accretive acquisitions while applying our proven conservative and disciplined approach.
A key component of this strategy is being very diligent and methodical in evaluating opportunities and determining which acquisitions are the best fit for our company. We work to identify the best people and best practices of each acquired business and apply those resources and practices to the entire enterprise. Accordingly, Berry represents the integrated processes, people and physical assets of the 44 acquisitions completed to-date. This historical disciplined track record is the foundation of what has led Berry to where we are today providing consistent 10-year compound annual growth rate of over 20% on revenue, EBITDA, and shareholder return and why we believe we have a very bright future ahead. Additionally, our share repurchase plan gives us the opportunity to return cash to shareholders through opportunistic repurchases and drive long-term shareholder value.
Finally, Berry will continue to take the steps necessary to remain a leader in the markets where we participate through a relentless focus on building and strengthening our competitive advantages ultimately maximizing shareholder value. I'm confident that people of Berry will continue to drive positive results and achieve our goals and mission of always advancing to protect what's important.
I thank you for your continued interest in Berry. And at this time, Mark and I will be glad to answer any questions you have. Operator?
The first question comes from the line of Mr. Anthony Pettinari. Your line is now open.
Good morning.
Hi, Anthony.
Hi. Just a question on free cash flow. You reiterated your 2018 guidance. When we think about 2019, you have Clopay, you have implementation of some of these price increases, maybe some working capital benefit. I guess to Tom's comments on your historical track record, do you think you could return to kind of double-digit free cash flow growth that you've historically generated in 2019 or do you have any kind of broad view on the puts and takes for free cash flow as you look to next fiscal year?
Anthony, good morning. Yes. Stay tuned. Next call is when we would typically give our guidance for 2019. Obviously, we've been successful in being able to demonstrate a track record of growing our cash flow every year. And stay tuned, we'll have more to come there on with respect to details of our fiscal 2019 guidance.
Okay. And then you talked about efforts to shorten lags on pass-throughs. For your non-resin raw material and freight costs, what's typically the lag in terms of recovery and where could that go given some of your current efforts?
Yes. It really depends by customer, by market space. The teams, as we've stated, we are fully committed to offsetting all inflation. And this year has been interesting in that we've seen a combination of not only resin inflation where 75% of our inflation is covered by escalator/de-escalators, but also in other raw materials and freight. We're making good progress in both those regards. If they're not covered by the confines of the agreements, it typically takes a little longer, but it really varies in duration.
I think we'll continue to see improvement in the months and quarters ahead as we continue to tackle that challenge. And I would also say as we look forward, I would expect some improved stability on the other raw material side and there continues to be efforts on the freight side, frankly, to utilize Berry's scale with 135 sites to find ways to locate more of our business and where we convert closer to our customers. It's unique advantage that we have. And to do that, it often would require some qualification time, but strategically customers are certainly interested to do that where we've got core capability that is of closer geographical proximity to them. So, lots going on in that area. We're making really strong progress, the lag efforts are something that we are fully committed to and driving that change. And if you consider, as a company, relative to price/cost spread we have a very good track record of the company delivering those offsets.
Okay. That's helpful. I'll turn it over.
The next question comes from the line of Ghansham Panjabi. Your line is now open.
Hey, guys. Good morning.
Good morning.
So, by our math you're lowering EBITDA by roughly $50 million relative to your previous guidance parameters for fiscal 2018. Can you sort of help us bridge that decline? How much is from higher resin and operating costs such as freight versus maybe lower than expected volumes? What are the major buckets behind that reduction?
Morning, Ghansham.
Morning.
Certainly it's a function of again timing of passing through cost inflation. We talked about polypropylene going up 20% just in May and June subsequent to our call. There's a lag in passing that through to our customers. And I think Tom just referenced the fact that we're working on reducing the timing of that. But at this point, that will create some short-term pressure in Health, Hygiene, and Specialties as well as Consumer Packaging who are heavy users of polypropylene.
We're continuing to work with customers as agreements mature. While most agreements have pass-through mechanisms relative to resin, which is about half of our cost, the other costs are not typically covered by mechanical pass-through arrangements. And so, we've got to work with customers as those agreements come due to pass through those additional cost increases. And so, it's an ongoing effort. I think Tom referenced most years were positive in that relationship, but there are years, every three or four years when you have significant inflation where you wind up in this catch-up mode.
