Graphic Packaging Holding Co

NYSE:GPK

Hello, everyone, and welcome to the Graphic Packaging Third Quarter 2023 Earnings Call. [Operator Instructions]. I would now like to turn the conference call over to our host, Melanie Skijus, Vice Principal of Investor Relations. Please go ahead.

Good morning, and welcome to Graphic Packaging Holding Company's Third Quarter 2023 Earnings Call. Joining us on our call today are Mike Doss, the company's President and CEO; and Steve Scherger, Executive Vice President and CFO. To help you follow along with today's call, we will be referencing our third quarter earnings presentation, which can be accessed through the webcast and also on the Investors section of our website at www.graphicpkt.com. . Before I turn the call over to Mike, let me remind you that today's press release, the third quarter earnings presentation and the statements made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the risks identified in the release and the presentation as well as our filings with the Securities and Exchange Commission. With that, I'll turn the call over to Mike.

Thank you, Melanie. Good morning, everyone, and thank you for joining us on the call today. Let's begin with the highlights on Slide 4. I'm very proud of our team's performance during the third quarter. Amid a very dynamic environment, we continue to make progress on our goals, deliver adjusted EBITDA growth and margin expansion, invest for the future and fulfill our purpose to package life's everyday moments for a renewable future. . As customers have pointed out in recent months, the consumer environment remains dynamic and uncertain and evolving macro climate has resulted in a relatively more cautious consumer in the near term. At the same time, and as we have discussed last quarter, retailers are operating with more normalized inventory levels versus a year ago as supply chain challenges have largely subsided. The combination of these factors has had a modest impact on our packaging volume and listening to a broad mix of our global customers, we are anticipating a return to our targeted 100 to 200 basis points of net organic sales growth in 2024.

Responding to external factors, our team leveraged the scale and flexibility inherent in our system and reduce paperboard production by 150,000 tons during the quarter. Through our disciplined commercial approach and active management of supply to meet demand, we met our commitments to customers and stakeholders while adapting to current volume changes. Together, our team, our capabilities and our strong operational execution provided a path to targeted EBITDA margin levels in the quarter.

Our performance demonstrates the resilience of our business and is a testament to our differentiated approach to servicing and growing consumer packaging markets. We are delivering value to customers with the packaging solutions we provide and optimizing our system to position Graphic Packaging for long-term growth.

A key element of our strategy is supporting growth through advancing innovation capabilities and making strategic investments. We made considerable progress on this front in the third quarter, including new innovations that are driving category and market expansion, continued progress on our multiyear CRB system transformation, both of which I will expand on in a moment, and lastly, the completion of the Bell Incorporated acquisition.

The acquisition of Bell is a good example of how we are investing in our packaging network by adding capabilities and expanding the customers and markets we serve. Acquisition integration is well underway, and we are excited about the new opportunities Bell provides.

As we look ahead, we are positioned to benefit from the long-term strength of demand for sustainable fiber-based packaging. We are focused on further distinguishing Graphic Packaging as the leader in recycled and recycled gold consumer packaging. We have updated our guidance and continue to expect 2023 adjusted EBITDA of $1.9 billion, at the midpoint of our guidance range. In addition, we are tracking to meet or exceed our enhanced Vision 2025 financial goals. We remain confident in our ability to achieve annual organic sales growth targets in the years ahead.

One of the many reasons we remain confident in our organic growth outlook is the continued advancements we are driving through innovation with our customers. Slide 5 provides another example of our innovation engine at work and the continued progress using fiber to replace packaging previously created with nonrenewable resources like plastic and foam. I'm sure many of you recognize the iconic Nissin Cup Noodles, a leading brand in the ramen comfort food category. Historically, the noodle cups have been made of foam. Through our innovation capabilities and expertise in both food service and retail packaging, the fiber-based solution we develop serves as a more sustainable packaging alternative to foam and is effective in a shelf stable retail environment.

Notably, our retail cup solution for Nissin provides added convenience for the consumer as it is safe for microwave use, eliminating an extra step required in meal preparation when using foam. We are excited to share with you today a new partnership we have with Nissin Foods and the upcoming launch of their cup noodles product packaging our proprietary retail double-wall fiber-based cup solution. The rollout is expected to begin in the first quarter of 2024, aligned with consumer preferences for more sustainable packaging options Nissin plans to convert their entire 16-ounce cup noodles product line in the U.S. from foam to our solution over time.

This packaging application marks our first in microwave cups as we continue to expand the addressable market within the more than $4 billion cup in container market in the U.S. Our history serving retail markets and our ability to invest behind and scale with customers creates new opportunities across various dry food categories that today are primarily in foam and plastic. Items such as pasta, cereals, breakfast mixes and single-serve dried foods are examples where our fiber-based solution has tremendous potential to win.

While discussing growth opportunities in the broader cup market, let me also provide an update on our program in Chick-fil-A. Last quarter, this important customer went to market with our new highly insulated double-walled beverage cup and approximately 10% of its stores as a potential long-term solution for its beverage program. Feedback from both stores and consumers has been favorable and Phase 1 of the program continues with roll-offs currently underway to additional stores. We continue to believe our innovation can be a long-term solution for Chick-fil-A and others currently using foam cups and containers.

Driving innovation with industry leaders like Chick-fil-A and Nissin Foods demonstrates how top brands are investing to transition towards more sustainable packaging solutions. Through our extensive design and packaging network, we are partnering with leading brands to effectively transition to sustainable packaging solutions that consumers prefer. We believe long-term tailwinds support the continued demand for this transition such as end-use consumers seeking more sustainable packaging, customers responding to demand and pursuing sustainability goals and in a growing number of jurisdictions, environmental legislation requiring the use of more sustainable packaging.

