ITEM 1.
BUSINESS
Overview
Graphic Packaging Holding Company (“GPHC” and, together with its subsidiaries, the “Company”) is committed to providing consumer packaging that makes a world of difference. The Company is a leading provider of paper-based packaging solutions for a wide variety of products to food, beverage and other consumer products companies. The Company operates on a global basis, is one of the largest producers of folding cartons in the United States ("U.S."), and holds leading market positions in coated unbleached kraft paperboard (“CUK”) and coated-recycled paperboard (“CRB”).
The Company’s customers include many of the world’s most widely recognized companies and brands with prominent market positions in beverage, food and other consumer products. The Company strives to provide its customers with packaging solutions designed to deliver marketing and performance benefits at a competitive cost by capitalizing on its low-cost paperboard mills and converting plants, its proprietary carton and packaging designs, and its commitment to quality and service.
Acquisitions and Dispositions
On April 29, 2016, the Company acquired Colorpak Limited ("Colorpak"), a leading folding carton supplier in Australia and New Zealand. Colorpak operates three folding carton facilities that convert paperboard into folding cartons for the food, beverage and consumer product markets. The folding carton facilities are located in Melbourne, Australia, Sydney, Australia and Auckland, New Zealand.
On March 31, 2016, the Company acquired substantially all the assets of Metro Packaging & Imaging, Inc. ("Metro"), a single converting facility located in Wayne, New Jersey.
On February 16, 2016, the Company acquired Walter G. Anderson, Inc. ("WG Anderson"), a premier folding carton manufacturer with a focus on store branded food and consumer product markets. WG Anderson operates two world-class sheet-fed folding carton converting facilities located in Hamel, Minnesota and Newton, Iowa.
On January 5, 2016, the Company acquired G-Box, S.A. de C.V., ("G-Box"). The acquisition includes two folding carton converting facilities located in Monterrey, Mexico and Tijuana, Mexico that service the food, beverage, and consumer product markets.
The Colorpak, Metro, WG Anderson and G-Box transactions are referred to collectively as the "2016 Acquisitions" and are included in the Americas Paperboard Packaging Segment.
On October 1, 2015, the Company acquired the converting assets of Staunton, VA-based Carded Graphics, LLC. ("Carded"), an award-winning folding carton producer with a strong regional presence in the food, craft beer and other consumer product markets.
On February 4, 2015, the Company acquired certain assets of Cascades Norampac Division ("Cascades") in Canada. Cascades primarily services the food and beverage markets and operates three folding carton converting facilities located in Cobourg, Ontario, Mississauga, Ontario and Winnipeg, Manitoba along with a thermo mechanical pulp ("TMP") mill located in Jonquiere, Quebec and a coated-recycled board mill located in East Angus, Quebec. The Jonquiere mill was closed in the third quarter of 2015.
On January 2, 2015, the Company acquired Rose City Printing and Packaging Inc. ("Rose City"). Rose City services food and beverage markets and operates two folding carton converting facilities located in Gresham, OR and Vancouver, WA.
The Carded, Cascades, and Rose City transactions are all referred to collectively as the "North American Acquisitions."
On June 30, 2014, the Company sold its multi-wall bag business. Products included multi-wall bags, such as pasted valve, pinched bottom, sewn open mouth and woven polypropylene, and coated paper. Key end-markets included food and agriculture, building and industrial materials, chemicals, minerals, and pet foods.
On May 23, 2014, the Company acquired Benson Box Holdings Limited ("Benson"), a leading food, beverage, and retail packaging company in the United Kingdom. Benson operates four folding carton facilities that convert paperboard into folding cartons for the food, beverage and healthcare industries.
On February 3, 2014, the Company sold its labels business.
Capital Allocation Plan and Equity Offerings
Capital Allocation Plan
On February 4, 2015, the Company's board of directors authorized a share repurchase program to allow management to purchase up to $250 million of the Company's issued and outstanding shares of common stock through open market purchases, privately negotiated transactions and Rule 10b5-1 plans. During 2016, the Company repurchased 13.2 million shares, or approximately $169 million, of its common stock under this program at an average price of $12.77. During 2015, the Company repurchased 4.6 million shares, or approximately $63 million at an average price of $13.60. At December 31, 2016, the Company had approximately $18 million remaining under this share repurchase program.
On January 10, 2017, the board of directors authorized a new $250 million share repurchase program.
During 2016 and 2015, the Company's board of directors declared a regular quarterly dividend per share of common stock to shareholders of record as follows:
During 2016, the Company declared and paid cash dividends of $71.7 million and $64.4 million, respectively.
During 2015, the Company declared and paid cash dividends of $65.5 million and $49.3 million, respectively.
Equity Offerings
During the first and second quarters of 2014, certain shareholders of the Company sold approximately 30 million and 43.7 million shares of common stock in two secondary public offerings at $9.85 and $10.45 per share, respectively. The shares were sold by certain affiliates of TPG Capital, L.P., certain Coors family trusts and the Adolph Coors Foundation, Clayton, Dubilier & Rice Fund V Limited Partnership, and Old Town, S.A., referred to collectively as the "Selling Stockholders." Following the completion of the offering in the second quarter, these Selling Stockholders no longer held shares of the Company's common stock.
Products
The Company reports its results in three segments:
Paperboard Mills includes the seven North American paperboard mills which produce primarily CUK and CRB. The majority of the paperboard is consumed internally to produce paperboard packaging for the Americas and Europe Paperboard Packaging segments. The remaining paperboard is sold externally to a wide variety of paperboard packaging converters and brokers.
Americas Paperboard Packaging includes paperboard folding cartons sold primarily to Consumer Packaged Goods ("CPG") companies serving the food, beverage, and consumer product markets primarily in the Americas.
Europe Paperboard Packaging includes paperboard folding cartons sold primarily to CPG companies serving the food, beverage and consumer product markets in Europe.
The Company also operates in three geographic areas: the Americas, Europe and Asia Pacific.
For reportable segment and geographic area information for each of the last three fiscal years, see Note 14 in the Notes to Consolidated Financial Statements included herein under “Item 8. Financial Statements and Supplementary Data."
Paperboard Packaging
The Company’s paperboard packaging products deliver brand, marketing and performance benefits at a competitive cost. The Company supplies paperboard cartons and carriers designed to protect and contain products while providing:
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convenience through ease of carrying, storage, delivery, dispensing of product and food preparation for consumers;
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a smooth surface printed with high-resolution, multi-color graphic images that help improve brand awareness and visibility of products on store shelves; and
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durability, stiffness and wet and dry tear strength; leak, abrasion and heat resistance; barrier protection from moisture, oxygen, oils and greases, as well as enhanced microwave heating performance.
The Company provides a wide range of paperboard packaging solutions for the following end-use markets:
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beverage, including beer, soft drinks, energy drinks, teas, water and juices;
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food, including cereal, desserts, frozen, refrigerated and microwavable foods and pet foods;
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prepared foods, including snacks, quick-serve foods for restaurants and food service products; and
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household products, including dishwasher and laundry detergent, health care and beauty aids, and tissues and papers.
The Company’s packaging applications meet the needs of its customers for:
Strength Packaging. The Company's products provide sturdiness to meet a variety of packaging needs, including tear and wet strength, puncture resistance, durability and compression strength (providing stacking strength to meet store display packaging requirements).
Promotional Packaging. The Company offers a broad range of promotional packaging options that help differentiate its customers’ products in the marketplace. These promotional enhancements improve brand awareness and visibility on store shelves.
Convenience Packaging. These packaging solutions improve package usage and food preparation:
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beverage multiple-packaging - multi-packs for beer, soft drinks, energy drinks, teas, water and juices;
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active microwave technologies - substrates that improve the preparation of foods in the microwave; and
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easy opening and closing features - dispensing features, pour spouts and sealable liners.
Barrier Packaging. The Company provides packages that protect against moisture, grease, oil, oxygen, sunlight, insects and other potential product-damaging factors.
Paperboard Mills and Converting Plants
The Company produces paperboard at its mills; prints, cuts, folds, and glues (“converts”) the paperboard into folding cartons at its converting plants; and designs and manufactures specialized, proprietary packaging machines that package bottles and cans and, to a lesser extent, non-beverage consumer products. The Company also installs its packaging machines at customer plants and provides support, service and advanced performance monitoring of the machines.
The Company offers a variety of laminated, coated and printed packaging structures that are produced from its CUK and CRB, as well as other grades of paperboard that are purchased from third-party suppliers.
Below is the production at each of the Company’s paperboard mills during 2016:
The Company consumes most of its coated board output in its carton converting operations, which is an integral part of the customer value proposition. In 2016, approximately 85% of mill production of CUK and CRB was consumed internally.
CUK Production. The Company is the largest of four worldwide producers of CUK. CUK is manufactured from pine-based wood fiber and is a specialized high-quality grade of coated paperboard with excellent wet and dry tear strength characteristics and printability for high resolution graphics that make it particularly well-suited for a variety of packaging applications. Both wood and recycled fibers are pulped, formed on paper machines, and clay-coated to provide an excellent printing surface for superior quality graphics and appearance characteristics.
CRB Production. The Company is the largest North American producer of CRB. CRB is manufactured entirely from recycled fibers, primarily old corrugated containers (“OCC”), doubled-lined kraft cuttings from corrugated box plants (“DLK”), old newspapers (“ONP”), and box cuttings. The recycled fibers are re-pulped, formed on paper machines, and clay-coated to provide an excellent printing surface for superior quality graphics and appearance characteristics.
Corrugated Medium. The Company manufactures corrugated medium for internal use and sale in the open market. Corrugated medium is combined with linerboard to make corrugated containers.
The Company converts CUK and CRB, as well as other grades of paperboard, into cartons at converting plants the Company operates in various locations globally, including a converting plant associated with the Company's joint venture in Japan, contract converters and at licensees outside the U.S. The converting plants print, cut, fold and glue paperboard into cartons designed to meet customer specifications.
Joint Venture
The Company is a party to a joint venture, Rengo Riverwood Packaging, Ltd. (in Japan), in which it holds a 50% ownership interest. The joint venture agreement covers CUK supply, use of proprietary carton designs and marketing and distribution of packaging systems.
Marketing and Distribution
The Company markets its products principally to multinational beverage, food, and other well-recognized consumer product companies. The beverage companies include Anheuser-Busch, Inc., MillerCoors LLC, PepsiCo, Inc. and The Coca-Cola Company, among others. Consumer product customers include Kraft Heinz Company, General Mills, Inc., Nestlé USA, Inc., Kellogg Company, HAVI Global Solutions, LLC and Kimberly-Clark Corporation, among others. The Company also sells paperboard in the open market to independent and integrated paperboard converters.
Distribution of the Company’s principal products is primarily accomplished through sales offices in the U.S., Australia, Brazil, China, France, Germany, Italy, Japan, Mexico, Spain, the Netherlands and the United Kingdom, and, to a lesser degree, through broker arrangements with third parties.
During 2016, the Company did not have any one customer that represented 10% or more of its net sales.
Competition
Although a relatively small number of large competitors hold a significant portion of the paperboard packaging market, the Company’s business is subject to strong competition. The Company and WestRock Company ("WestRock") are the two major CUK producers in the U.S. Internationally, The Klabin Company in Brazil and Stora Enzo in Sweden produce similar grades of paperboard.
In beverage packaging, cartons made from CUK compete with substitutes such as plastics and corrugated packaging for packaging glass or plastic bottles, cans and other primary containers. Although plastics and corrugated packaging may be priced lower than CUK, the Company believes that cartons made from CUK offer advantages over these materials in areas such as distribution, brand awareness, carton designs, package performance, package line speed, environmental friendliness and design flexibility.
In non-beverage consumer packaging, the Company’s paperboard competes with WestRock CUK, as well as CRB and solid bleach sulfate ("SBS") from numerous competitors, and internationally, folding boxboard and white-lined chip. There are a large number of producers in the paperboard markets. Suppliers of paperboard compete primarily on the basis of price, strength and printability of their paperboard, quality and service.