Hey, Ghansham, as I stated I am personally involved in a number of those discussions and negotiations around our commitment to fully offset. And as Mark said, if you look at the basket of agreements that we have, they vary in length and duration. And not only are we working with our customers, but we're also working with our vendors to thoughtfully find ways and under the confines of those agreements to fully pass on the higher inflation that we're experiencing and do it in a productive way. And as I said, we're making very good progress. It's never fast enough, but we as a team and an organization remain committed.
Okay. And I guess my second question relates to Tom, your comments and your sort of optimism on new products. You seem very excited about these, yet CapEx is a little bit lower. I'm trying to reconcile the difference between the two. And then second as relates to PCR and some of the new next generation products with recycled content, et cetera. Why should we not expect simple cannibalization relative to your current product portfolio? Thanks so much.
Let me start with the last first, if you will, and relative to the environment. Listen, we continue to believe that plastics as a raw material continues to make people's lives better every day. I'm encouraged frankly by the efforts that have been put forth by the Plastics Industry Association, the ACC, in terms of combating much of the negative sentiment that we've seen with really a fact-based data driven dialogue. And I think you'll hear and see a lot more in that regard.
In terms of our company, we're frankly taking share from other substrates as we speak and people continue to see the advantages of our materials. For example, inside our Engineered Materials space, when you see higher freight costs, as an example, people want to migrate to other substrates that are lighter weight and ultimately provide better protection for damage, breakage, and loss. So, we're seeing improvements there in terms of share, on our substrate conversion. We're also seeing it inside our Consumer Packaging space with the foodservice portfolio. So, the prospects for our raw material based on our prowess and know-how around understanding design, finding ways to be more efficient in the use of our materials and, ultimately, working with groups like the Plastics Industry Association, our end users, better means to recycle and reclaim, all have a real positive outcomes.
In terms of growth, unfortunately, in some instances the time to deploy the investments around CapEx to ultimately realize growth, sometimes it's never as long as we like. We've been talking about our investment in Consumer Packaging for many quarters now. We were very pleased to see it happen as we predicted and as we committed. However, what we actually saw was demand far outpaced our expectation in the initial launch. And I have to thank our teams inside Berry because we did not disrupt the customers. And during that time, frankly, we not only balanced incremental demand that was unanticipated with new product launch, but also a couple of different force majeures that occurred during the period.
So, prospects seem to be -- for me it's very good. We've talked about how we've deployed more assets to the higher growth regions of the world inside HHS. And, yes, we're bullish about the growth prospects moving forward.
Thanks so much.
The next question comes from the line of George Staphos. You may ask your question.
Thanks, operator. Good morning, everybody. Thanks for the details. Hey, Tom. I mean, I had some questions on the new product launch as well and I want to weave it in with – candidly, I didn't quite hear an answer to Ghansham's question in terms of why you think this will not cannibalize your existing products. So, if you could sort of touch on that, why you don't see cannibalization. And in turn, what is so good about these new products for your customers that you're seeing this growth and was this just trade loading on growing 4% or you're seeing sell-through, so to speak, at the same rate? And then I had a follow-on.
Yes. In this application, we're actually taking share from other substrates. So, it's not cannibalized in our existing position. These new products inside foodservice allow us to provide a clear or a white cup that's fully recyclable and significantly lighter weight and more cost efficient for our end customers. So, it's of high expansion (00:38:21) for you – for us, if you will, in that we're actually taking share from another substrate. So, feel very good about that. And again, the foodservice space for us inside our Consumer Packaging business continues to deliver and uncover pipeline of opportunities that's quite impressive. If you look at the growth rate inside that business, it's been in the low-double digit now for the last several quarters. And frankly with this launch right now we would expect continued improvement as this product builds and ramps in the coming quarters.
Okay. Thanks for the review on that, Tom. I appreciate it. And then my other question for now is you mentioned the share repurchase authorization of $500 million. Have you been able to be active in that regard since the board approved it? You mentioned conditions dictating when you will use the repurchase authorization and just kind of see what's in your thinking and management – market conditions would seem to be better than they've been, say, six months or a year ago given the way the stocks acted. So, what kind of timing should we expect on the repurchase and what have you done so far? Thank you.