Moving to Slide 6. Let me provide a brief update on the significant progress we have made on our CRB transformation. Since 2019, we have embarked on a multiyear optimization effort to simplify our CRB system while strategically expanding capacity and lowering cost. The end result will further distinguish Graphic Packaging as the lowest cost and highest quality coated recycled paperboard producer in North America. Our efforts to optimize and strategically expand capacity are the result of trends we identified early on, including growing consumer demand for packaging made from recycled materials. Our focused investments will ensure, we will sustain unmatched quality and cost advantage in this important category for years to come.

Since the project began, we have made significant progress in our CRB system transformation with our new 550,000 tonne K2 machine ramped in Kalamazoo, we have effectively increased our net CRB capacity by 70,000 tons to support our growth. Three, higher cost, less efficient facilities and our longest running paperboard machine in Kalamazoo, had total production of 480,000 tons have been removed from the system. As noted, this total includes our recently announced permanent decommissioning of the K3 machine. Our decision on K3 reflects the incredible success of the state-of-the-art K2 machine, which has been operating at or above committed efficiency and quality levels. We look forward to replicating the success of K2 with our new CRB paperboard machine in [indiscernible], Texas, which will expand upon our quality and cost advantages when it begins production in late 2025.

As we have talked about before, the ability to cost effectively produce higher-quality CRB allows us to meaningfully and profitably expand opportunities within new markets and ones we already serve. One example of this quality improvement is the new [indiscernible] cycle paperboard, which we introduced last quarter. This new grade of the highest quality recycled paperboard available will facilitate CRB in more consumer packaging experiences across the food, health, pharmaceutical and beauty product applications. We are pleased to have our first sale of [indiscernible] in October and look forward to sharing many more packaging example wins in the quarters to come.

The third quarter also included the release of our 2022 ESG report detailing the progress we have made towards achieving our Vision 2025 ESG goals. Sustainability is an integral part of our business strategy and our impact extends well beyond our own business. We enable customers, including many of the world's leading household brands to transition towards recycled and more recyclable packaging solutions.

I'd like to note a few key highlights from the report that can be seen on Slide 7. To start, we successfully achieved our goals for greenhouse gas emission intensity and nonrenewable energy intensity 3 years early. We did so through investments in efficient manufacturing and expanding the scale of our packaging operations. For example, the K2 machine helped reduce emissions intensity associated with CRB production by an estimated 3% in 2022.

We also highlighted we are on track with our goal to have 100% of our global facilities compliant with a fiber certification standard. More certification and certified sourcing programs give consumers confidence that our packaging does not contribute to deforestation or biodiversity loss. The goal demonstrates our support for sustainable forest management and forest product sourcing practices we follow to ensure compliance.

We have more than 24,000 teammates worldwide, and I am proud of the progress we are making as we build a more diverse and inclusive workforce. There is always more work we can do, and we remain committed to fostering continuous improvement in the workplace centered upon our employees' growth and sense of belonging.

Slide 8 highlights the recent sustainability achievement I'm very excited to share with you. We learned in early October that the science-based targets initiative approved our 2032 carbon reduction goals, which are outlined here. As an increasing number of consumers are voting with their wallets by purchasing products from brands that are doing the right thing for the planet, we are proud to be filling our purpose to package life's everyday moments for a renewable future. With that, I'll turn the call over to Steve to provide more detail on the financial results. Steve?

Thanks, Mike, and good morning. Let me start on Slide 9 with an overview of the key financial highlights for the third quarter and the first 9 months of 2023. Overall, our results demonstrate the resiliency of our business and ability to operate effectively through a very dynamic macro environment. Net sales declined 4% year-over-year to $2.3 billion. As Mike discussed, sales during the quarter were impacted by some fluctuations in consumer purchasing behavior and by efforts from retailers to adjust inventory levels. Those headwinds were partially offset by positive pricing execution and the impact of foreign exchange.

Net organic sales growth adjusted for the same number of shipping days as in the prior year period, was down 4.6% during the quarter. We now expect net organic sales to be plus or minus 2% in the fourth quarter. With an anticipated return to our targeted 100 to 200 basis points of net organic sales growth in 2024. We remain confident in our innovation pipeline and our ability to execute on commercial opportunities to fuel our organic growth in the years ahead. Our expected 4-year cumulative average organic sales growth rate of approximately 2% and from 2019 to 2023 remains at the high end of our annual range established with Vision 2025.

Our top line performance is benefiting from our diverse portfolio of end markets and customers. While sales for the food, beverage and consumer markets decreased 6% in the quarter from the prior year period, sales in our food service markets grew 8% as our packaging solutions continue to win as mobile consumers are looking for convenience when heating and drinking on the go.

We are actively managing our supply to meet current demand, exercising discipline and production while minimizing the cost of doing so, and focusing on servicing long-term customer relationships with their packaging needs. Given the disciplined approach to production, we exercised throughout our packaging business, reported profitability is as strong as we anticipated despite short-term fluctuations in the consumer environment.

Adjusted EBITDA grew 9% year-over-year to $482 million and adjusted EBITDA margin expanded by 250 basis points year-over-year to 20.5%. Adjusted EPS also continued to grow, expanding 10% year-over-year to $0.74. As a reminder, our sales and EBITDA waterfalls are available for reference in the appendix of today's presentation.

Global liquidity remains strong at nearly $1.2 billion. Our success driving integration rates higher was evident in the quarter with paperboard integration into our consumer packaging business at 79%. This is an increase of 500 basis points from the prior year period. As a reminder, this is an increase of 1,200 basis points from 67% since January 2018, when we completed the combination with International Paper's North American Consumer Packaging business. We will continue to drive integration rates higher as we capture and execute growth opportunities in consumer packaging.

Slide 10 outlines updated full year guidance for 2023, reflecting our current expectations as well as the recent acquisition of Bell Incorporated. Most notably, the midpoint of our adjusted EBITDA and adjusted EPS guidance remains fundamentally unchanged.

Turning to Slide 11. We continue our balanced approach to capital allocation, which focuses on growth and capital return. As discussed during today's call, we remain focused on investing for growth, such as the recent acquisition of Bell, ongoing advancements in innovation and the new recycled paperboard facility in Waco, while also reducing leverage to the lower end of our targeted range and returning capital to shareholders.