Raw Materials
The paperboard packaging produced by the Company comes from pine trees and recycled fibers. Pine pulpwood, paper and recycled fibers (including DLK and OCC) and energy used in the manufacture of paperboard, as well as poly sheeting, plastic resins and various chemicals used in the coating of paperboard, represent the largest components of the Company’s variable costs of paperboard production.
For the West Monroe, LA and Macon, GA mills, the Company relies on private landowners and the open market for all of its pine pulpwood and recycled fiber requirements, supplemented by CUK clippings that are obtained from its converting operations. The Company believes that adequate supplies from both private landowners and open market fiber sellers currently are available in close proximity to meet its fiber needs at these mills.
The paperboard grades produced at the Kalamazoo, MI, Battle Creek, MI, Middletown, OH, Santa Clara, CA, and East Angus, Quebec mills are made from 100% recycled fiber. The Company procures its recycled fiber from external suppliers and internal converting operations. The market price of each of the various recycled fiber grades fluctuates with supply and demand. The Company’s internal recycled fiber procurement function enables the Company to pay lower prices for its recycled fiber needs given the Company’s highly fragmented supplier base. The Company believes there are adequate supplies of recycled fiber to serve its mills.
In North America, the Company also converts a variety of other paperboard grades such as SBS, in addition to paperboard that is supplied to its converting operations from its own mills. The Company purchases such paperboard requirements, including additional CRB, from outside vendors. The majority of external paperboard purchases are acquired through long-term arrangements with other major industry suppliers. The Company's European converting plants consume CUK supplied from the Company's mills and also convert other paperboard grades such as white-lined chip and folding box board purchased from external suppliers.
Energy
Energy, including natural gas, fuel oil and electricity, represents a significant portion of the Company’s manufacturing costs. The Company has entered into contracts designed to manage risks associated with future variability in cash flows and price risk related to future energy cost increases for a portion of its natural gas requirements at its U.S. mills. The Company’s hedging program for natural gas is discussed in Note 9 in the Notes to Consolidated Financial Statements included herein under “Item 8., Financial Statements and Supplementary Data.”
Backlog
Orders from the Company’s principal customers are manufactured and shipped with minimal lead time. The Company did not have a material amount relating to backlog orders at December 31, 2016 or 2015.
Seasonality
The Company’s net sales, income from operations and cash flows from operations are subject to moderate seasonality, with demand usually increasing in the late spring through early fall due to increases in demand for beverage and food products.
Research and Development
The Company’s research and development team works directly with its sales, marketing and consumer insights personnel to understand long-term consumer and retailer trends and create relevant new packaging. These innovative solutions provide customers with differentiated packaging to meet customer needs. The Company’s development efforts include, but are not limited to, extending the shelf life of customers’ products; reducing production and waste costs; enhancing the heat-managing characteristics of food packaging; improving the sturdiness and compression strength of packaging to meet store display needs; and refining packaging appearance through new printing techniques and materials.
Sustainability represents one of the strongest trends in the packaging industry and the Company focuses on developing more sustainable and eco-friendly manufacturing processes and products. The Company’s strategy is to combine sustainability with innovation to create new packaging solutions for its customers.
For more information on research and development expenses see Note 1 in the Notes to Consolidated Financial Statements included herein under “Item 8., Financial Statements and Supplementary Data.”
Patents and Trademarks
As of December 31, 2016, the Company had a large patent portfolio, presently owning, controlling or holding rights to more than 2,000 U.S. and foreign patents, with more than 600 U.S. and foreign patent applications currently pending. The Company’s patent portfolio consists primarily of patents relating to packaging machinery, manufacturing methods, structural carton designs, active microwave packaging technology and barrier protection packaging. These patents and processes are significant to the Company’s operations and are supported by trademarks such as Fridge Vendor®, IntegraPakTM, MicroFlex-Q® , MicroRite®, Quilt Wave®, Qwik Crisp®, Tite-Pak®, and Z-Flute®. The Company takes significant steps to protect its intellectual property and proprietary rights.
Culture and Employees
The Company’s corporate vision - Inspired packaging. A world of difference. - and values of integrity, respect, accountability, relationships and teamwork guide employee behavior, expectations and relations. The Company’s ongoing efforts to build a high-performance culture and improve the manner in which work is done across the Company includes a significant focus on continuous improvement utilizing processes like Lean Sigma and Six Sigma.
As of December 31, 2016, the Company had approximately 13,000 employees worldwide, of which approximately 51% were represented by labor unions and covered by collective bargaining agreements or covered by works councils in Europe. As of December 31, 2016, 170 of the Company’s employees were working under expired contracts, which are currently being negotiated, and 379 were covered under collective bargaining agreements that expire within one year. The Company considers its employee relations to be satisfactory.
Environmental Matters
The Company is subject to a broad range of foreign, federal, state and local environmental and health and safety regulations and employs a team of professionals in order to maintain compliance at each of its facilities. For additional information on such regulation and compliance, see “Environmental Matters” in “Item 7., Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 13 in the Notes to Consolidated Financial Statements included herein under “Item 8., Financial Statements and Supplementary Data.”
The Company does not have material capital expenditures for environmental control or compliance.
Available Information
The Company’s website is located at http://www.graphicpkg.com. The Company makes available, free of charge through its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after such materials are electronically filed or furnished to the Securities and Exchange Commission (the “SEC”). The Company also makes certain investor presentations and access to analyst conference calls available through its website. The information contained or incorporated into the Company’s website is not a part of this Annual Report on Form 10-K.
The SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers like the Company that file electronically with the SEC at http://www.SEC.gov.
Item 1A.
Item 1A.
RISK FACTORS
The following risks could affect (and in some cases have affected) the Company's actual results and could cause such results to differ materially from estimates or expectations reflected in certain forward-looking statements:
The Company's financial results could be adversely impacted if there are significant increases in prices for raw materials, energy, transportation and other necessary supplies, and the Company is unable to raise prices, or improve productivity to reduce costs.
Limitations on the availability of, and increases in, the costs of raw materials, including petroleum-based materials, energy, wood, transportation and other necessary goods and services, could have an adverse effect on the Company's financial results. Because negotiated sales contracts and the market largely determine the pricing for its products, the Company is at times limited in its ability to raise prices and pass through to its customers any inflationary or other cost increases that the Company may incur.
The Company uses productivity improvements to reduce costs and offset inflation. These include global continuous improvement initiatives that use statistical process control to help design and manage many types of activities, including production and maintenance. The Company's ability to realize anticipated savings from these improvements is subject to significant operational, economic and competitive uncertainties and contingencies, many of which are beyond the Company's control. If the Company cannot successfully implement cost savings plans, it may not be able to continue to compete successfully against other manufacturers. In addition, any failure to generate the anticipated efficiencies and savings could adversely affect the Company's financial results.
Changes in consumer buying habits and preferences for products could have an effect on our sales volumes.
Changing consumer dietary habits and preferences have slowed sales growth for many of the food and beverage products the Company packages. If these trends continue, the Company’s financial results could be adversely affected.
Competition and product substitution could have an adverse effect on the Company's financial results.
The Company competes with other paperboard manufacturers and carton converters, both domestically and internationally. The Company's products compete with those made from other manufacturers' CUK board, as well as SBS and CRB, and other board substrates. Substitute products include plastic, shrink film and corrugated containers. In addition, while the Company has long-term relationships with many of its customers, the underlying contracts may be re-bid or renegotiated from time to time, and the Company may not be successful in renewing such contracts on favorable terms or at all. The Company works to maintain market share through efficiency, product innovations and strategic sourcing to its customers; however, pricing and other competitive pressures may occasionally result in the loss of a customer relationship.
The Company's future growth and financial results could be adversely impacted if the Company is unable to identify strategic acquisitions and to successfully integrate the acquired businesses.
The Company has made several acquisitions in recent years. The Company's ability to continue to make strategic acquisitions and to integrate the acquired businesses successfully, including obtaining anticipated cost savings or synergies and expected operating results within a reasonable period of time, is an important factor in the Company's future growth. If the Company is unable to realize the expected revenue and cash flow growth and other benefits from its acquisitions, the Company may be required to spend additional time or money on integration efforts that would otherwise have been spent on the development and expansion of its business.
The Company may not be able to develop and introduce new products and adequately protect its intellectual property and proprietary rights, which could harm its future success and competitive position.
The Company works to increase market share and profitability through product innovation and the introduction of new products. The inability to develop new or better products that satisfy customer and consumer preferences in a timely manner may impact the Company's competitive position.
The Company's future success and competitive position also depends, in part, upon its ability to obtain and maintain protection for certain proprietary carton and packaging machine technologies used in its value-added products, particularly those incorporating the Fridge Vendor, IntegraPak, MicroFlex-Q, MicroRite, Quilt Wave, Qwik Crisp, Tite-Pak, and Z-Flute technologies. Failure to protect the Company's existing intellectual property rights may result in the loss of valuable technologies or may require it to license other companies' intellectual property rights. It is possible that any of the patents owned by the Company may be invalidated, rendered unenforceable, circumvented, challenged or licensed to others or any of its pending or future patent applications may not be issued within the scope of the claims sought by the Company, if at all. Further, others may develop technologies that are similar or superior to the Company's technologies, duplicate its technologies or design around its patents, and steps taken by the Company to protect its technologies may not prevent misappropriation of such technologies.
The Company could experience material disruptions at our facilities.
Although the Company takes appropriate measures to minimize the risk and effect of material disruptions to the business conducted at our facilities, natural disasters such as hurricanes, tornadoes, floods and fires, as well as other unexpected disruptions such as the unavailability of critical raw materials, power outages and equipment failures can reduce production and increase manufacturing costs. These types of disruptions could materially adversely affect our earnings, depending upon the duration of the disruption and our ability to shift business to other facilities or find other sources of materials or energy. Any losses due to these events may not be covered by our existing insurance policies or may be subject to certain deductibles.
The Company is subject to the risks of doing business in foreign countries.
The Company has converting plants in 11 countries outside of the U.S. and sells its products worldwide. For 2016, before intercompany eliminations, net sales from operations outside of the U.S. represented approximately 23% of the Company’s net sales. The Company’s revenues from foreign sales fluctuate with changes in foreign currency exchange rates. The Company pursues a currency hedging program in order to reduce the impact of foreign currency exchange fluctuations on financial results. At December 31, 2016, approximately 20% of its total assets were denominated in currencies other than the U.S. dollar.
The Company is also subject to the following significant risks associated with operating in foreign countries:
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Compliance with and enforcement of environmental, health and safety and labor laws and other regulations of the foreign countries in which the Company operates;
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Export compliance;
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Imposition or increase of withholding and other taxes on remittances and other payments by foreign subsidiaries; and
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Imposition of new or increases in capital investment requirements and other financing requirements by foreign governments.
The Company’s information technology systems could suffer interruptions, failures or breaches and our business operations could be disrupted adversely effecting results of operations and the Company’s reputation.
The Company’s information technology systems, some of which are dependent on services provided by third parties, serve an important role in the operation of the business. These systems could be damaged or cease to function properly due to any number of causes, such as catastrophic events, power outages, security breaches, computer viruses or cyber-based attacks. The Company has contingency plans in place to prevent or mitigate the impact of these events, however, if they are not effective on a timely basis, business interruptions could occur which may adversely impact results of operations.
Increased cyber-security threats also pose a potential risk to the security of the Company’s information technology systems, as well as the confidentiality, integrity and availability of data stored on those systems. Any breach could result in disclosure or misuse of confidential or proprietary information, including sensitive customer, vendor, employee or financial information. Such event could cause damage to the Company’s reputation and result in significant recovery or remediation costs, which may adversely impact results of operations.
The Company is subject to environmental, health and safety laws and regulations, and costs to comply with such laws and regulations, or any liability or obligation imposed under new laws or regulations, could negatively impact its financial condition and results of operations.