Well, we've done nothing so far. We just got the approval and frankly the first time we'd be able to do anything is Monday afternoon if I'm not mistaken. And listen, in the maturation of our company, we're first and foremost thrilled that our balance sheet, our financial performance have strengthened considerably over the past several years, and it gives us the opportunity to consider multiple vehicles to create shareholder value. If we see near-term dislocation in our share price and we want to advantage ourselves with that with the share purchase, we can do that. And then in the meantime, if M&A in the dynamic industry and world that it is, becomes near-term available, we can also execute on that which had provided historical very positive returns for our shareholders.
So, it gives a tremendous flexibility and that's what we wanted. We wanted a vehicle that would ultimately give us maximum flexibility to create more shareholder value, and we think this does it for us. And I think it's important to note we're not going to lose the discipline around how we acquire, identify, and integrate businesses. That's not going to change. And this is a vehicle as we see dislocation to take advantage of it. And as I said we can do it as early as Monday afternoon should we desire.
Okay. We'll be watching. Thanks. I'll turn it over.
Next question comes from the line of Tyler Langton. Your line is now open.
Hi. Good morning. Thank you. Just had a question on, I guess, the volumes in HH&S because they were down 3%. Can you just talk a little bit about what's driving that by other (00:41:21) products, nonwovens and the regions?
Yes. The primary driver of the light volumes in HHS was really around baby care. That was the primary category that was negatively impacted. You've seen major end users post their announcements. We continue to work with them on ways to cost effectively create different feature benefits to support their needs. We serve a very wide range of that space but the primary driver was in baby care.
Okay. That's helpful. And then just still within HH&S. The cost, the under recovery, is that still resins or freight. I know there's the issues in Brazil but those, I think, were supposed to have been lapped. So, if you just kind of sort of walk through the big categories there?
Yes. It's clearly we're working with the agreements that we have in place with our end users. As we've said, they vary in length and duration and we're working presently within the confines of the agreements to pass on all inflation not just to, obviously, resin which are covered by escalator/de-escalators but finding ways to shorten the lag as well as offset other raw materials and freight works where it's impacting us. So, that's an ongoing work in process inside that business. But I'm personally also involved in it.
(00:42:46) cause any inflationary or currency pressures in other regions or is it really just more sort of resins and freight excluding currency?
Yes. Resins, raw materials, other raw materials, freight, with currency being a very minor component of it.
Got it. Okay. Thank you.
Next question comes from the line of Sam McLaughlin (00:43:14). You may ask your question.
Good morning, guys.
Hi, Sam (00:43:20).
When you guys think about free cash flow, EBITDA growth, and the buyback program, do you guys still expect to be at 3.5 times leverage at year-end? Or are you guys pushing out the timing of that to take advantage of where your stock is trading currently?
Given the current market conditions, we still believe our leverage to stay below 4 times. We're still of that belief given what we know today in the market.
Great. And then you touched upon this when answering George's questions, but when you look at the landscape for M&A, how do you think about opportunities for acquisitions versus buying back your own stock given your current multiples? Is M&A still on the table and how are you guys looking at the pipeline.
M&A is absolutely still on the table. We have a very long proven track record of identifying and integrating businesses into our company and create a lot of shareholder value. So, we have opportunities in every region of the world right now, but we're going to do M&A with a very disciplined approach and there's still that opportunity where we continue to be bullish on.
The good fortune that we have is these markets continue to be very fragmented and our ability to ultimately be a known buyer of businesses and to be able to do it with speed. It's attractive component to people considering market and businesses to us. So, we're committed to it. It's still part of our strategy, near term and long term, and it's simply supplemented now with attractive buyback that we announced today.
Great. Thanks a lot. I'll pass along.
Next question comes from the line of Scott Gaffner. Your line is now open.
Thanks. Good morning, Tom. Good morning, Mark.
Hi, Scott.
Good morning, Scott.
Mark, I just had a question on – so you had $60 million year-to-date of negative price/cost. It looks like maybe it's another $20-million-plus in 4Q. So, it's $80 million of, let's call it, unrecovered price/cost in 2018. Can you talk a little bit about how much of that is raw material inflation that you didn't catch up versus transportation cost or other cost?
Yes. Sure, Scott. Good morning. Yes. I mean, some of that gets obviously commingled in the pricing discussion, right, because you're recovering cost and how much of that you recover and what the categories are somewhat gets commingled. So, a little difficult to separate it, I would characterize it as we're certainly feeling the impact of the mechanical pass-through timing lag. And we're also suffering from, again, increased cost across the other categories, but we're making progress. I think your assessment was right. We've been about $20 million negative in fiscal 2018 per quarter. And we expect a little improvement as we look to Q4 and look to continue to drive that to a better category going into fiscal 2019 next year.