As of today, we have repurchased $54 million of stock year-to-date. Our balanced approach to capital allocation positions the business for continued success and delivers value for our stakeholders. With that, I will turn the call back to Mike.

Thanks, Steve, and I'd like to thank our talented team around the globe. Their strong execution positions Graphic Packaging to meet our commitments to customers, deliver value for stakeholders and continue our leadership in fiber-based consumer packaging. I'm pleased to share with you that we will be hosting an Investor Day in New York on February 21, 2024. In addition to a strategic update on the business, we will provide Q4 and full year 2023 financial results, guidance for 2024 and looking further into the future, our new Vision 2030 aspiration and goals. We are excited to see many of you in person and look forward to providing more details on our plans for the future. I will now turn the call back to the operator to begin the question-and-answer session. Operator? .

[Operator Instructions]. So our first question comes from the line of Ghansham Panjabi of Baird.

Mike, so just kind of looking back at 2023, it seems like this was the year of price cost led margin expansion and just much weaker than forecast end markets given destocking and some level of consumer elasticity that perhaps offset any of your internal growth and productivity initiatives. Based on what you see at this point, what does 2024 look like? Would it be just better volumes just based on the comparison and some level of margin give back based on the pricing trend line in the industry? And then maybe as a correlate to that for Steve, any variances you can share with us on an EBITDA basis, such as price cost for '24 ?

Good to hear you. We are a little break up there. But I think I got just your question talking about volumes here in '23, how we're thinking about them and kind of the -- as we're exiting '23 and into '24. I'd say this. I mean, as we told you going into this quarter, our third quarter, this is going to be the toughest quarter [indiscernible] '22, we're up almost 5%. [indiscernible] adjusted basis, we came in with second quarter really what we indicated at the end of the second quarter. So pretty much in line with what we thought and our [indiscernible] get a little easier here in Q4. We were up a little less than 1% last year in Q4. So we've got a range out there of minus 2 -- plus 2. And really, the real reason for that, as you know, is the recovery rate is just not linear. It tends to be a little bit lumpier than anybody says.

And from our standpoint, our crystal ball is no better or worse than anybody else's in terms of when the actual inflection occurs. We have some customers that are talking about an elongated recovery. We have some customers that are talking about promotions that are going to occur in Q4 and drive volume. So it's a balance between those 2 things. [indiscernible] give us confidence as we head into '24 around our ability to grow at our medium- to long-term advertises to put out there 100 to 200 basis points of growth. The first, of course, just the comps get easier, not coming off of this year. So that's point number one. Point number 2 is we've got a very robust and deep innovation pipeline. Examples like we gave here today, the cup noodles and the Chick-fil-A, cold and gold cups, and there's been others almost every 1 of our updates are we going to another thing that we're doing out there to replace usually [indiscernible] packaging. So we know we'll grow with our innovation.

And then the third point that I'd make is that's really what our customers are telling us. They need to grow too because ultimately, their stocks don't work if they don't have top line growth that also translates into volumes as well. So those 3 things really can give us confidence as we go into 2024. Now exactly what's going to happen in Q1? Probably not. But our confidence is high that in '24 will grow again. And if you really take a step back to over a 4-year period of time. Now -- and you just say we're at kind of the midpoint of our guide for volumes here in Q4, we grew 3% a year for the 3 years coming into this year. This year, if we take a step back [indiscernible] 2.5%. But if you look at a 4-year stack on that we're at our 2% target that we put out there at the high end of the 100 to 200 basis points. So we knew over a long-term aspiration goal that we put out like Vision 2025, there'd be some ups and downs that occurred. But overall, we're very pleased with the overall trajectory and the growth that we've experienced in the business and expect that to continue in '24 .

Ghansham, it's Steve, do you want to just repeat a little bit of your [indiscernible], just to make sure I got it right?

Yes. I was just curious on the variances on EBITDA, on price cost and whatever else you can share at this point.

Yes. No, thank you for that. I just want to make sure that's what I thought you said. I mean, listen, as Mike just said, as we look into 2024, there's some [indiscernible] that we would expect will be beneficial to the P&L if you kind of look out to next year. We'll have a full year of the Bell acquisition. We acquired that in the fourth quarter. So a modest EBITDA this year. Just by way of reminder, we bought $30 million of EBITDA and $10 million of synergy. So we'll pick up probably an incremental [indiscernible] from that next year along with the synergies. So think of that as a plus $30 million [indiscernible] 100 to 200 basis points of organic sales growth. As you know what that value perspective, it would be at or above our margins as we generate.

And we should have a very strong productivity here. We will have less planned maintenance [indiscernible] less market-related downtime as we return to growth and [indiscernible] weather-related event that was of substance, which certainly, we don't plan for that to repeat. So those are 3 very positive benefits as we [indiscernible] labor and benefits inflation this year, running a little bit normal. We'd expect that to get [indiscernible] levels.

And if you mark-to-market the current price cost environment, so just mark [indiscernible] all of it pricing related to $80 on SBS, the [indiscernible] on we're in a very benign inflationary environment year obviously, as we've talked, we're very committed to operating the company in a pretty narrow range of EBITDA margins. And this year, we can move towards the 20%, and certainly, we would expect to operate in a pretty thin band around that 20% as we look out to 2024. So hopefully, that gives you some of the components. We'll obviously provide detailed guidance when we're together in February and provided that to you in a more granular level. But those are, I think, the high points if you kind of look at the year ahead.

Our next question comes from the line of Mike Roxland. Please go ahead.