The Company is subject to a broad range of foreign, federal, state and local environmental, health and safety laws and regulations, including those governing discharges to air, soil and water, the management, treatment and disposal of hazardous substances, the investigation and remediation of contamination resulting from releases of hazardous substances, and the health and safety of employees. The Company cannot currently assess the impact that future emission standards, climate control initiatives and enforcement practices will have on the Company's operations and capital expenditure requirements. Environmental liabilities and obligations may result in significant costs, which could negatively impact the Company's financial position, results of operations or cash flows. See Note 13 in the Notes to Consolidated Financial Statements included herein under “Item 8., Financial Statements and Supplementary Data.”
The Company's indebtedness may adversely affect its financial condition and its ability to react to changes in its business.
As of December 31, 2016, the Company had an aggregate principal amount of $2,167.8 million of outstanding debt. Because of the Company's debt level, a portion of its cash flows from operations will be dedicated to payments on indebtedness and the Company's ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes may be restricted in the future.
Additionally, the Company’s Second Amended and Restated Credit Agreement dated October 1, 2014 (as amended, the “Credit Agreement”) and the indentures governing the 4.75% Senior Notes due 2021, 4.875% Senior Notes due 2022, and 4.125% Senior Notes due 2024 (the “Indentures”) may prohibit or restrict, among other things, the disposal of assets, the incurrence of additional indebtedness (including guarantees), payment of dividends, share repurchases, loans or advances and certain other types of transactions. These restrictions could limit the Company’s flexibility to respond to changing market conditions and competitive pressures. The debt obligations and restrictions may also leave the Company more vulnerable to a downturn in general economic conditions or its business, or unable to carry out capital expenditures that are necessary or important to its growth strategy and productivity improvement programs.
Approximately 33% of the Company’s debt is subject to variable rates of interest and exposes the Company to increased debt service obligations in the event of increased interest rates.
The Company's pension plans are currently underfunded, and the Company may be required to make cash payments to the plans, reducing the cash available for its business.
The Company's cash flows may be adversely impacted by the Company's pension funding obligations. The Company's pension funding obligations are dependent upon multiple factors resulting from actual plan experience and assumptions of future experience. The Company has unfunded obligations of $163.4 million under its domestic and foreign defined benefit pension plans. The funded status of these plans is dependent upon various factors, including returns on invested assets, the level of certain market interest rates and the discount rate used to determine the pension obligations. Unfavorable returns on the plan assets or unfavorable changes in applicable laws or regulations could materially change the timing and amount of required plan funding, which would reduce the cash available to the Company for other purposes.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
Headquarters
The Company leases its principal executive offices in Atlanta, GA.
Operating Facilities
A listing of the principal properties owned or leased and operated by the Company is set forth below. The Company’s buildings are adequate and suitable for the business of the Company and have sufficient capacity to meet current requirements. The Company also leases certain smaller facilities, warehouses and office space throughout the U.S. and in foreign countries from time to time.
Location
Related Products or Use of Facility
Mills:
Battle Creek, MI
CRB
East Angus, Québec
CRB
Kalamazoo, MI
CRB
Macon, GA
CUK
Middletown, OH
CRB
Santa Clara, CA
CRB
West Monroe, LA
CUK; Corrugated Medium; Research and Development
Other:
Atlanta, GA(a)
Research and Development, Packaging Machinery and Design
Concord, NH(a)
Research and Development, Design Center
Crosby, MN
Packaging Machinery Engineering, Design and Manufacturing
Louisville, CO(a)
Research and Development
North American Converting Plants:
International Converting Plants:
Atlanta, GA(a)
Monterrey, Mexico(a)
Auckland, New Zealand(a)
Carol Stream, IL
Newton, IA
Bremen, Germany(a)
Centralia, IL
North Portland, OR
Bristol, United Kingdom
Charlotte, NC
Oroville, CA(a)
Coalville, United Kingdom(a)
Cobourg, Ontario(a)
Pacific, MO
Gateshead, United Kingdom(a)
Elk Grove, IL (a)(b)
Perry, GA
Hoogerheide, Netherlands
Fort Smith, AR (b)
Piscataway, NJ(a)(d)
Newcastle Upon Tyne, United Kingdom(a)
Gordonsville, TN(a)
Queretaro, Mexico(a)
Igualada, Barcelona, Spain
Gresham, OR(a)
Renton, WA(c)
Jundiai, Sao Paulo, Brazil
Hamel, MN
Solon, OH
Leeds, United Kingdom
Irvine, CA
Staunton, VA
Masnieres, France(a)
Kalamazoo, MI
Tijuana, Mexico(a)
Melbourne, Australia(a)
Kendallville, IN
Tuscaloosa, AL
Portlaoise, Ireland(a)
Lawrenceburg, TN
Vancouver, WA(a)
Sneek, Netherlands
Lumberton, NC
Valley Forge, PA
Sydney, Australia(a)
Marion, OH
Wayne, NJ
Menasha, WI(c)
Wausau, WI
Mississauga, Ontario(a)
West Monroe, LA (b)
Mitchell, SD
Winnipeg, Manitoba
Note:
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
The Company is a party to a number of lawsuits arising in the ordinary conduct of its business. Although the timing and outcome of these lawsuits cannot be predicted with certainty, the Company does not believe that disposition of these lawsuits will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows. See Note 13 in the Notes to Consolidated Financial Statements included herein under “Item 8., Financial Statements and Supplementary Data.”
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not Applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to General Instruction G.(3) of Form 10-K, the following list is included as an unnumbered item in Part I of this Report in lieu of being included in the definitive proxy statement that will be filed within 120 days after December 31, 2016.
Michael P. Doss, 50, is the President and Chief Executive Officer of Graphic Packaging Holding Company. Prior to January 1, 2016, Mr. Doss held the position of President and Chief Operating Officer from May 20, 2015 through December 31, 2015 and Chief Operating Officer from January 1, 2014 until May 19, 2015. Prior to these positions he served as the Executive Vice President, Commercial Operations of Graphic Packaging Holding Company. Prior to this Mr. Doss held the position of Senior Vice President, Consumer Packaging Division. Prior to the Altivity Transaction, he had served as Senior Vice President, Consumer Products Packaging of Graphic Packaging Corporation since September 2006. From July 2000 until September 2006, he was the Vice President of Operations, Universal Packaging Division. Mr. Doss was Director of Web Systems for the Universal Packaging Division prior to his promotion to Vice President of Operations. Since joining Graphic Packaging International Corporation in 1990, Mr. Doss has held positions of increasing management responsibility, including Plant Manager at the Gordonsville, TN and Wausau, WI plants.
Stephen R. Scherger, 52, is the Senior Vice President and Chief Financial Officer of Graphic Packaging Holding Company. From October 1, 2014 through December 31, 2014, Mr. Scherger was the Senior Vice President - Finance. From April 2012 through September 2014, Mr. Scherger served as Senior Vice President, Consumer Packaging Division. Mr. Scherger joined Graphic Packaging Holding Company in April of 2012 from MeadWestvaco Corporation, where he served as President, Beverage and Consumer Electronics. Mr. Scherger was with MeadWestvaco Corporation from 1986 to 2012 and held positions including Vice President, Corporate Strategy; Vice President and General Manager, Beverage Packaging; Vice President and CFO, Papers Group, Vice President Asia Pacific and Latin America, Beverage Packaging, CFO Beverage Packaging and other executive-level positions.
Carla J. Chaney, 46, is the Senior Vice President, Human Resources of Graphic Packaging Holding Company, a position she has held since July 15, 2013. Ms. Chaney joined Graphic Packaging Holding Company from Exide Technologies. Ms. Chaney was with Exide Technologies from February 2012 to July 2013 and served most recently as Executive Vice President, Human Resources and Communications. Prior to Exide Technologies, Ms. Chaney held a variety of leadership roles with Newell Rubbermaid, Inc. from 2004 to 2011, including Group Vice President, Human Resources for the Home & Family business segment, Regional Vice President, Human Resources, EMEA; Corporate Vice President, Global Organization and People Development; and Vice President, Human Resources, Culinary Lifestyles Business. Ms. Chaney also worked for Georgia-Pacific from 1992 to 2004.
Alan R. Nichols, 54, is the Senior Vice President, Mills Division of Graphic Packaging Holding Company. He served as Vice President, Mills from August 2008 until March 2009. From March 2008 until August 2008, Mr. Nichols was Vice President, CRB Mills. Prior to the Altivity Transaction, Mr. Nichols served as Vice President, CRB Mills for Altivity Packaging, LLC from February 2007 until March 2008 and was the Division Manufacturing Manager, Mills for Altivity Packaging and the Consumer Products Division of Smurfit-Stone Container Corporation from August 2005 to February 2007. From February 2001 until August 2005, Mr. Nichols was the General Manager of the Wabash Mill for Smurfit-Stone.
Lauren S. Tashma, 50, is the Senior Vice President, General Counsel and Secretary of Graphic Packaging Holding Company, serving in this position since February, 2014. Previously, Ms. Tashma served as Senior Vice President, General Counsel and Secretary of Fortune Brands Home & Security, Inc., where she led the legal, compliance and EHS functions. Prior to that, Ms. Tashma had various roles with Fortune Brands, Inc., including Vice President and Associate General Counsel.
Michael S. Ukropina, 50, was the Senior Vice President, Consumer Packaging Division for Graphic Packaging Holding Company from October 24, 2014 through January 4, 2017. Beginning in August 2014, Mr. Ukropina served as the Senior Vice President, Strategy. Mr. Ukropina joined the Company in August of 2014 from ASG Worldwide, a specialty consumer packaging company, where he led ASG as President and CEO from 2012 to 2014. Prior to that, Mr. Ukropina was an officer with International Paper and his work there from 1993 to 2011 included positions such as Vice President and General Manager, Shorewood Packaging; Vice President of Operations for xpedx; and Director of Finance & Planning for Industrial Packaging. During that time, Mr. Ukropina led packaging growth strategies across multiple businesses in Latin America, Europe and Asia.
Joseph P. Yost, 49, is the Senior Vice President, and President, Americas of Graphic Packaging Holding Company. Prior to January 5, 2017, Mr. Yost served as Senior Vice President, Global Beverage and Europe from September 1, 2015 to January 4, 2017, Senior Vice President, Europe from March 1, 2014 to August 31, 2015 and Senior Vice President, European Chief Integration Officer/Chief Financial Officer from February 2013 until February, 2014. From 2009 until February 2013, Mr. Yost was the Senior Vice President, Supply Chain of Graphic Packaging Holding Company. From 2006 to 2009, he served as Vice President, Operations Support, Consumer Packaging for Graphic Packaging International, Inc. Mr. Yost has also served in the following positions: Director, Finance and Centralized Services from 2003 to 2006 with Graphic Packaging International, Inc. and from 2000 to 2003 with Graphic Packaging Corporation; Manager, Operations Planning and Analysis, Consumer Products Division from 1999 to 2000 with Graphic Packaging Corporation; and other management positions from 1997 to 1999 with Fort James Corporation.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
GPHC’s common stock (together with the associated stock purchase rights) is traded on the New York Stock Exchange under the symbol “GPK.” The historical range of the high and low sales price per share for each quarter of 2016 and 2015 are as follows:
On February 4, 2015, the Company's board of directors authorized a share repurchase program to allow management to purchase up to $250 million of the Company's issued and outstanding shares of common stock through open market purchases, privately negotiated transactions and Rule 10b5-1 plans. During 2016, the Company repurchased approximately 13.2 million shares, or $169 million, under this repurchase program at an average price of $12.77. During 2015, the Company repurchased 4.6 million shares, or approximately $63 million at an average price of $13.60.
During 2016 and 2015, the Company's board of directors declared a regular quarterly dividend per share of common stock to shareholders of record as follows:
During 2016, the Company declared and paid cash dividends of $71.7 million and $64.4 million, respectively.