Right. So, that's a...
But they're separated – separating it becomes difficult just because price gets commingled.
No. I completely understand. I guess I was trying to get at – I mean if you're negative $80 million this year with some of the lags, I mean even if you got half of that back in 2019 and then you layer on some of these capital projects that you've been talking about, some of the new product wins, you don't have the AEP volumes that you're walking away from – you're starting to get through that. I mean it sets up fairly nicely for growth in EBITDA, not just growth in free cash flow in 2019. Is there anything you would add as far as puts and takes to 2019?
No. I think that's a fair way to think about it. Again, years where we've had this situation where you've had significant inflation that's created a timing headwind, the following year has historically been very positive.
I think it's important to remind everyone that this is not unusual. The cost inflation that we see inside the business, if you look over the history, this is nothing we haven't dealt with before. We have pass-through mechanisms that's transitory in nature, and it's part of the normal course of business. Sometimes it creates near-term headwinds, but we feel comfortable that we'll manage through that and ultimately be able to successfully pass on this inflation.
Thanks. I apologize. One last quick one on CapEx. I mean, you've pulled it down this year. Does that CapEx have to go flow through into 2019, or is there still a view to maybe slightly reduce CapEx in 2019 without some of these larger projects? Thanks. Good luck in the quarter.
We have a robust pipeline of internal growth projects as well as cost reduction, and we'll continue to evaluate the strongest returns of those and prioritize them accordingly. We have a modest reduction this year in our capital plan. I wouldn't say that $340 million, which was our original plan for this year is an unusual year. We think we can accomplish our strategic growth objectives with $340 million-ish in capital per year.
And, Scott, we're very focused. We want to make certain that as we articulate where we're investing strategically in the business that we're also able to showcase the delivery in terms of growth that it creates. I think with the share repurchase, with the ongoing focus on M&A, with the efforts we're putting forth, with CapEx towards increasing automation throughout all of our plants, we've got a host of levers to continue, as Mark said, find ways to create more shareholder value.
Thank you. I appreciate it.
The next question comes from the line of Brian Maguire. Your line is now open.
Hey, good morning. Just a question back to the financial outlook. Tom, I guess, in response to – I apologize if I misheard it, but in response to George's question, just wasn't sure if you were indicating that that 4% volume growth in Consumer could continue into 4Q and beyond or if there were some one-time benefits from just filling in the channel there. And one for you Mark on the working capital assumptions. I think before you talked about that being around $40 million. Just wondering if you could give an update. And tied in with that, what sort of resin assumptions do you have for the remainder of the fiscal year?
I guess I'll start out. Yes, we believe we'll be – growth will be in the low-single digits in Consumer Packaging, is what our forecast is and consistent with what you're seeing here. Low-single digits.
Yes. And with respect to working capital, obviously the inflation we've experienced kind of since the last call, specifically from a material perspective in polypropylene, that certainly puts pressure on working capital just from a dollar perspective. But I'm really proud of the teams, the Berry group is doing a great job in managing working capital and kind of number of initiatives in place such that we think we can still hit the target that we relayed last quarter, thanks to a lot of hard work.
Okay. Great. And then a follow-up maybe just on the – well, I guess, on the resin assumptions into year-end tied to that. But then I just wanted to also ask about the efforts to reduce some of the contractual lags. Obviously, that would be a win if you got it. I would imagine customers are going to ask for something in response. Just wondering if you would, in relation to that, consider giving up some pricing or what kind of a mechanism do you think you might have to give up to accomplish that goal?
Yes. I'll answer the first part and I'll defer to Tom on the second. The first part, May and June, obviously, we had increases. Actually, July on the resin side settled basically flat, very, very modest movements in a few materials, but essentially flat. Beyond – August and September would have – to the extent it does move which I don't have a great crystal ball in terms of what's going to happen with resin for the foreseeable future here, but I would say it would have modest impact on fiscal 2018 to the extent it does move beyond July.