Mike, Steve and Melanie [indiscernible] questions, congrats on the good quarter despite the backdrop. On your last call, you mentioned contract resets particularly in North America, which have long duration 2 to 5 years. And you mentioned, I think, the way that you phrased it was that there's a meaningful number of contracts out there that you still need to be addressed over the next 12 to 24 months, but have yet to reflect the higher prices. So is there any way that you could help us size that? Is that 20% of all contracts, 80% of all contracts. And the reason I'm trying to just drill down on that is because Steve just answered the prior question on some of the drivers for 2024. But wouldn't those contract resets also be beneficial to driving EBITDA growth next year?

Yes, Mike, it's Steve. And [indiscernible] drive benefit next year. As we also talked on the last quarter, and we don't tend to put those into the kind of mark-to-mark market discussions as we were just having -- and at any time, to your point, we've got 20% or 30% of our contracts that are in negotiations and coming due. So as those play out, we'll certainly articulating those if there are some that play out here late this year [indiscernible] those in the guidance.

But to your point, we continue to actively engage with our customers to put in appropriate value for the products that we're producing and have the kind of long-term relationships that we have enjoyed with many of our customers.

Got it. I appreciate that, Steve. And just 1 quick follow-up. Any comments you have on trends that you're seeing thus far in October? Has there been any improvement at all sequentially. I know whatever you peer report yesterday basically noted no improvement thus far in 4Q. So any commentary or color you can provide around what's happened thus far in October, in terms of order patterns [indiscernible] promotional activity, I think that would be helpful.

Well, Mike, we've obviously gotten a look into October. And with October, it's consistent with the plus or minus 2%. So we do expect to see sequential improvement quarter-to-quarter. And as Mike said, we've got customers who are seeing a positive move volumetrically already. We've got others who are seeing it taking a little bit longer. And so we're seeing it's a good mix of customers who are starting to see some promotional activity materialize in Q4. Others aren't quite there yet as Mike articulated earlier, but sequential improvement in Q4, we can see happening.

Our next question comes from the line of George Staphos of Bank of America. Please go ahead.

Hi, everyone. Good morning. Thanks for the details. Stephen, Mike, I don't know if everyone is hearing it, but your phone has been cutting in and out a bit, at least on our end. And I just wanted to make sure when you're answering Ghansham's question, did you put out at least mark-to-market on pricing that you see for '24. Because if you did, we didn't hear that before we get into our questions.

Yes, George, it's Steve. And our apologies if they're experiencing some technical challenges here. But let me in replying Ghansham's question, what we did indicate is that if you just do a pure mark-to-market on price cost, we've got very little happening on inflation, so pretty benign. And if you sequentially just look at the price impact year-over-year, it's down roughly about $80 million year-over-year. And as Mike Roxland just mentioned, obviously, we've got other customer negotiations that we're always involved with and improving terms and conditions where they're in our negotiations. And so I think that hopefully, you were able to get that in response to anything that may have cut out. Did that work, George?

That's perfect. And actually, that's kind of where we were modeling -- doing [indiscernible], thank you for that. So 2 questions here very quickly. First of all, in terms of the noodle cup and related markets, what do you think that market opportunity is for you and maybe what kind of tonnage do you expect maybe for '24 and '25 from those markets? The coding in that cup is that a bio coating? Or is that a poly coating and how will you handle that?

And then the other question is just sort of near term, we noticed that -- and again, performance was good given the backdrop, we don't want to take away from that. The free cash flow guide came down a little bit this year, and you mentioned the labor and benefit is running a little bit hotter this year than your prior guide. What were the factors in that?

I'll take the first part of that, George, and then I'll let Steve handle the questions there on working capital, in particular. But the reality of it is if you look at our total addressable market and we put out there, $12-plus billion and within that addressable market, there's a $4 billion segment of it, that's what we call cups and containers. So that's really where that is. And so it's a very big opportunity for us and 1 that we can work on for years to come. . In fact, the vast majority of our cups, including the [indiscernible] has some form of a [indiscernible] polyethylene or polyethylene barrier coating inside. And as we talked about, what we're really excited about is our ability to take those cups back to Waco, and we can process with new vertical drum pulper that we're installing there, up to 15 million of those paper cups today. With that, coating on the inside, cleam them up, take advantage of the fiber that will be on the top wire. It will be the first fiber we put down, and we'll recycle those cups.

So we're working with our customers within about a 200-mile radius of the mill to be able to have that capability and eventually, you can expect that we'll be able to do that in Kalamazoo as well. That's our plan. So we feel like ...

I'm sorry. Could that be 50,000 tons next year, do you think this new market is new customers?

I don't know. We're not going to put a tonnage number up there right now. I mean, I can tell you this that fully transition [indiscernible]. So I mean [indiscernible] numbers that come forward. So then it depends on kind of what Chick-fil-A trajectory looks like and some of the other conversions that are out there. But over the medium term, we expect that we'll be able to make a pretty strong pivot out of our coated SBS and get more into manufacturing to cup stock, which, as you know, George, the split right now of about 1.2 million tons, it's roughly 400,000 tons to 800,000 tons. So every time we sell a cup is something that we integrate into our own operation.

Did you get all that [indiscernible]? .

Yes, that's perfect. And on the variance .

Yes. And let me just touch on that a couple of things. Really on cash flow, we're just dialing in our working capital. We're running very much true demand, as you know, and all we were really doing and saying, okay, we're just going to continue to service customers, make the products that we need to make, [indiscernible] inventory that we want to carry to make sure we're servicing customers. So we were really just dialing in that cash flow.

I also will remind folks that when we had talked about 2.5x leverage ratio, that excluded Bell [indiscernible] as we mentioned, we've got to be up in the 2.6 range. We put 2.6 to 2.7 because we've also been acquiring some shares as you saw in the modeling that we shared with you on the guidance.

So hopefully, that gives you a sense for -- we're real pleased with where we're generating the cash flow. And as we look into 2024, it sets itself well to make sure we're servicing customers as they return towards growth.

[Operator Instructions]. Our next question comes from the line of Adam Samuelson of Goldman Sachs.