During 2015, the Company declared and paid cash dividends of $65.5 million and $49.3 million, respectively. There were no dividends paid prior to 2015. GPHC depends on GPII for cash to pay dividends. Unless GPHC receives dividends, distributions or transfers from such domestic subsidiaries, it cannot pay cash dividends on its common stock, because it has no independent operations. Such dividends, distributions or transfers from GPHC’s domestic subsidiaries may be restricted because the terms of the GPII’s debt agreements and indentures limit its ability to make such payments to the Company. See "Item 1A - Risk Factors" and Note - 5 in the Notes to Consolidated Financial Statements in "Item 8 - Financial Statements and Supplementary Data."
On February 6, 2017, there were 1,279 stockholders of record and approximately 22,000 beneficial holders of GPHC’s common stock.
During the fourth quarter of 2016, pursuant to the share repurchase program described above, the Company purchased shares of its common stock as follows:
Issuer Purchases of Equity Securities
(a) Based on the closing price of the Company's common stock as of the end of each period.
Total Return to Stockholders
The following graph compares the total returns (assuming reinvestment of dividends) of the common stock of the Company, the Standard & Poor’s (“S&P”) 500 Stock Index and the Dow Jones (“DJ”) U.S. Container & Packaging Index. The graph assumes $100 invested on December 31, 2011 in GPHC’s common stock and each of the indices. The stock price performance on the following graph is not necessarily indicative of future stock price performance.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in conjunction with “Item 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
This management’s discussion and analysis of financial conditions and results of operations is intended to provide investors with an understanding of the Company’s past performance, financial condition and prospects. The following will be discussed and analyzed:
Overview of Business
Overview of 2016 Results
Results of Operations
Financial Condition, Liquidity and Capital Resources
Critical Accounting Policies
New Accounting Standards
Business Outlook
OVERVIEW OF BUSINESS
The Company’s objective is to strengthen its position as a leading provider of paper-based packaging solutions. To achieve this objective, the Company offers customers its paperboard, cartons and packaging machines, either as an integrated solution or separately. Cartons and carriers are designed to protect and contain products. Product offerings include a variety of laminated, coated and printed packaging structures that are produced from the Company’s coated unbleached kraft paperboard (“CUK”) and coated-recycled paperboard (“CRB”), as well as other grades of paperboard that are purchased from third party suppliers. Innovative designs and combinations of paperboard, films, foils, metallization, holographics and embossing are customized to the individual needs of the customers.
Prior to the sale of the Company's multi-wall bag business on June 30, 2014, the Company was also a leading supplier of flexible packaging in North America. Flexible Packaging products included multi-wall bags, such as pasted valve, pinched bottom, sewn open mouth and woven polypropylene, and coated paper. Coated paper products included institutional french fry packaging, barrier pouch rollstock and freezer paper. Key markets included food and agriculture, building and industrial materials, chemicals, minerals and pet foods.
The Company is implementing strategies (i) to expand market share in its current markets and to identify and penetrate new markets; (ii) to capitalize on the Company’s customer relationships, business competencies, and mills and converting assets; (iii) to develop and market innovative, sustainable products and applications; and (iv) to continue to reduce costs by focusing on operational improvements. The Company’s ability to fully implement its strategies and achieve its objectives may be influenced by a variety of factors, many of which are beyond its control, such as inflation of raw material and other costs, which the Company cannot always pass through to its customers, and the effect of overcapacity in the worldwide paperboard packaging industry.
Significant Factors That Impact The Company’s Business and Results of Operations
Impact of Inflation/Deflation. The Company’s cost of sales consists primarily of energy (including natural gas, fuel oil and electricity), pine pulpwood, chemicals, secondary fibers, purchased paperboard, aluminum foil, ink, plastic film and resins, depreciation expense and labor. Costs increased year over year by $25.0 million in 2016 and increased year over year by $9.0 million in 2015. The higher costs in 2016 were primarily due to higher labor and benefit costs ($20.6 million) secondary fiber ($10.7 million), net energy related costs ($9.8 million), and other costs ($0.8 million), partially offset by lower costs for wood ($4.8 million), chemicals ($3.6 million), freight ($3.5 million), corrugate ($3.3 million), and resin and film ($1.7 million).
Because the price of natural gas experiences significant volatility, the Company has entered into contracts designed to manage risks associated with future variability in cash flows caused by changes in the price of natural gas. The Company has entered into natural gas swap contracts to hedge prices for a portion of its expected usage for 2017. Since negotiated sales contracts and the market largely determine the pricing for its products, the Company is at times limited in its ability to raise prices and pass through to its customers any inflationary or other cost increases that the Company may incur.
Commitment to Cost Reduction. In light of increasing margin pressure throughout the packaging industry, the Company has programs in place that are designed to reduce costs, improve productivity and increase profitability. The Company utilizes a global continuous improvement initiative that uses statistical process control to help design and manage many types of activities, including production and maintenance. This includes a Six Sigma process focused on reducing variable and fixed manufacturing and administrative costs. The Company expanded the continuous improvement initiative to include the deployment of Lean Sigma principles into manufacturing and supply chain services.
The Company’s ability to continue to successfully implement its business strategies and to realize anticipated savings and operating efficiencies is subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. If the Company cannot successfully implement the strategic cost reductions or other cost savings plans it may not be able to continue to compete successfully against other manufacturers. In addition, any failure to generate the anticipated efficiencies and savings could adversely affect the Company’s financial results.
Competition and Market Factors. As some products can be packaged in different types of materials, the Company’s sales are affected by competition from other manufacturers’ CUK board and CRB board and other paper substrates such as solid bleach sulfate ("SBS") and recycled clay-coated news. Additional substitute products also include plastic, shrink film and corrugated containers. In addition, while the Company has long-term relationships with many of its customers, the underlying contracts may be re-bid or renegotiated from time to time, and the Company may not be successful in renewing on favorable terms or at all. The Company works to maintain market share through efficiency, product innovation and strategic sourcing to its customers; however, pricing and other competitive pressures may occasionally result in the loss of a customer relationship.
In addition, the Company’s sales historically are driven by consumer buying habits in the markets its customers serve. Changes in consumer dietary habits and preferences, increases in the costs of living, unemployment rates, access to credit markets, as well as other macroeconomic factors, may negatively affect consumer spending behavior. New product introductions and promotional activity by the Company’s customers and the Company’s introduction of new packaging products also impact its sales.
Debt Obligations. The Company had $2,167.8 million of outstanding debt obligations as of December 31, 2016. This debt has consequences for the Company, as it requires a portion of cash flow from operations to be used for the payment of principal and interest, exposes the Company to the risk of increased interest rates and restricts the Company’s ability to obtain additional financing. Covenants in the Company’s Credit Agreement and Indentures may also restrict, among other things, the disposal of assets, the incurrence of additional indebtedness (including guarantees), payment of dividends, loans or advances and certain other types of transactions. The Credit Agreement also requires compliance with a maximum consolidated leverage ratio and a minimum consolidated interest coverage ratio. The Company’s ability to comply in future periods with the financial covenants will depend on its ongoing financial and operating performance, which in turn will be subject to many other factors, many of which are beyond the Company’s control. See “Covenant Restrictions” in “Financial Condition, Liquidity and Capital Resources” for additional information regarding the Company’s debt obligations.
The debt and the restrictions under the Credit Agreement and the Indentures could limit the Company’s flexibility to respond to changing market conditions and competitive pressures. The outstanding debt obligations and the restrictions may also leave the Company more vulnerable to a downturn in general economic conditions or its business, or unable to carry out capital expenditures that are necessary or important to its growth strategy and productivity improvement programs.
OVERVIEW OF RESULTS
This management’s discussion and analysis contains an analysis of Net Sales, Income from Operations and other information relevant to an understanding of the Company's results of operations.
•
Net Sales in 2016 increased by $137.9 million or 3.3%, to $4,298.1 million from $4,160.2 million in 2015 primarily due to the acquisitions discussed below, partially offset by the shut down of certain assets during 2015, unfavorable foreign exchange rates and lower pricing.
•
Income from Operations in 2016 decreased by $31.1 million or 7.3%, to $396.0 million from $427.1 million in 2015 due to the lower pricing, higher inflation, higher depreciation and amortization related to purchase accounting for the acquisitions and unfavorable foreign exchange rates. These decreases were offset by net improved performance, primarily cost savings through continuous improvement programs, and the acquisitions.
Acquisitions
•
On April 29, 2016, the Company acquired Colorpak Limited ("Colorpak"), a leading folding carton supplier in Australia and New Zealand. Colorpak operates three folding carton facilities that convert paperboard into folding cartons for the food, beverage and consumer product markets. The folding carton facilities are located in Melbourne, Australia, Sydney, Australia and Auckland, New Zealand.
•
On March 31, 2016, the Company acquired substantially all of the assets of Metro Packaging & Imaging, Inc. ("Metro"), a single converting facility located in Wayne, New Jersey.
•
On February 16, 2016, the Company acquired Walter G. Anderson, Inc., ("WG Anderson") a premier folding carton manufacturer with a focus on store branded food and consumer product markets. WG Anderson operates two world-class sheet-fed folding carton converting facilities located in Hamel, Minnesota and Newton, Iowa.
•
On January 5, 2016, the Company acquired G-Box, S.A. de C.V., ("G-Box"). The acquisition includes two folding carton converting facilities located in Monterrey, Mexico and Tijuana, Mexico that service the food, beverage and consumer product markets.
The Colorpak, Metro, WG Anderson and G-Box transactions are referred to collectively as the "2016 Acquisitions."
•
During 2015, the Company acquired Carded Graphics, LLC. ("Carded"), certain assets of Cascades Norampac Division ("Cascades"), Rose City Printing and Packaging Inc. ("Rose City"). These transactions are referred to collectively as the "North American Acquisitions."
Capital Allocations
•
During 2016, the Company repurchased 13.2 million shares, or approximately $169 million of shares, at an average price of $12.77 in accordance with the previously announced share repurchase program. The program allows management to purchase up to $250 million of the Company's issued and outstanding shares of common stock through open market purchases, privately negotiated transactions and Rule 10b5-1 plans. As of December 31, 2016, the Company has approximately $18 million remaining under the current share repurchase program. On January 10, 2017, the Company's board of directors authorized a new $250 million share repurchase program.
•
During 2016, the Company declared and paid cash dividends of $71.7 million and $64.4 million, respectively. On October 24, 2016, the Company's board of directors declared a quarterly dividend of $0.075 per common share which increased the quarterly dividend by fifty percent. The Company intends to increase the annual dividend in 2017 from $0.20 per share to $0.30 per share, subject to Board approval.
RESULTS OF OPERATIONS
2016 COMPARED WITH 2015
Net Sales
The components of the change in Net Sales are as follows:
The Company's Net Sales in 2016 increased by $137.9 million or 3.3%, to $4,298.1 million from $4,160.2 million for the same period in 2015, primarily due to Net Sales of $280.7 million for the 2016 Acquisitions as well as the acquisition of Carded on October 1, 2015 and Cascades on February 5, 2015. Net sales were $74.5 million lower due to the closure or shutdown of certain assets in the latter part of 2015. Global beverage volumes were up modestly while softness continued for certain consumer products, including dry foods, frozen foods and cereal. Unfavorable exchange rates, primarily the British pound, and lower pricing also negatively impacted Net Sales.
Income (Loss) from Operations
The components of the change in Income (Loss) from Operations are as follows:
(a)
Includes the Company’s cost reduction initiatives, sales of assets and expenses related to acquisitions, integration activities, and shutdown costs.
The Company's Income from Operations for 2016 decreased $31.1 million or 7.3%, to $396.0 million from $427.1 million for the same period in 2015 due to the lower pricing, higher inflation, unfavorable foreign exchange rates, higher depreciation and amortization related to purchase accounting for the 2016 and Carded Acquisitions, costs and operational issues related to the onboarding of new or transferred business related to the closed or announced closure of facilities, and the approximate $15 million impact related to the downtime taken to upgrade a paper machine at West Monroe. Inflation in 2016 was primarily due to higher labor and benefit costs ($20.6 million) secondary fiber ($10.7 million), net energy related costs ($9.8 million), and other costs ($0.8 million), partially offset by lower costs for wood ($4.8 million), chemicals ($3.6 million), freight ($3.5 million), corrugate ($3.3 million), and resin and film ($1.7 million).