And I concur with Mark. Yes, I think clearly from a resin perspective, 2018 has been probably a little more volatile than people had forecasted and predicted more so on the polypropylene side than the polyethylene side. And as Mark said, we've got most of our agreements tied to escalator/de-escalators to ultimately offset that inflation. But clearly, I think the view going forward is a little more stable environment. Again, that can change overnight. We understand that.
But in terms of agreements and how we negotiate with customers, listen, we're looking to come up and collaborate to find productive solutions to these challenges that frankly both sides are impacted by. So, our commitment is to continue to maintain, grow our margins as a business. I think we saw 30 basis points sequential improvement in this quarter versus prior quarters. And if you look at Berry's historic track record, we've stayed between 18%, 19% typically in most years. So, we've been able to do a good job in terms of that raw material offset with these transitory expenses that we're incurring right now and that we've demonstrated the ability to ultimately affect that change and an offset recover (00:53:22). So, the conversations are going well. We're making good progress in that regard and more to come in the future.
Okay. Thanks very much.
The next question comes from the line of Gabe Hajde. Your line is now open.
Good morning. Thanks for taking the question. One, to start with the HH&S segment, we've read out in I guess a public format that some of your customers in the baby care market are raising their prices. Can you talk about if this – or I guess in quarters before you talked about lower promotional activity on their end and that impacting your volumes. Does this change in any way sort of your outlook for that business or are there ways that you can work with them to lower costs and keep that kind of low-single digit growth trajectory in that business?
No. Listen, we're still a big believer in our nonwovens business. We're a global leader in this space. I'm excited frankly to support these customers and where they're growing. It coincides where we're making investments. Our nonwovens investment in China, high growth region, high targeted growth rates for our end customers that we can match with innovative technology. Reinforcing our investment in our wipes business with the Spinlace investment. So, they see us investing alongside them. But in addition to that, inside this business we're supporting the healthcare, adult incontinence, and fem care space.
I will tell you and we can talk about it more on future calls, but Berry has a unique opportunity inside our HHS business. There's a variety of megatrends that are happening throughout the world right now that really you can't ignore. One of those is global aging and wellness. And the opportunity for Berry to take advantage of that, focusing on this growing global aging population. It's not only aging but they're living longer, have higher expectations in terms of quality of life. And, oh, by the way, have higher personal income than they have in any previous generation.
So, developing things and working on things like the next generation of adult incontinence products, unique fem care products, is a unique opportunity inside HHS that we'll be excited to report on the development of those initiatives inside that space. And by the way, it's matching and it's aligned with these major end users. So, we continue to be excited about the prospects. This will be a low-single-digit growth business in the future and we remain committed to it as well as our end-use partners
Okay. Thank you, Tom. And then, Mark, I think previous assumptions for cash taxes and then the kind of restructuring spend bucket had been $130 million and $50 million, respectively. Have those – I mean, you guys lowered it by $30 million collectively, but can you talk about which bucket in particular. And then, was this a onetime item in tax that won't repeat next year or do you guys figure out a way to kind of lower your annual tax obligation?
Yes. No. The taxes, we still think the right number for Berry is around 25%. Obviously, we're working diligently to try to reduce that. But there's nothing unusual with respect to taxes and outlook, just reflects the new earnings projection of the company.
Thanks
Nothing one time in nature there, Gabe.
Next question comes from the line of Edlain Rodriguez. Your line is now open.
Thank you. Good morning. Just one quick question on HHS in terms of the volume decline. I mean like the last quarter it was down 1% and I think the culprit was South America, like Brazil. Are we seeing the same issues in Brazil or is that improving at all there?
Look, yes, we lapped the prior headwind in the March quarter and we expect improvement as we migrate into 2019 inside that – in that region for us.
Okay. And in terms of like Engineered Materials, now that the portfolio pruning is over with, like what does that mean for volume going forward? I mean, should we expect to see a positive volume, 1%, 2% in that going forward?
Yes. We believe on a go-forward basis, our Engineered Materials is a low-single-digit business. We're proud of that portfolio and how it continues to change, to address some of the growing demand in the marketplace.
Okay. Thank you.
Next question comes from the line of Arun Viswanathan. Your line is now open.
Great. Thanks. Good morning. I had a kind of similar line of questioning. So, in HHS, as you turn on the new line, how much does that kind of add to your volume over the next couple of years?
Yes. The new investment will be coming on the back half of 2019. We haven't given specifics around the total size in terms of impact on volumes. Obviously, as Tom said, we're pivoting towards the higher growth regions. But it certainly won't materially move our volumes for that segment, just the single addition of that line.