Yes. Thank you. I guess the first question, just to clarify in what the fourth quarter, the slides talk about organic kind of volume mix down to up to. Steve, it sounded like you're talking about plus 2% in the fourth quarter, and I just wanted to make sure I was -- make sure I was talking about the same year, hearing the same thing or taking up the same thing that we're seeing on the slides.

Yes. No, Adam, for clarity and maybe something that got lost there with some of the technical issues. No, what we're saying is Q4, plus 2% to minus 2%, so 0 at the midpoint. And so we will see sequential improvement over the minus 4 that we've seen over the last 2 quarters. And so it was [ plus 2 minus ]2 and October is playing itself out consistent with that as we kind of look towards the fourth quarter.

Okay. No, that's helpful. And then as we think about moving into next year, you talked on a bunch of these calls about kind of the -- how optimistic you've been about [indiscernible] and the quality of that Board and the opportunities that, that can unlock for our recycled board in new applications. How should we think about the commercialization of that and meaningful volumes that can be switched into CRB-based products away from a [indiscernible] type offering and what that can do from a margin perspective in '24 if you think about that bridge?

Yes, I think it's really a longer play than just '24, Adam, what I'm really encouraged about is the fact that we had our first sale in the quarter. It will shift actually here in Q4, which is great. I'd tell you that customer interest is extremely high. We have got many trials going underway and continue to have a lot of interest, as you'd expect, given its characteristics as we described on prior calls. So what it really does is gives us confidence as we look out at the end of '25 and '26 as we get Waco up and going. And as you know, we're adding a couple of hundred thousand tons that we're going to be able to grow into that with the work that we're doing with the trial work in this new grade that we've got, some of the things we have around our mailer business that we got from Bell, we expect that will grow. That's all CRB.

So we're in a really nice spot. We've optimized Kalamazoo. We're building out Waco. It's on schedule. It's coming along great. I was there a couple of weeks ago and got a chance to tour the site. And all the efforts that we've got going on here are really focused on making sure that we've got the demand, take advantage of that 200,000 tons of growth, that will show up when we start that machine on.

Okay. I appreciate that color, I'll pass on.

Our next question comes from Arun Viswanathan of RBC Capital. Please go ahead.

I guess first question around volume. I think prior to this call, you had made some comments that your customers were reducing inventories at both maybe the brand level as well as the retail level. What have you noticed there? I mean is that ongoing? And then similarly, do you consider any of those reductions as structural that is just given the high interest rate environment and the inflation that we've seen, would it take really reductions in those 2 areas to really get things going again? And do you expect that should materialize next year. So maybe we'll start with that.

Yes, Arun, I'll take the first cut at it, and then Steve can add any commentary that he's got. I think, look, what you're referencing there and what we talked about on our second quarter call was the destocking phenomenon that really, in our industry started to hit the end of Q1 and kind of played out into second quarter, a little bit of third. We view destocking largely in our rearview mirror now. We're dealing with some elasticities with pricing and some of the products that our customers are selling. That's probably having more of an impact on top line sales than anything else right now, as I talked about with Ghansham, with his question.

Trading down, we don't see a lot of that in North America yet, and it makes sense. If you think about it, we still have less than 4% unemployment here. So anybody that wants a job, they have a job. Mobility is high. That's really why our foodservice business actually grew organically from a volume standpoint. And of course, from a net sales standpoint, it was up almost 8% in the quarter. So that's solid.

If we're seeing trading down anywhere, it's in Europe, which you'd expect, given the inflationary pressures that they're seeing, and we're well positioned to be able to handle that there, too, with the portfolio of business that we have.

Okay. And then just kind of a follow-on would be, have you seen an increased promotional activity from some of these customers. And then another topic that I was just curious about was just on the side of pricing. I know that there was a reduction in SBS folding carton grades. Is that all that we've seen on the pricing front? Do we expect any more maybe some price normalization or reductions next year. So maybe you can just address the promotional environment as well as the pricing environment. .

Yes. So as I said, around the promotional side of things, it's a bit of a -- it's lumpy. I mean some customers are doing more of that right now and some have said they're protecting their pricing and expect more of an elongated recovery. So it's a bit of a mixed bag there. I expect as most of our customers have told us they want to grow their volumes next year, as I commented earlier. So I'd expect them to figure out ways to do that. And that usually comes in the form of promotions that they do or different merchandising options they've got available to us, and I don't think this will be any different this time. That's what gives us confidence in our ability to grow 100 to 200 basis points next year a room too.

In regards to pricing, you mentioned the SBS folding that's decoded. That is down $80 a ton. CRB and CUK have moved down $20 in total this year. So that would be a complete summary of what has happened in terms of pricing in 2023. And as you would expect, we're not going to prognosticate around pricing here on a call. But what I would tell you is that at Graphic Packaging, our overall operating rates were pretty good. I mean you saw it on 1 of the slides, 3 of the 4 substrates that we manufacture, we are actually at 90%, that being CRB, CUK and cup stock, those are highly integrated businesses for us, as all of you know. The 1 that actually was light was the [indiscernible] SBS. And in our case, that was down around 70% as we chose to really operate those assets to match our supply and our demand, which would be our plan going forward here, too.

If you really take a step back from that and think about CUK in terms of what's going on there, over the last couple of years, we were buying globally some additional paperboard in different geographies to run our business and service our customers. Because of some of the efficiencies we see and some of the demand adjustments that have taken place, we can now integrate all those tons into our own operation and export to more tonnes to Europe as well as to Australia and New Zealand. And so that really helps us on the CUK side.

And on CRB, with our K3 machine now being dump down and it didn't produce actually in the third quarter, but we did have a very significant annual outage in Kalamazoo both our paper machines ranging from 7 to 9 days. If you factor that 7 to 9 days out, our 90% was actually in the mid-90s. And we're running wide open on our CRB system, the mills we have, Kalamazoo, Middletown and East Angus to service our business in Q4, and we expect that to be the case as we go into 2024 as well.