Interest Expense, Net
Interest Expense, Net increased by $8.8 million to $76.6 million in 2016 from $67.8 million in 2015. Interest Expense, Net increased due primarily to higher average debt balances and higher average interest rates as compared to prior year. As of December 31, 2016, approximately 33% of the Company’s total debt was subject to floating interest rates.
Income Tax Expense
During 2016, the Company recognized Income Tax Expense of $93.2 million on Income before Income Taxes and Equity Income of Unconsolidated Entity of $319.4 million. During 2015, the Company recognized Income Tax Expense of $130.4 million on Income before Income Taxes and Equity Income of Unconsolidated Entity of $359.3 million. The effective tax rate for 2016 was different than the statutory rate primarily due to an agreement executed with the Internal Revenue Service. As a result of the agreement, the Company has amended its 2011 and 2012 U.S. federal and state income tax returns resulting in the utilization of previously expired net operating loss carryforwards. The Company recorded a discrete benefit during the second quarter of 2016 of $22.4 million to reflect the changes as a reduction in its net long-term deferred tax liability. The effective tax rate was also different than the statutory tax rate due to the mix and levels between foreign and domestic earnings, including losses in jurisdictions with full valuation allowances. The Company has recognized net operating losses ("NOLs") of approximately $351 million as well as additional NOLs of approximately $107 million that are currently prohibited from recognition under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 718, Compensation-Stock Compensation, as discussed in Note 8 in the Notes to Consolidated Financial Statements included herein under “Item 8. Financial Statements and Supplementary Data," for U.S. federal income tax purposes, which may be used to offset future taxable income.
Equity Income of Unconsolidated Entity
Equity Income of Unconsolidated Entity was $1.8 million in 2016 and $1.2 million in 2015 and is related to the Company’s equity investment in the joint venture, Rengo Riverwood Packaging, Ltd.
2015 COMPARED WITH 2014
Net Sales
The components of the change in Net Sales are as follows:
The Company’s Net Sales in 2015 decreased by $80.3 million, or 1.9% to 4,160.2 million from 4,240.5 million in 2014. Excluding net sales of the divestitures of the Company's multi-wall bag and label businesses in 2014 of $221.6 million, net sales increased $141.3 million. The increase was due primarily to the North American Acquisitions and Benson acquisition of approximately $303.3 million, partially offset by unfavorable foreign currency exchange rates of $109.0 million, lower pricing due to deflationary cost pass throughs and settlements. Volumes were even with prior year as decreases due to the continuation of soft demand in key markets for certain consumer products, primarily cereal and frozen and dry foods, were offset by new products. Global beverage volumes were essentially even with prior year as declines in soft drink and big beer were offset by increases in craft beer, specialty beverage (energy drinks and teas) and open market beverage. The unfavorable currency impact was primarily in Europe and the United Kingdom.
Income (Loss) from Operations
The components of the change in Income (Loss) from Operations are as follows:
(a)
Includes the Company’s cost reduction initiatives, sales of assets and expenses related to acquisitions, integration activities, and shutdown costs.
The Company's Income from Operations for 2015 increased $199.3 million or 87.5%, to $427.1 million from $227.8 million for the same period in 2014 primarily due to the loss on sale of multi-wall bag in 2014, cost savings through continuous improvement programs as well as general and administrative cost savings following the divestitures in 2014 and lower integration costs and synergies related to the Benson acquisition. These increases were partially offset by unfavorable foreign currency exchange rates, inflation and the lower pricing. The inflation costs in 2015 primarily related to labor and benefits ($27.9 million) and wood ($6.8 million), partially offset by lower costs for chemicals ($8.4 million), energy ($10.0 million), primarily due to the price of natural gas, freight ($4.6 million), fiber ($0.8 million), external board ($0.8 million), and other ($1.1 million).
Interest Expense, Net
Interest Expense, Net decreased by $12.9 million to $67.8 million in 2015 from $80.7 million in 2014. Interest Expense, Net decreased due to both lower total debt levels and lower interest rates on the Company’s debt. As of December 31, 2015, approximately 34% of the Company’s total debt was subject to floating interest rates.
Income Tax Expense
During 2015, the Company recognized Income Tax Expense of $130.4 million on Income before Income Taxes and Equity Income of Unconsolidated Entities of $359.3 million. During 2014, the Company recognized Income Tax Expense of $45.4 million on Income before Income Taxes and Equity Income of Unconsolidated Entities of $132.7 million. The effective tax rate for 2015 was different than the statutory rate primarily due to the mix and levels between foreign and domestic earnings, including losses in jurisdictions with full valuation allowances, as well as the effects of certain discrete tax items.
Equity Income of Unconsolidated Entity
Equity Income of Unconsolidated Entity was $1.2 million in 2015 and $1.7 million in 2014 and is related to the Company’s equity investment in the joint venture, Rengo Riverwood Packaging, Ltd.
Segment Reporting
Prior to the sale of the multi-wall bag business on June 30, 2014, the Company reported its results in two reportable segments: paperboard packaging and flexible packaging. During 2015, the Company reevaluated the aggregation of operating segments into reportable segments in accordance with FASB Accounting Standards Codification (“ASC”) 280 Segment Reporting, and concluded there are three reportable segments:
Paperboard Mills includes the seven North American paperboard mills which produce primarily CUK and CRB. The majority of the paperboard is consumed internally to produce paperboard packaging for the Americas and Europe Paperboard Packaging segments. The remaining paperboard is sold externally to a wide variety of paperboard packaging converters and brokers. The Paperboard Mills segment Net Sales represent the sale of paperboard to external customers. The effect of intercompany transfers to the paperboard packaging segments has been eliminated from the Paperboard Mills segment to reflect the economics of the integration of these segments.
Americas Paperboard Packaging includes paperboard folding cartons sold primarily to Consumer Packaged Goods ("CPG") companies serving the food, beverage, and consumer product markets primarily in the Americas.
Europe Paperboard Packaging includes paperboard folding cartons sold primarily to CPG companies serving the food, beverage and consumer product markets in Europe.
The Company allocates certain mill and corporate costs to the reportable segments to appropriately represent the economics of these segments. The Corporate and Other caption includes the Pacific Rim operating segment and unallocated corporate and one-time costs.
These segments are evaluated by the chief operating decision maker based primarily on Income from Operations, as adjusted for depreciation and amortization. The accounting policies of the reportable segments are the same as those described in Note 1 in the Notes to Consolidated Financial Statements included herein under “Item 8. Financial Statements and Supplementary Data."
(a) Includes Loss on Sale of Assets of multi-wall bag business of $171.1 million in 2014.
2016 COMPARED WITH 2015
Paperboard Mills - Net sales decreased $85.8 million primarily due to the third quarter of 2015 shutdown of the Jonquire, Quebec mill (part of the February 4, 2015 Cascades acquisition) and the October 2015 shut down of the kraft paper machine in West Monroe, LA of $74.5 million, as well as lower open market sales across all substrates. In addition, more tons were internalized due to the acquisitions.
Income from Operations decreased due to downtime taken to upgrade a paper machine at West Monroe, LA. and higher inflation, partially offset by productivity improvements.
Americas Paperboard Packaging - Sales increased primarily due to Net Sales of $277.0 million for the 2016, Carded and Cascades Acquisitions, higher global beverage volumes and new product introductions. These increases were partially offset by lower volume for certain consumer products and lower pricing.
Income from Operations increased due to cost savings through continuous improvement programs, partially offset by the lower pricing, higher depreciation and amortization related to purchase accounting for the acquisitions, and operational issues related to the onboarding of new or transferred business.
Europe Paperboard Packaging - Sales decreased primarily due to unfavorable foreign currency exchange rates and lower pricing, partially offset by higher volume due to new product introductions.
Income from Operations decreased due to unfavorable foreign currency exchange rates and lower pricing, partially offset by improved operating performance and cost savings.
2015 COMPARED WITH 2014
Paperboard Mills - Open market paperboard Net Sales and Income from Operations increased due to the acquisition of Cascades Norampac Division.
Americas Paperboard Packaging - Sales increased due to the North American Acquisitions, new product introductions and increased sales of craft beer and specialty beverage (energy drinks and teas) packaging. This increase was partially offset by soft
demand for certain consumer and beverage products, primarily cereal, frozen and dried foods, soft drink and big beer, as well as unfavorable exchange rates primarily in Brazil.
Income from Operations decreased slightly due to higher inflation, which was partially offset by the acquisitions and improved operating performance.
Europe Paperboard Packaging - Sales increased due to the May 2014 Benson acquisition and new business, partially offset by unfavorable exchange rates.
Income from Operations increased due to synergies and improved operating performance.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
The Company broadly defines liquidity as its ability to generate sufficient funds from both internal and external sources to meet its obligations and commitments. In addition, liquidity includes the ability to obtain appropriate debt and equity financing and to convert into cash those assets that are no longer required to meet existing strategic and financial objectives. Therefore, liquidity cannot be considered separately from capital resources that consist of current or potentially available funds for use in achieving long-range business objectives and meeting debt service commitments.
Cash Flows
Net cash provided by operating activities in 2016 totaled $641.4 million, compared to $589.2 million in 2015. The increase was due primarily to the 2016 Acquisitions and lower inventory balances, excluding the impact of the 2016 Acquisitions. Pension contributions in 2016 and 2015 were $51.4 million and $53.4 million, respectively.
Net cash used in investing activities in 2016 totaled $632.5 million, compared to $399.8 million in 2015. Current year activities consisted primarily of capital spending of $294.6 million and $332.7 million for the 2016 Acquisitions, net of cash acquired. In the prior year, capital spending was $244.1 million and the Company paid $163.2 million, net of cash acquired, for the North American Acquisitions.
Net cash used in financing activities in 2016 totaled $3.1 million, compared to $210.9 million used in financing activities in 2015. The Company completed its debt offering of $300 million aggregated principal amount of 4.125% senior notes due 2024 in a registered public offering and used the net proceeds to repay a portion of its outstanding borrowings of its senior secured revolving credit facility. The Company also paid dividends of $64.4 million, repurchased $164.9 million of its common stock, and withheld $11.3 million of restricted stock units to satisfy tax withholding payments related to the payout of restricted stock units. Current year activities also include net payments under revolving credit facilities of $35.8 million and payments on debt of $25.0 million. In the prior year, the Company made net payments under revolving credit facilities of $50.8 million and payments on debt of $25.0 million. The Company also paid dividends of $49.3 million, repurchased $63.0 million of its common stock, and withheld $21.5 million of restricted stock units to satisfy tax withholding payments related to the payout of restricted stock units.
Liquidity and Capital Resources
The Company's liquidity needs arise primarily from debt service on its indebtedness and from the funding of its capital expenditures, ongoing operating costs, working capital, share repurchases and dividend payments. Principal and interest payments under the term loan facility and the revolving credit facilities, together with principal and interest payments on the Company's 4.75%
Senior Notes due 2021, 4.875% Senior Notes due 2022 and 4.125% Senior Notes due 2024 (the “Notes”), represent liquidity requirements for the Company. Based upon current levels of operations, anticipated cost savings and expectations as to future growth, the Company believes that cash generated from operations, together with amounts available under its revolving credit facilities and other available financing sources, will be adequate to permit the Company to meet its debt service obligations, necessary capital expenditure program requirements and ongoing operating costs and working capital needs, although no assurance can be given in this regard. The Company's future financial and operating performance, ability to service or refinance its debt and ability to comply with the covenants and restrictions contained in its debt agreements (see “Covenant Restrictions” below) will be subject to future economic conditions, including conditions in the credit markets, and to financial, business and other factors, many of which are beyond the Company's control, and will be substantially dependent on the selling prices and demand for the Company's products, raw material and energy costs, and the Company's ability to successfully implement its overall business and profitability strategies.