We are currently – I apologize, I really didn't hear your question first. We are working also collaboratively with our end-use customers. We want to make certain and the basis of that investment was customer needs. And so, it's a customer-linked commercialization. We're focused with them on development initiatives as we build out this capacity. It's on-track. We continue to push the teams to drive as much performance as possible in terms of speed. But as Mark said, a little impact on 2019, but certainly high expectations for 2020 and beyond.
And then just as a follow-up, could you describe the environment in Latin America and Asia? Have you seen kind of a trade down in diapers and is that expected to continue? Or is there increased adoption in either of those regions? And if so, should we expect volume growth, I guess, to resume in HH&S next year?
Yes. As we said, in South America we lapped some of the prior headwinds in the March quarter. So, our expectations are improved performance in 2019. Inside China specifically, still a tremendous opportunity for premium product to support the diaper space, the fem care space and also the growing adult incontinence space as well.
And then just lastly on capital allocation, you now have the $500 million authorization. If you look at the M&A landscape, are there any potential opportunities like AEP last year where you could potentially do an equity finance deal that would also improve your leverage position, or is that not something you'd consider, and how do you view that in light of – or as far as priority versus stock buyback? Thanks.
It's a timing thing. It's a dynamic space. The pipeline inside each of our three businesses continue to be very robust. And we'll make disciplined decisions based on the timing of that opportunity. I would love to be able to perfectly sequence that. I think that's the beauty of the share buyback authorization that it gives us flexibility in the near term should we so desire to buy back shares, create value that ultimately would sequence with a potential M&A. So, it gives us maximum flexibility, and both of those options can create exceptional shareholder value. And we'll do it just based on that, what's going to drive the most value for our shareholders.
Yes. I would just add. I mean our equity is our most expensive form of capital, and so it takes obviously a unique opportunity for that to make sense. So, that's certainly not our base case from an M&A strategy. We're deleveraging half a turn or so a year which creates a lot of capacity for us to do thoughtful, disciplined acquisitions to the extent they're available.
Great. Thanks a lot.
Thanks.
Next question comes from the line of Adam Josephson. You may ask your question.
Thanks. Good morning, everyone. Just a couple of questions. One on Mark, back to the guidance question for a second, the $50 million reduction to EBITDA. Is that all just the jump in polypropylene costs of about $0.15 a pound or was there anything else that happened in the quarter that led to that change?
No. I'd say that's certainly a large component of it. There's obviously other costs that have also increased, things like freight and other raw materials that are used in the production of our product that have also increased, creating that headwind for us in the back half.
Okay. And...
A component but not the only component.
Got it. Okay. And just on the cash tax issue for a second, you reduced your cash tax expectation by $30 million. I think in the previous quarter you had reduced it by $20 million. Is that all attributable to just lower earnings? And if so, is it reasonable to think that would reverse next year?
Yes. No. Sorry. So, yes, I was referring earlier when I said there wasn't any kind of "onetime items" in our tax relative to this quarter's guidance. Last quarter, we did have a benefit as a result of the Clopay acquisition that we completed this year that was nonrecurring that benefited our taxes in the $30 million range that would not be recurring to the extent we don't have acquisitions but give us that opportunity. So, last quarter we did have a $30 million kind of "onetime" benefit in taxes.
Okay. So, this quarter's $30 million is recurring whereas last quarter's was not?
Correct.
Okay. Got it. And just to be clear on the CapEx, you said $340 million is a reasonable number going forward, right? Did I hear you correctly on that?
Yes, that's right, Adam. We think we can achieve the organic growth objectives and cost reduction with that capital amount.
Thanks so much, Mark.
Thanks.
Next question comes from the line of Mark Wilde. Your line is now open.
Thanks. Good morning. Hey, Tom, I wondered if we could come back briefly on just that growth in foodservice. You mentioned a few different things, different geographies, substrate substitution and the fact that you've come up with a newer, lighter weight product. I wondered if you could just give us a little more color on that. And then should I make too much of the fact that you are up 4% in Consumer this quarter and then you said kind of going forward kind of low-single digits?
Yes. I look at 4% as being low-single digits. So, listen, I think we believe we have a very positive growth outlook inside our Consumer Packaging business. It's consistent with the investments that we've made here supporting our drink cup investment. The fact – and we talked about some of the drivers in the marketplace, this is a material that ultimately is lighter weight, so it's reducing material consumption that has the same rigidity as a heavier cup.