Cup stock, as we talked about, with things like [indiscernible] and our Chick-fil-A and our overall foodservice business, which grew in the quarter organically from a volume standpoint, that's a very solid business. It's highly integrated, over 90%. So our challenge is on the coated SBS has been well chronicled. But in our case, I gave the math for George, 400,000 tonnes a cup, 800,000 tons of coated that high-level numbers, we need about [ $300,000 ] of that to run our business. So the open market portion of it for Graphic is 500,000 tons. So it's about 10% of our overall volume. That's it.

And as I've stated earlier, we're trying to find ways to continue to grow our cup business, and we're going to need that capacity to ultimately service customers as these transitions out of foam and plastic continue to grow on the fiber side. So that's how I think you should think about the overall demand profile, which usually is tied to some level of pricing.

Our next question comes from the line of Matt Roberts from Raymond James. Please go ahead. .

My question in regard to permanently shutting the K3 machine in the quarter, while that seems consistent with the initial plan you laid out in 2019. Can you discuss how the timing of that played out versus your initial expectations? And what are some of the assumptions or scenarios you're considering on the timing of closing East Angus and Middletown ahead of Wako?

And I appreciate the question. I mean from our standpoint, our plan was always to shut down our K3 facility. The question was when could we do so and take care of our customers. And so with the ramp-up of K2 and exceeding our expectations in terms of productivity and quality, we were able to do that on June 30. So that timing was good. And as I just mentioned, we need our remaining mills and assets to run well to take care of the business that we have. And so we do not plan on shutting down any of those mills prior to our Waco facility up and running, just simply because we're going to need the times to service our business on the CRB side. .

Yes. Matt, just to expand on that, if you kind of step back and we shared it on 1 of the slides, I mean, we've really played this out since 2019 as described. How we got there is a little different, of course, but the 550,000 tons in and 480,000 tons out we've grown at a 2% CAGR over the last couple of years. We need those tons. And we've got demand for our CRB. And so as Mike mentioned, we'll continue to run the CRB platform very full, taking, of course, our planned typical maintenance outages where appropriate. But there's a real strong outcome there relative to our original commitments and just repeating something I mentioned the same applies with CUK because of global demand for [indiscernible] solutions.

Right. That makes sense. Mike and Steve if I could follow on to that, thinking about maybe the longer-term supply here. A competitor announced it seems like they're delaying [indiscernible] conversion citing market softness. So how has that action changed your longer-term industry supply estimate through 2025 and beyond? If so, [indiscernible]

I think on the margin, they're seeing exactly what I just got done describing, where the FBB was going to compete is on the coated SBS side, which is the weakest of all the grades. So that probably causing them to take some pause. In our case, we're actually shifting out of coated SBS as we can and growing our cup stock business. We're going to have the lowest cost platform for CRB. In the Western Hemisphere, our CUK is incredibly competitive and a highly integrated business, over 95% integrated. So we're just running a different race in terms of how we're putting it together. And that isn't where we're going to spend our capital dollars to place our emphasis.

We're a packaging company. We want to sell a cup. We want to sell a carton. And we'll make the grades of paper where we can actually earn a good return for our investors. And that's how you'll see us allocate our capital.

Yes. Matt, just to add to Mike's point, if you kind of then step back and assume that there's a long-term delay on the project that you were referencing from a capacity perspective, there's very limited capacity that is underway coming into the market. There's 1 conversion happening with the competitor up in the [indiscernible] that has some incremental capacity. Obviously, we will bring on a little bit of incremental capacity to support our growth. And you've actually had some capacity reductions that are playing themselves out in SBS. And they take some time to roll through the market. I mean the Canton mill that was closed here is now fully down, and I'm sure inventory levels are being managed through.

So actual capacity across all 3 substrates, very modest additions if you look out over the next 3 to 5 years, knowing the time lines for any other decisions that someone may or may not make over time.

Our next question comes from the line of Mark Weintraub of Seaport Research Partners. Please go ahead.

There had been quite a bit of static when you're answering Ghansham's questions. And I apologize, I didn't get everything. So I just wanted to quickly review some of the framework on bridging [indiscernible]. I think you mentioned Bell including synergies was about $30 million positive EBITDA and then 100 to 200 basis points being your kind of baseline. So those -- I did hear -- and I apologize, I sort of lost -- I didn't hear too much on the productivity versus labor historically, that used to be a bit of a wash. Did you give specifics on sort of netting those 2 out for next year? .

Yes. Why don't I given it sounds like there was a problem with that. Let me just repeat the answer for you, Mark, just so that you have kind of the whole context again. What we indicated was that on the positive front, as you just articulated, but playing it back to you again, Bell will be an incremental positive next year, probably in the $30 million range, a combination of the business we acquired plus the synergies we'll earn on our 100 to 200 basis points of organic sales growth. So if you assume $100 million to $200 million of top line growth, we'll earn on that. That actually is a bit of a counterbalance to the price cost relationship on a mark-to-market basis. So just all known pricing actions, probably about an $80 million net headwind offsetting the significant price that we've executed on over the last 3 years. . And then we would expect our productivity to be very strong next year. We will have less planned maintenance downtime. We won't plan for a weather-related event that occurred in 2023 in the first quarter. And less market-related downtime as we return to growth. And so we would expect that to fully offset our labor and benefits inflation as it normalizes back towards probably more towards that $100 million range. And so those were the components, Mark, that we would see playing themselves out in 2024. So it will be a different year than 2023 in terms of some of the pluses and minuses. But is also repeating it, we expect to operate in EBITDA margins that are in range, a tight range, a tight range around that 20% that we're executing on this year.

Okay. Great. And then lastly, and a follow-up, I think, from Mike, you were talking about how there were resets, et cetera. And I just [indiscernible] quite clear. So is the bias on the resets necessarily to the positive, and it's a question of magnitude? Or is that to be determined? .