As of December 31, 2016, the Company had approximately $351 million of NOLs for U.S. federal income tax purposes. These NOLs generally may be used by the Company to offset taxable income earned in subsequent taxable years.
As of December 31, 2016, the Company had $53.0 million of cash in foreign jurisdictions for which deferred taxes in the U.S. have not been provided, as earnings have been deemed indefinitely reinvested outside the U.S.
Accounts receivable are stated at the amount owed by the customer, net of an allowance for estimated uncollectible accounts, returns and allowances, and cash discounts. The allowance for doubtful accounts is estimated based on historical experience, current economic conditions and the creditworthiness of customers. Receivables are charged to the allowance when determined to be no longer collectible.
The Company has entered into agreements for the purchasing and servicing of receivables to sell, on a revolving basis, certain trade accounts receivable balances to third party financial institutions. Transfers under these agreements meet the requirements to be accounted for as sales in accordance with the Transfers and Servicing topic of the FASB Codification. During 2016, under these agreements, the Company sold and derecognized $1.3 billion of receivables, collected $1.2 billion on behalf of the financial institution, and received funding of approximately $116 million by the financial institution, resulting in deferred proceeds of approximately $31 million as of December 31, 2016. During 2015 under the agreement, the Company sold and derecognized $1.1 billion of receivables, collected approximately $920 million on behalf of the financial institution, and received funding of approximately $154 million by the financial institution, resulting in deferred proceeds of approximately $51 million as of December 31, 2015. Cash proceeds related to the sales are included in cash from operating activities on the Consolidated Statements of Cash Flows in the Changes in Operating Assets and Liabilities line item. The loss on sale is not material and is included in Other Expense (Income), Net line item on the Consolidated Statement of Operations.
The Company has also entered into various factoring and supply chain financing arrangements which also qualify for sale accounting in accordance with the Transfers and Servicing topic of the FASB Codification. For the years ended December 31, 2016 and 2015, the Company sold receivables of approximately $66 million and $129 million, respectively, related to these factoring arrangements.
Receivables sold under all programs subject to continuing involvement, which consists principally of collection services, were approximately $376 million and $282 million as of December 31, 2016 and 2015, respectively.
Covenant Restrictions
The Credit Agreement and the Indentures limit the Company's ability to incur additional indebtedness. Additional covenants contained in the Credit Agreement and the Indentures may, among other things, restrict the ability of the Company to dispose of assets, incur guarantee obligations, prepay other indebtedness, repurchase shares, pay dividends and make other restricted payments, create liens, make equity or debt investments, make acquisitions, modify terms of the indentures under which the Notes are issued, engage in mergers or consolidations, change the business conducted by the Company and its subsidiaries, and engage in certain transactions with affiliates. Such restrictions, together with disruptions in the credit markets, could limit the Company's ability to respond to changing market conditions, fund its capital spending program, provide for unexpected capital investments or take advantage of business opportunities.
Under the terms of the Credit Agreement, the Company must comply with a maximum Consolidated Total Leverage Ratio covenant and a minimum Consolidated Interest Expense Ratio covenant. The Second Amended and Restated Credit Agreement, which contains the definitions of these covenants, was filed as an exhibit to the Company's Form 8-K filed on October 7, 2014.
The Company must maintain a maximum Consolidated Total Leverage Ratio of less than 4.25 to 1.00. At December 31, 2016, the Company was in compliance with the Consolidated Total Leverage Ratio covenant in the Credit Agreement and the ratio was 2.63 to 1.00.
The Company must also comply with a minimum Consolidated Interest Expense Ratio of 3.00 to 1.00. At December 31, 2016, the Company was in compliance with the minimum Consolidated Interest Expense Ratio covenant in the Credit Agreement and the ratio was 11.08 to 1.00.
As of December 31, 2016, the Company's credit was rated BB+ by Standard & Poor's and Ba1 by Moody's Investor Services. Standard & Poor's and Moody's Investor Services' rating on the Company included a stable outlook.
Capital Investment
The Company’s capital investment in 2016 was $280.0 million ($294.6 million was paid), compared to $253.8 million ($244.1 million was paid) in 2015. During 2016, the Company had capital spending of $232.6 million for improving process capabilities, $31.4 million for capital spares and $16.0 million for manufacturing packaging machinery.
Environmental Matters
Some of the Company’s current and former facilities are the subject of environmental investigations and remediations resulting from historical operations and the release of hazardous substances or other constituents. Some current and former facilities have a history of industrial usage for which investigation and remediation obligations may be imposed in the future or for which indemnification claims may be asserted against the Company. Also, potential future closures or sales of facilities may necessitate further investigation and may result in future remediation at those facilities. The Company has established reserves for those facilities or issues where liability is probable and the costs are reasonably estimable.
For further discussion of the Company’s environmental matters, see Note 13 in the Notes to Consolidated Financial Statements included herein under “Item 8., Financial Statements and Supplementary Data.”
Contractual Obligations and Commitments
A summary of our contractual obligations and commitments as of December 31, 2016 is as follows:
(a) Purchase obligations primarily consist of commitments related to pine pulpwood, wood chips, and wood processing and
handling.
(b)
Certain amounts included in this table are based on management’s estimates and assumptions about these obligations. Because these estimates and assumptions are necessarily subjective, the obligations the Company will actually pay in the future periods may vary from those reflected in the table.
International Operations
For 2016, before intercompany eliminations, net sales from operations outside of the U.S. represented approximately 23% of the Company’s net sales. The Company’s revenues from export sales fluctuate with changes in foreign currency exchange rates. At December 31, 2016, approximately 20% of the Company’s total assets were denominated in currencies other than the U.S. dollar. The Company has significant operations in countries that use the euro, British pound sterling, the Australian dollar, the Canadian Dollar, the Mexico Peso or the Japanese yen as their functional currencies. The effect of changes in the U.S. dollar exchange rate against these currencies produced a net currency translation adjustment loss of $58.9 million, which was recorded in Other Comprehensive (Loss) Income for the year ended December 31, 2016. The magnitude and direction of this adjustment in the future depends on the relationship of the U.S. dollar to other currencies. The Company pursues a currency hedging program in order to reduce the impact of foreign currency exchange fluctuations on financial results. See “Financial Instruments” below.
The functional currency of the Company’s international subsidiaries is the local currency for the country in which the subsidiaries own their primary assets. The translation of the applicable currencies into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. Any related translation adjustments are recorded directly to Shareholders’ Equity. Gains and losses on foreign currency transactions are included in Other Expense (Income), Net for the period in which the exchange rate changes.
Financial Instruments
The Company pursues a currency hedging program which utilizes derivatives to reduce the impact of foreign currency exchange fluctuations on its consolidated financial results. Under this program, the Company has entered into forward exchange contracts in the normal course of business to hedge certain foreign currency denominated transactions. Realized and unrealized gains and losses on these forward contracts are included in the measurement of the basis of the related foreign currency transaction when recorded. The Company also pursues a hedging program that utilizes derivatives designed to manage risks associated with future variability in cash flows and price risk related to future energy cost increases. Under this program, the Company has entered into natural gas swap contracts to hedge a portion of its forecasted natural gas usage for 2017. Realized gains and losses on these contracts are included in the financial results concurrently with the recognition of the commodity consumed. The Company uses interest rate swaps to manage interest rate risks on future interest payments caused by interest rate changes on its variable rate
term loan facility. The Company does not hold or issue financial instruments for trading purposes. See “Item 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company does not trade or use derivative instruments with the objective of earning financial gains on interest or currency rates, nor does it use leveraged instruments or instruments where there are no underlying exposures identified.
Interest Rates
The Company is exposed to changes in interest rates, primarily as a result of its short-term and long-term debt, which include both fixed and floating rate debt. The Company uses interest rate swap agreements effectively to fix the LIBOR rate on certain variable rate borrowings. At December 31, 2016, the Company had active interest rate swap agreements with an aggregate notional amount of $450 million which will mature on December 31, 2017, and a notional amount of $250 million which will mature on October 1, 2018.
The table below sets forth interest rate sensitivity information related to the Company’s debt.
Long-Term Debt Principal Amount by Maturity-Average Interest Rate
Total Interest Rate Swaps-Notional Amount by Expiration-Average Swap Rate
(a) For 2017, the amount includes $400 million of forward starting interest rate swaps on February 1, 2017 and maturing on December 1, 2017.
Foreign Exchange Rates
The Company enters into forward exchange contracts to effectively hedge substantially all accounts receivable resulting from transactions denominated in foreign currencies. The purpose of these forward exchange contracts is to protect the Company from the risk that the eventual functional currency cash flows resulting from the collection of these accounts receivable will be adversely affected by changes in exchange rates. At December 31, 2016, multiple foreign currency forward exchange contracts existed, with maturities ranging up to three months. Those forward currency exchange contracts outstanding at December 31, 2016, when aggregated and measured in U.S. dollars at December 31, 2016 exchange rates, had net notional amounts totaling $68.1 million. The Company continuously monitors these forward exchange contracts and adjusts accordingly to minimize the exposure.
The Company also enters into forward exchange contracts to hedge certain other anticipated foreign currency transactions. The purpose of these contracts is to protect the Company from the risk that the eventual functional currency cash flows resulting from anticipated foreign currency transactions will be adversely affected by changes in exchange rates.
During the years ended December 31, 2016 and 2015, there were minimal amounts reclassified to earnings in connection with forecasted transactions that were no longer considered probable of occurring and there was no amount of ineffectiveness related to changes in the fair value of foreign currency forward contracts. Additionally, there were no amounts excluded from the measure of effectiveness during the years ended December 31, 2016 and 2015.
Foreign Exchange Rates Contractual Amount by Expected
Maturity-Average Contractual Exchange Rate
Natural Gas Contracts
The Company has hedged a portion of its expected natural gas usage for 2017. The carrying amount and fair value of the natural gas swap contracts is a net asset of $3.8 million as of December 31, 2016. Such contracts are designated as cash flow hedges and are accounted for by deferring the quarterly change in fair value of the outstanding contracts in Accumulated Other Comprehensive (Loss), Income in Shareholders’ Equity. The resulting gain or loss is reclassified into Cost of Sales concurrently with the recognition of the commodity consumed. The ineffective portion of the swap contracts change in fair value, if any, would be recognized immediately in earnings.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
GRAPHIC PACKAGING HOLDING COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of the consolidated financial statements.
GRAPHIC PACKAGING HOLDING COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
The accompanying notes are an integral part of the consolidated financial statements.
GRAPHIC PACKAGING HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of the consolidated financial statements.
GRAPHIC PACKAGING HOLDING COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(a) Includes 388,000 shares repurchased but not yet settled.
The accompanying notes are an integral part of the consolidated financial statements.
GRAPHIC PACKAGING HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Non-cash investing activities:
The accompanying notes are an integral part of the consolidated financial statements.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1.
NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Graphic Packaging Holding Company (“GPHC” and, together with its subsidiaries, the “Company”) is a leading provider of paper-based packaging solutions for a wide variety of products to food, beverage and other consumer products companies. The Company is one of the largest producers of folding cartons in the United States ("U.S.") and holds a leading market position in coated unbleached kraft paperboard (“CUK”) and coated-recycled paperboard (“CRB”). The Company’s customers include some of the most widely recognized companies in the world. The Company strives to provide its customers with packaging solutions designed to deliver marketing and performance benefits at a competitive cost by capitalizing on its low-cost paperboard mills and converting plants, its proprietary carton and packaging designs, and its commitment to customer service.
GPHC conducts no significant business and has no independent assets or operations other than its ownership of all of Graphic Packaging International, Inc.'s ("GPII") outstanding common stock.