So, product performance is enhanced. It gives the end customers the opportunity in either a clear or a white cup. From a marketing perspective, it's advantaged when you consider that versus other substrates. I'm not going to talk negatively about other substrates. And it answers the environmental question relative to recyclability. So, it's a great development. We are fortunate with these products to be working in conjunction with our end users, so that we're understanding what their unmet needs are and ultimately finding ways to fill them. So, it's a good story in CP. And frankly we talk a lot about the investments they're making in other areas, healthcare packaging, personal care packaging. So, target position is improving. Hit rate is improving. So, as we work through the transitory inflationary items, we're going to remain focused on demonstrating our ability to grow organically.
Okay. And can you just – as a follow-on, can you just talk a little bit about international expansion plans? I mean you talked about the nonwovens in Asia. But you purposefully changed the name of the company to Berry Global, and I think it kind of tells us about your aspirations. But just maybe some thoughts on kind of pacing of that international growth, which markets, which regions and sort of is this going to be opportunistic or what's the strategy here in terms of international expansion?
Yes. Well, first and foremost, it's methodical and very thoughtful. I'd give you an example around our healthcare business right now. We're very fortunate to have locations in India, in Bangalore, as well as Offranville, France, both those facilities are benefiting from additional capital investment in more capacity to meet, driving, improving customer demand. And we're somewhat agnostic in terms of the region of the world. We want to make certain that we can capture and create value and that we've got a value proposition that's sustainable. Clearly, with what we've seen inside the healthcare space, we believe this is the case and our investments have been measured and metered, along with the opportunities. So, that continues to be an opportunity for us. But again our history has been a very disciplined approach, and that won't change whether it's in the U.S. or somewhere else in other regions of the world. But I'm happy to say our pipeline is robust and it's global in nature.
Okay. Very good. Good luck in the fourth quarter.
Thanks a lot, Mark.
The last question comes from the line of Chip Dillon. You may ask your question.
Hi, guys. It's Salvator Tiano filling in for Chip. How are you?
Doing well. How about yourself?
Great. So, my first question and I don't know if it's something you addressed and I missed at the very beginning of the call. But you do quote in your outlook $30 million of lower cash taxes and other cash cost. And I was just wondering, there's been some discussion about what's the implied EBITDA decline. But is there – are you offsetting some of the price/cost headwind and lower volumes with cash cost reductions? And is your EBITDA decline – the implied EBITDA decline perhaps a little bit less than what's implied from the press release?
Yes. We're always looking to take actions to improve our cash flow. It's an intense focus of the company. And so, yes, really proud the team is doing a great job offsetting inflation which is obviously putting pressure on not only earnings but working capital. And so, we're really proud of the efforts of the team. So, certainly we're doing a great job in holding that. The implied kind of resin pressure on our working capital will imply a much bigger headwind. So, certainly, yes, we're taking actions that we think are sustainable to reduce the working capital of the company.
Sure. Perfect. And my second question is actually on the resin pass-throughs and got a number of questions. I just wanted to get a little bit your opinion, we've seen already some of your peers reporting and it seems like the second calendar quarter of the year was an inflection point where some saw very small headwind and some others even turn the price/cost positive in the quarter. So, I'm wondering I know you have bigger exposure in polypropylene which is obviously price are going higher versus other resin substrates, but we also have higher contract – higher percentage of contracts that have pass-through mechanisms than your peers. So, what is driving kind of this underperformance on this metric versus other companies that use resins?
Like we said, our agreements vary in duration as well as contractually how the pass-through is ultimately written. That's why we're working, as Mark and I both stated throughout the call, helping us reduce the lag and the time by which we ultimately can pass on those transitory cost. It's very important – it's a priority for us right now and that's where we're spending our time and energy, to make certain that – actually for both our end customers as well as ourselves, it's faster and more balanced.
Okay. Great. Thanks.
There are no further questions at this time. Presenters, please continue.
Well, thank you, operator. I want to thank everyone for your attention to the call and I also want to thank Berry's 24,000 employees around the world who are a key component to our success and the future success that we'll have in the company. Thanks for your interest in our company. Thanks so much.
This concludes today's conference call. You may now disconnect. Have a great weekend.