This is Steve, Mark. Our bias is to the positive, obviously, because we're renegotiating if someone has been under contract for quite some time and may not have the full increases that we've executed on because of the model they were on or what have you, the resets we would expect be net favorable as we renegotiate them. And as repeating it from earlier, we don't outlook those until we're done until we've successfully executed on them. And that's 1 of the reasons you've seen price generally moving beyond what might be expected because of those successful negotiations that we've been undertaking for the last couple of years. And of course, we would continue to embark on as you look out to 2024. I don't know, Mike, if there's anything you'd add to that.

No, I think you said it well .

Got it. Very helpful. And maybe just lastly, and top you've already been hitting on. Totally understand kind of the idea of shifting some of the SBS folding carton over to cup stock over time. I mean you are operating at 70%. So I guess there's also opportunity if that market gets better next year, just selling it as coded board. Can you give us kind of what is it that would make that -- what is it that needs to happen for that market to get better, so you'd be running more full in that business? And is that part of the improved productivity that you were expecting and alluded to in the prior comments?

Yes. So it's really 2 things. We need demand to obviously pick up. And there's a variety of different verticals where that could happen. On the coated side of SBS, some of the more high-end stuff, as you know, that historically has been used for that kind of paperboard. So that would be -- we'd earn on that if we had those sales. But as we talked about here, our approach has been we're going to match our supply and our demand and that's what we did here in the quarter. And ultimately, yes, it inerts itself and we pick up under absorbed fixed costs. I mean, that's exactly how it works if we're able to operate the mill. But we're only going to do that if we have the orders to actually match that. .

Yes. And Mark, to Mike's point, as you know, SBS folding cartons, so that specific grade is the most fragmented, most global least integrated. And so given that there was obviously an overproduction of a little more magnitude over the last year, I think that speaks to the depth of the down, so down towards the 70%. We're matching our supply with demand. And to your point, when all of that plays out, which it is, whether it plays out and you go into 2024, when it does return to a normal pattern of buy, sell, if you will, there should be value creation there as you get to more normalized volumes rolling into 2024.

Our next question comes from the line of Anthony Pettinari of Citi. Please go ahead.

I think you saw net organic volumes down, I think, 6% year-over-year, but vol/mix was a 9% top line headwind. I was just wondering if you could talk about any mix shift you saw during the quarter? And then separately, I guess, in 3Q, Foodservice outperformed grocery on easier comps. Is it reasonable to expect maybe those end markets could perform similarly in 4Q as they did in 3Q? .

Yes, Anthony, it's Steve. I think the differential there that you're describing is all the open market paperboard sales, which were down year-over-year. So we outlined that on the third quarter net sales performance. You've got open market sales down a little over $100 million. So that's us matching supply and demand, only producing paperboard that we sell into the open market where we have orders at pricing that we find consistent and acceptable. And so that's really the point there.

The organic sales, as you know, as we've described it is on when we make an end consumer package. And so hopefully, that kind of breaks it out for you.

Got it. Got it. And then the foodservice versus grocery, I mean, you think 4Q would maybe play out similarly to 3Q?

Yes. I think the relationship is probably, yes, it will all be sequentially better as we were articulating. But I think as Mike has said and we've shared with you, the drive-thru just continues to win, and fiber-based packaging through the drive-thru is winning. And so overall, the performance of our Foodservice business has been very good. It was actually up modestly organically in the quarter, which was a favorable outcome as part of the 8% improvement year-over-year. So there's good momentum there as consumers want to be mobile, and they also want to have products that are delivered to them effectively mostly through the drive-thru. So I think the momentum there is very strong. And then it's supported by the innovation activity that we articulated to you as well here like Chick-fil-A and others.

Okay. That's helpful. And then shifting gears. There have been a lot of questions in the CPG and foodservice space around potential long-term impact of GLP-1 drugs. I'm just wondering if you had any kind of high level or initial thoughts on if or how this could impact your business or any anecdotes if consumers using GLP-1 or maybe buying less or more or shifting their mix of products that you provide packaging for?

Yes. So Anthony, if you really -- and you've been watching many of our customers have done their releases over the last couple of weeks, and they've commented a lot on this because they've gotten a lot of questions on it. And it's early days in terms of that drug, and I don't think we even know all the questions to ask yet. But having said that, many of them have actually said, they don't expect it to be much of an impact, if at all, on their business. And several have said they anticipate that this can be an area that perhaps they can innovate behind it. So I think, we're just going to have to wait and see how that plays out over time, what the adoption rates are and how it all plays out. But there's nothing there we've seen or read that gives us pause relative to our ability to drive our 100 to 200 basis points of organic volume growth over the medium to long term.

Our next question comes from the line of Phil Ng of Jefferies.

Appreciate squeezing me in here. Sorry to harp on this. I mean the nonintegrated tons are obviously quite small for you, but you've given some color on how your volume trends have progressed through October and since you stripped that out, your net organic sales number. And certainly, SPS [indiscernible] seems to be a little more under pressure. How do you kind of see the open market tons progressing through the year? And I'm curious if you've seen any more impact just broadly on imports, at least RESI seems to be dialing up comments around that and maybe having more of an impact and making its way in the Midwest? .

I think the way we're dealing with the open market, particularly on the coated SBS side, as you've seen in terms of the 70% operating rate for graphic is we're matching our supply and our demand. And we'll continue to do that. That's our plan relative to how we would operate the business.

I've already told you our CUK and CRB and uncoated cup business, those are strong businesses, highly integrated. Our operating rates are solid there. And I'd expect that to continue to be the case, particularly as we get some growth.