Basis of Presentation and Principles of Consolidation
The Company’s Consolidated Financial Statements include all subsidiaries in which the Company has the ability to exercise direct or indirect control over operating and financial policies. Intercompany transactions and balances are eliminated in consolidation. Certain reclassifications have been made to prior year amounts to conform to current year presentation.
The Company holds a 50% ownership interest in a joint venture called Rengo Riverwood Packaging, Ltd. (in Japan) which is accounted for using the equity method.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting periods. Actual results could differ from these estimates, and changes in these estimates are recorded when known. Estimates are used in accounting for, among other things, pension benefits, retained insurable risks, slow-moving and obsolete inventory, allowance for doubtful accounts, useful lives for depreciation and amortization, impairment testing of goodwill and long-term assets, fair values related to acquisition accounting, fair value of derivative financial instruments, deferred income tax assets and potential income tax assessments, and loss contingencies.
Cash and Cash Equivalents
Cash and cash equivalents include time deposits, certificates of deposit and other marketable securities with original maturities of three months or less.
Accounts Receivable and Allowances
Accounts receivable are stated at the amount owed by the customer, net of an allowance for estimated uncollectible accounts, returns and allowances, and cash discounts. The allowance for doubtful accounts is estimated based on historical experience, current economic conditions and the credit worthiness of customers. Receivables are charged to the allowance when determined to be no longer collectible.
The Company has entered into agreements for the purchasing and servicing of receivables to sell, on a revolving basis, certain trade accounts receivable balances to third party financial institutions. Transfers under these agreements meet the requirements to be accounted for as sales in accordance with the Transfers and Servicing topic of the Financial Accounting Standards Board ("FASB") Accounting Standards Codification (the "Codification" or "ASC"). During 2016, the Company sold and derecognized
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
$1.3 billion of receivables, collected $1.2 billion on behalf of the financial institution, and received funding of approximately $116 million by the financial institution, resulting in deferred proceeds of approximately $31 million as of December 31, 2016. During 2015, the Company sold and derecognized $1.1 billion of receivables, collected approximately $920 million on behalf of the financial institution, and received funding of approximately $154 million by the financial institution, resulting in deferred proceeds of approximately $51 million as of December 31, 2015. Cash proceeds related to the sales are included in cash from operating activities on the Consolidated Statements of Cash Flows in the Changes in Operating Assets and Liabilities line item. The loss on sale is not material and is included in Other Expense (Income), Net line item on the Consolidated Statement of Operations.
The Company has also entered into various factoring and supply chain financing arrangements which also qualify for sale accounting in accordance with the Transfers and Servicing topic of the FASB Codification. For the years ended December 31, 2016 and 2015, the Company sold receivables of approximately $66 million and $129 million respectively, related to these factoring arrangements.
Receivables sold under all programs subject to continuing involvement, which consists principally of collection services, were approximately $376 million and $282 million as of December 31, 2016 and 2015, respectively.
Concentration of Credit Risk
The Company’s cash, cash equivalents, and accounts receivable are potentially subject to concentration of credit risk. Cash and cash equivalents are placed with financial institutions that management believes are of high credit quality. Accounts receivable are derived from revenue earned from customers located in the U.S. and internationally and generally do not require collateral. As of and for the years ended December 31, 2016 and 2015, no customer accounted for more than 10% of net sales.
Inventories
Inventories are stated at the lower of cost or market with cost determined principally by the first-in, first-out (“FIFO”) basis. Average cost basis is used to determine the cost of supply inventories and certain raw materials. Raw materials and consumables used in the production process such as wood chips and chemicals are valued at purchase cost on a FIFO basis upon receipt. Work in progress and finished goods inventories are valued at the cost of raw material consumed plus direct manufacturing costs (such as labor, utilities and supplies) as incurred and an applicable portion of manufacturing overhead. Inventories are stated net of an allowance for slow-moving and obsolete inventory.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Betterments, renewals and extraordinary repairs that extend the life of the asset are capitalized; other repairs and maintenance charges are expensed as incurred. The Company’s cost and related accumulated depreciation applicable to assets retired or sold are removed from the accounts and the gain or loss on disposition is included in income from operations.
Interest is capitalized on assets under construction for one year or longer with an estimated spending of $1.0 million or more. The capitalized interest is recorded as part of the asset to which it relates and is amortized over the asset’s estimated useful life. Capitalized interest was $1.3 million, $0.8 million and $1.6 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The Company assesses its long-lived assets, including certain identifiable intangibles, for impairment whenever events or circumstances indicate that the carrying value of an asset may not be recoverable. To analyze recoverability, the Company projects future cash flows, undiscounted and before interest, over the remaining life of such assets. If these projected cash flows are less than the carrying amount, an impairment would be recognized, resulting in a write-down of assets with a corresponding charge to earnings. The impairment loss is measured based upon the difference between the carrying amount and the fair value of the assets. The Company assesses the appropriateness of the useful life of its long-lived assets periodically.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Depreciation and Amortization
Depreciation is computed using the straight-line method based on the following estimated useful lives of the related assets:
Depreciation expense, including the depreciation expense of assets under capital leases, for 2016, 2015 and 2014 was $240.0 million, $227.6 million and $221.6 million, respectively.
Intangible assets with a determinable life are amortized on a straight-line or accelerated basis over their useful lives. The amortization expense for each intangible asset is recorded in the Consolidated Statements of Operations according to the nature of that asset.
Goodwill is the Company’s only intangible asset not subject to amortization. The following table displays the intangible assets that continue to be subject to amortization and aggregate amortization expense as of December 31, 2016 and 2015:
The Company recorded amortization expense for the years ended December 31, 2016, 2015 and 2014 of $59.3 million,
$52.9 million and $48.4 million, respectively. The Company expects amortization expense for the next five years to be as follows: $58 million, $56 million, $54 million, $50 million, and $43 million.
Goodwill
The Company tests goodwill for impairment annually as of October 1, as well as whenever events or changes in circumstances suggest that the estimated fair value of a reporting unit may no longer exceeds its carrying amount.
The Company tests goodwill for impairment at the reporting unit level, which is an operating segment or a level below an operating segment, which is referred to as a component. A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and management regularly reviews the operating results of that component. However, two or more components of an operating segment are aggregated and deemed a single reporting unit if the components have similar economic characteristics.
Potential goodwill impairment is measured at the reporting unit level by comparing the reporting unit’s carrying amount (including goodwill), to the fair value of the reporting unit. When performing the quantitative analysis, the estimated fair value of each reporting unit is determined by utilizing a discounted cash flow analysis based on the Company’s forecasts, discounted using a weighted average cost of capital and market indicators of terminal year cash flows based upon a multiple of EBITDA. If the carrying amount of a reporting unit exceeds its estimated fair value, goodwill is considered potentially impaired. In determining fair value, management relies on and considers a number of factors, including but not limited to, operating results, business plans, economic projections, forecasts including future cash flows, and market data and analysis, including market capitalization. The
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
assumptions used are based on what a hypothetical market participant would use in estimating fair value. Fair value determinations are sensitive to changes in the factors described above. There are inherent uncertainties related to these factors and judgments in applying them to the analysis of goodwill impairment.
Periodically, the Company may perform a qualitative impairment analysis of goodwill associated with each of its reporting units to determine if it is more likely than not that the carrying value of a reporting unit exceeded its fair value. As a result of its testing of goodwill as of October 1, 2016, the Company concluded goodwill was not impaired.
The following is a rollforward of goodwill by reportable segment:
Retained Insurable Risks
It is the Company’s policy to self-insure or fund a portion of certain expected losses related to group health benefits and workers’ compensation claims. Provisions for expected losses are recorded based on the Company’s estimates, on an undiscounted basis, of the aggregate liabilities for known claims and estimated claims incurred but not reported.
Asset Retirement Obligations
Asset retirement obligations are accounted for in accordance with the provisions of the Asset Retirement and Environmental Obligations topic of the FASB Codification. A liability and asset are recorded equal to the present value of the estimated costs associated with the retirement of long-lived assets where a legal or contractual obligation exists and the liability can be reasonably estimated. The liability is accreted over time and the asset is depreciated over the remaining life of the asset. Upon settlement of the liability, the Company will recognize a gain or loss for any difference between the settlement amount and the liability recorded. Asset retirement obligations with indeterminate settlement dates are not recorded until such time that a reasonable estimate may be made.
International Currency
The functional currency of the international subsidiaries is the local currency for the country in which the subsidiaries own their primary assets. The translation of the applicable currencies into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using an average exchange rate during the period. Any related translation adjustments are recorded directly to a separate component of Shareholders’ Equity, unless there is a sale or substantially complete liquidation of the underlying foreign investments.
The Company pursues a currency hedging program which utilizes derivatives to reduce the impact of foreign currency exchange fluctuations on its consolidated financial results. Under this program, the Company has entered into forward exchange contracts in the normal course of business to hedge certain foreign currency denominated transactions. Realized and unrealized gains and losses on these forward contracts are included in the measurement of the basis of the related foreign currency transaction when recorded.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Revenue Recognition
The Company recognizes revenue when all of the following criteria are met: persuasive evidence of an agreement exists, delivery has occurred or services have been rendered, the Company’s price to the buyer is fixed or determinable and collectability is reasonably assured. Delivery is not considered to have occurred until the customer takes title and assumes the risks and rewards of ownership.
The timing of revenue recognition is largely dependent on the location of title transfer which is normally either at our plant (shipping point) or upon arrival at our customer’s plant (destination). The Company recognizes revenues on its annual and multi-year carton supply contracts as the shipment occurs in accordance with the title transfer discussed above.
Discounts and allowances are comprised of trade allowances and rebates, cash discounts and sales returns. Cash discounts and sales returns are estimated using historical experience. Trade allowances are based on the estimated obligations and historical experience. Customer rebates are determined based on contract terms and are recorded at the time of sale.
Shipping and Handling
The Company includes shipping and handling costs in Cost of Sales.
Research and Development
Research and development costs, which relate primarily to the development and design of new packaging machines and products and are recorded as a component of Selling, General and Administrative expenses, are expensed as incurred. Expenses for the years ended December 31, 2016, 2015 and 2014 were $14.9 million, $13.8 million and $14.9 million, respectively.
Business Combinations and Other Special Charges
The following table summarizes the transactions recorded in Business Combinations and Other Special Charges in the Consolidated Statements of Operations as of December 31:
On April 29, 2016, the Company acquired Colorpak Limited ("Colorpak"), a leading folding carton supplier in Australia and New Zealand. Colorpak operates three folding carton facilities that convert paperboard into folding cartons for the food, beverage and consumer product markets. The folding carton facilities are located in Melbourne, Australia, Sydney, Australia and Auckland, New Zealand.
On March 31, 2016, the Company acquired substantially all of the assets of Metro Packaging & Imaging, Inc. ("Metro"), a single converting facility located in Wayne, New Jersey.
On February 16, 2016, the Company acquired Walter G. Anderson, Inc., ("WG Anderson") a premier folding carton manufacturer with a focus on store branded food and consumer product markets. WG Anderson operates two world-class sheet-fed folding carton converting facilities located in Hamel, Minnesota and Newton, Iowa.
On January 5, 2016, the Company acquired G-Box, S.A. de C.V., ("G-Box"). The acquisition includes two folding carton converting facilities located in Monterrey, Mexico and Tijuana, Mexico that service the food, beverage and consumer product markets.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
On October 1, 2015, the Company acquired the converting assets of Staunton, VA-based Carded Graphics, LLC. ("Carded"), an award winning folding carton producer with a strong regional presence in the food, craft beer and other consumer product markets.
On February 4, 2015, the Company acquired certain assets of Cascades Norampac Division ("Cascades") in Canada. Cascades services the food and beverage markets and operates three folding carton converting facilities located in Cobourg, Ontario, Mississauga, Ontario and Winnipeg, Manitoba along with a thermo mechanical pulp mill located in Jonquiere, Quebec and a coated recycled board mill located in East Angus, Quebec. The Jonquiere mill was shutdown in the third quarter of 2015.