Yes. I mean it's a great question around imports. When you read some of the trade journals and how they talk about imports, it sounds like there's a wave coming. And I was interested particularly on the most recent 1 relative to CRP coming from Western Europe. So our team went back and pulled all the census data. We look back a couple of years in terms of what it looked like. Bill, 20,000 tons or less a year for the last 3 years. It's a 2 million-ton market. It's like 1%. So what's most surprising to me on that is just the amount of [indiscernible] that got, because we don't see it in the marketplace, and we're out there every day, we're the biggest producer of coated CRB, as you know, and we're getting bigger. And maybe even to build on that a little bit, we're the lowest-cost CRB producer in North America. And if you compare [indiscernible] against Europe even today, it's almost 5x more expensive, almost $20 an MMBtu. And it's more expensive to get a container from Europe than it is to go from the United States to Europe, almost 2x. And so we thought selling CRB to ourselves where we buy over 100,000 tons of material in Europe was a good long-term plan. We'd be doing it, and we're not. Because it just isn't economically profitable over the cycle to be able to do that. So there's some stuff maybe around the margin out there. It gets a lot of airplay. But when you really look at the data and the numbers, it doesn't support the hype.

Okay. That's helpful. That's great color. And then since you brought up Europe, just curious how is your business holding up there? Appreciating you're on the converting side, maybe you're able to kind of work through all this, but your ability to kind of match price cost in the medium term as well? .

Our overall volumes in Europe were substantially similar to those in the United States. And I'll tell you what -- in a word -- well, a couple of words maybe, our strategy is working there. And if you look at how we're doing it, we've got a nonintegrated business there where we're 1 of the largest buyers of paperboard in Europe, and that puts us in a great spot right now where the markets are a little bit softer, as you've already mentioned here. And so we're buying paperboard very effectively. We're able to export our CUK into that market profitably and have for a long time as we continue to grow our beverage business.

So when you really look at it, and Steve and I talk about it a lot, having a nonintegrated business over there, we don't have as much capital tied up to drive the revenue line in our European business. So when you look at our return on invested capital and compare Europe to North America, which is obviously heavily integrated, in our own paperboard, they're on top of 1 another. So our overall strategy is actually delivering good results for shareholders.

Our last question comes from the line of Gabe Hajde of Wells Fargo Securities. Please go ahead.

Mike, Steve. I had a question about backlogs. And I know you guys don't necessarily express it this way, but the 3 to 4 weeks, I think historically speaking, you guys have talked about as probably being towards the low end of what you'd consider to be sort of a healthy balanced market. I'm just curious, for this time of the year, taking into account seasonality. Is there anything different unique about that number. You called out the 15,000 tons that would be associated with Nissin, and I appreciate that was, I think, full adoption. So more thinking about Chick-fil-A. I think you've identified that as maybe an 80,000 ton opportunity. And correct me if I'm inaccurate. Is there anything in that backlog number sort of for a pipeline fill into '24 associated with those 2 products.

And then sort of when you're talking in February, would you expect to see that backlog number change materially from where we're at today? Again, just taking into account seasonality?

Well, I'll answer the second part of your question first. I mean the overall numbers you talked about are accurate relative to what some of those full conversion and adoption rates would be, they're directionally correct at least for your modeling. In regards to backlog, I think you got to take a step back and think about -- we're talking about operating rates now when you're taking downtime to match supply and demand. So backlogs, quite frankly, are artificial because they can be whatever you want them to be based on the amount of downtime that you take. So the more germane point is as we try to articulate here, Gabe, out of 3 of the 4 substrates, we're very busy on 3 of those. It's the coated SBS that's the 1 that is -- it's got the biggest challenges for us for the reasons we've already chronicled.

So I won't get overly hung up around whether it's 3, 4, 5, 6 weeks. That matters when you're running both. And right now, particularly on the coated SBS side, we're not. And so I'd watch those operating rates and really watch and see what our overall growth development looks like here in Q4 and into 2024 because as we grow 100 to 200 basis points, that's where those tons come. And I already mentioned the other thing that is out there is that we're no longer going to buy as many tons internationally on the CUK side. So that will actually help drive some of that back to .

Yes, Gabe, just playing that back. I mean you just kind of rounded as Mike was just articulating, we've got fundamentally SBS folding carton in the open market, which has the appropriate headwinds, and it's well under 10% of the company, well under 10% of the company. And so you've got 90-plus percent of the company that's functioning as we've been articulating to you here this morning with good volume and an expectation of a return to organic sales growth that we'll earn on in 2024.

Okay. I appreciate that, gentlemen. The last one, if I could squeeze it in real quick. If my model is correct or my notes, you had about $65 million last second half of 2022 of additional [indiscernible] sort of bridging this into the free cash flow number. So I'm assuming -- I don't know what that relationship looks like on the IC front versus H2 2023. Just curious if that's helping the second half at all? And then really, again, to put a finer point on the working capital component of our cash flow bridge. Are you assuming some sort of, call it, $150 million, $175 million use this year?

Gabe, it's Steve. On the first component, the incentive compensation year-over-year is very similar. So there's not anything there that is a headwind or a tailwind. So it's all pretty consistent 22% to 23%, and it's all in the guide. I don't have the exact number in front of me. But yes, to get to the midpoint of our working capital, there will be some use of cash on the working capital front as we dial in kind of where do we want to end the year on inventory levels, where do we want to run supply to meet demand.

So I'm sure your model on the use knowing where interest expenses, where pension expenses, where taxes are. You may be a little light on taxes. Our cash taxes this year are moving up as we become a U.S. cash taxpayer. We're on the right to do that. So we'll provide some more detail as we kind of work through modeling for next year. But I think the key is that we're going to generate the midpoint of that cash flow, and our leverage is going to end the year at the lower end of our range. And by the way, that's a raw leverage calculation. It's not pro forma. It's the real leverage of the company after spending $260 million to [indiscernible] Bell.

There are no additional questions [indiscernible] at this time, I'd like to hand the call back to the President and CEO, Mike Doss for closing remarks.

I want to thank all of you for joining us on the call today. We apologize for the technical difficulties if you experience those on your end. And we look forward to talking to all of you in February at our Investor Event in New York City. So I hope everybody has a great fall and a safe day today. Happy Halloween. .

Ladies and gentlemen, thank you for joining the Graphic Packaging Third Quarter 2023 Earnings Call. Have a great rest of your day. You may now disconnect your lines.