On January 2, 2015, the Company acquired Rose City Printing and Packaging Inc. ("Rose City"). Rose City services food and beverage markets and operates two folding carton converting facilities located in Gresham, OR and Vancouver, WA.
As also disclosed in Note 1 - Nature of Business and Summary of Significant Accounting Policies, the Company acquired Rose City, Cascades and Carded and are referred to collectively as the "North American Acquisitions."
On June 30, 2014, the Company sold its multi-wall bag business.
On May 23, 2014, the Company acquired Benson Box Holdings Limited ("Benson"), a leading food, beverage, and retail packaging company in the United Kingdom.
On February 3, 2014, the Company sold its labels business.
Charges associated with all acquisitions are included in Net Charges Associated with Business Combinations in the table above. For more information regarding these acquisitions see Note 4 - Acquisitions.
The financial impact of the sale of a business is reflected in Loss on Sale of Assets in the table above.
Capital Allocation Plan, Equity Offerings and Share Repurchases
Capital Allocation Plan
On February 4, 2015, the Company's board of directors authorized a share repurchase program to allow management to purchase up to $250 million of the Company's issued and outstanding shares of common stock through open market purchases, privately negotiated transactions and Rule 10b5-1 plans. During 2016, the Company repurchased 13.2 million shares, or approximately $169 million, of its common stock under this program at an average price of $12.77. During 2015, the Company repurchased 4.6 million shares, or approximately $63 million, of its common stock under this program at an average price of $13.60. At December 31, 2016, the Company had approximately $18 million remaining under this share repurchase program.
During 2016 and 2015, the Company's board of directors declared a quarterly dividend per share of common stock to shareholders of record as follows:
During 2016, the Company declared and paid cash dividends of $71.7 million and $64.4 million, respectively.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During 2015, the Company declared and paid cash dividends of $65.5 million and $49.3 million, respectively.
Adoption of New Accounting Standards
Effective January 1, 2016, the Company adopted Accounting Standards Update ("ASU") No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. The amendments in this ASU eliminated the requirement to retrospectively account for provisional amounts recognized in a business combination. The adoption did not have any impact on the Company's disclosure for business combinations and financial position.
Effective January 1, 2016 the Company adopted ASU No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The amendments in the ASU clarify the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The adoption had no impact on the Company's financial position, results of operations and cash flows.
Accounting Standards Not Yet Adopted
In August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. This ASU provides guidance to clarify how certain cash receipts and payments should be presented in the statement of cash flows. The guidance is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted in any annual or interim period. The updated guidance requires a modified retrospective adoption. The Company is evaluating the impact of adoption on the Company's financial position, results of operations and cash flow.
In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718); Improvements to Employees Share-Based Payment Accounting. The amendments in this ASU are part of the simplification initiative by the FASB and involve several aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as equity or liabilities, forfeitures, and classification on the statement of cash flows. The amendments in this update are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company plans to adopt these amendments in first quarter of 2017. Under the modified retrospective method, the Company will recognize approximately $39 million in accumulated deficit and deferred tax liabilities for the previously unrecognized cumulative federal and state income tax effects of net operating loss carryforwards generated through historical excess tax benefit deductions which are currently prohibited from recognition. All other adopted amendments are not expected to have a material impact on the Company's financial position, results of operations and cash flow.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The amendments in this ASU require an entity to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months. Recognition, measurement and presentation of expenses will depend on classification as a finance or operating lease. The amendments also require certain quantitative and qualitative disclosures about leasing arrangements. The amendments are effective for fiscal years beginning after December 15, 2018 and interim periods within those years. Early adoption is permitted. The updated guidance requires a modified retrospective adoption. The Company is evaluating the impact of adoption on the Company's financial position, results of operation and cash flows.
In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. This amendment replaces the current method of measuring inventories at lower of cost or market with a lower of cost and net realizable value method. The amendments are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The amendments should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The Company does not expect the adoption of this standard to have a material impact on the Company's financial position, results of operations and cash flows.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. Adoption of ASU No. 2014-09 requires that an entity recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. On July 9, 2015, the FASB deferred the effective
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
date by one year to December 15, 2017 for interim and annual reporting periods beginning after that date and permitted early adoption of the standard but not before the original effective date of December 15, 2016, and can be applied using a full retrospective or modified retrospective approach. The Company is adopting this standard in the first quarter of fiscal 2018 and currently expects to use the modified retrospective approach. Based on certain contractual terms with some customers, the adoption may require acceleration of revenue for products produced by the Company without an alternative use and where the Company would have a legally enforceable right of payment for production completed to date. The Company is continuing to evaluate these contractual terms, including possible modifications to certain contracts, as well as evaluating the materiality of the impact to the financial statements. Currently, the Company does not believe the adoption of the other elements of the standard will have a material impact on the Company's financial position, results of operations and cash flows.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 2.
SUPPLEMENTAL BALANCE SHEET DATA
The following tables provide disclosure related to the components of certain line items included in our consolidated balance sheets.
Receivables, Net:
(1) Includes a receivable of approximately $31 million and $51 million for 2016 and 2015, respectively, from the financial institution under the purchasing and servicing of receivables agreements, which is a Level 3 fair value measurement.
Inventories, Net by major class:
Other Current Assets:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Property, Plant and Equipment, Net:
(2) Includes gross assets under capital lease of $25.6 million and related accumulated depreciation of $5.0 million as of December 31, 2016 and gross assets under capital lease of $8.8 million and related accumulated depreciation of $4.1 million as of December 31, 2015.
Other Assets:
Other Accrued Liabilities:
Other Noncurrent Liabilities:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 3.
SUPPLEMENTAL CASH FLOW INFORMATION
Cash Flow Provided by (Used in) Operations Due to Changes in Operating Assets and Liabilities, net of acquisitions and dispositions:
Cash paid for interest and cash paid, net of refunds, for income taxes was as follows:
NOTE 4.
ACQUISITIONS
As disclosed in Note 1 - Nature of Business and Summary of Significant Accounting Policies, the Company acquired Colorpak, Metro, WG Anderson and G-Box which are referred to collectively as the "2016 Acquisitions" and are included in the Americas Paperboard Packaging segment.
The Company paid approximately $333 million, net of cash acquired, for the 2016 Acquisitions using existing cash and borrowings under its revolving line of credit, and assumed debt of approximately $31 million. The acquisition accounting for the 2016 Acquisitions is preliminarily based on the estimated fair values as of the purchase dates and is subject to adjustments in subsequent periods once the third party valuations are completed. Adjustments, if any, subsequent to December 31, 2016, would relate primarily to deferred taxes. Management believes that the purchase price attributable to goodwill represents the benefits expected as the acquisitions were made to continue to grow the food and beverage business, integrate paperboard from the Company's mills and to further optimize the Company's supply chain footprint.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company expects that the goodwill related to Metro will be deductible for tax purposes. The preliminary acquisition accounting allocation for the 2016 Acquisitions is as follows:
(a) The weighted average life of Intangibles, Net, is 7.2 years. The Intangible Assets, Net were valued using the income approach and are a Level 3 fair value measurement.
During 2016, Net Sales and Income from Operations for the 2016 Acquisitions were approximately $246 million and $0.2 million, respectively.
As also disclosed in Note 1 - Nature of Business and Summary of Significant Accounting Policies, during 2015, the Company acquired Rose City, Cascades and Carded and are referred to collectively as the "North American Acquisitions."
In 2015, the Company paid approximately $164 million for the North American Acquisitions and the acquisition accounting has been finalized.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 5.
DEBT
Short-Term Debt is comprised of the following:
Short-term borrowings are principally at the Company’s international subsidiaries. The weighted average interest rate on short-term borrowings as of December 31, 2016 and 2015 was 3.2% and 9.2%, respectively.
Long-Term Debt is comprised of the following:
Long-Term Debt maturities (excluding capital leases) are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Senior Notes
During November 2014, the Company completed the issuance and sale of $250 million aggregate principal amount of 4.875% Notes due 2022. The Company also redeemed 100% of $250.0 million aggregate principal of its 7.875% Senior Notes due in 2018. The notes were redeemed at a price of 103.94%. In conjunction with both of these transactions, $12.1 million of fees were expensed and are reflected as Loss on Modification or Extinguishment of Debt in the Company's Consolidated Statement of Operations. The remaining fees of $4.4 million were deferred and are being amortized using the effective interest method until maturity.
During August 2016, the Company completed the issuance and sale of $300 million aggregate principal amount of 4.125% Notes due 2024. In connection with the new notes, the Company recorded deferred financing cost of approximately $5.4 million.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Credit Facilities
The following describes the Senior Secured Term Loan and Revolving Credit Facilities:
(a) The Company's obligations under the Credit Agreement are secured by substantially all of the Company's domestic assets.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
At December 31, 2016, the Company and its U.S. and international subsidiaries had the following commitments, amounts outstanding and amounts available under revolving credit facilities:
(a)In accordance with its debt agreements, the Company's availability under its Revolving Credit Facility has been reduced by the amount of standby letters of credit issued of $22.3 million as of December 31, 2016. These letters of credit are primarily used as security against its self-insurance obligations and workers' compensation obligations. These letters of credit expire through mid- 2018 unless extended.
The Credit Agreement and the indentures governing the 4.75% Senior Notes due 2021, 4.875% Senior Notes due 2022 and 4.125% Senior Notes due 2024, (the “Indentures”) limit the Company’s ability to incur additional indebtedness. Additional covenants contained in the Credit Agreement and the Indentures may, among other things, restrict the ability of the Company to dispose of assets, incur guarantee obligations, prepay other indebtedness, repurchase stock, pay dividends and make other restricted payments, create liens, make equity or debt investments, make acquisitions, modify terms of the Indenture, engage in mergers or consolidations, change the business conducted by the Company and its subsidiaries, and engage in certain transactions with affiliates. Such restrictions could limit the Company’s ability to respond to changing market conditions, fund its capital spending program, provide for unexpected capital investments or take advantage of business opportunities.
As of December 31, 2016, the Company was in compliance with the covenants in the Credit Agreement and the Indentures.
NOTE 6.
STOCK INCENTIVE PLANS
The Company has one active equity compensation plan from which new grants may be made, the Graphic Packaging Holding Company 2014 Omnibus Stock and Incentive Compensation Plan (the “2014 Plan”). Under the 2014 Plan, the Company may grant stock options, stock appreciation rights, restricted stock, restricted stock units (“RSU’s”) and other types of stock-based and cash awards. Prior to the approval of the 2014 Plan and the expiration of the Graphic Packaging Holding Company Amended and Restated 2004 Stock and Incentive Compensation Plan (the “2004 Plan”) in 2014, the Company made all new grants under the 2004 Plan. Awards under the 2014 Plan and the 2004 Plan generally vest and expire in accordance with terms established at the time of grant. Shares issued pursuant to awards under the 2014 Plan and 2004 Plan are from the Company’s authorized but unissued shares. Compensation costs are recognized on a straight-line basis over the requisite service period of the award.
Stock Awards, Restricted Stock and Restricted Stock Units
Under the 2014 Plan and 2004 Plan, all RSUs generally vest and become payable in three years from date of grant. RSUs granted to employees generally contain performance conditions based on various financial targets or service requirements that must be met for the shares to vest. Stock awards granted to non-employee directors as part of their compensation for service on the Board are unrestricted on the grant date.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Data concerning RSUs and stock awards granted in the years ended December 31:
A summary of the changes in the number of unvested RSUs from December 31, 2013 to December 31, 2016 is presented below:
The initial value of the RSUs is based on the market value of the Company’s common stock on the date of grant. RSUs are recorded in Stockholders' Equity. The unrecognized expense at December 31, 2016 is approximately $25 million and is expected to be recognized over a weighted average period of 2 years.
The value of stock awards granted to the Company's directors are based on the market value of the Company’s common stock on the date of grant. These awards are unrestricted on the date of grant.
During 2016, 2015, and 2014, $20.2 million, $20.4 million and $18.7 million, respectively, were charged to compensation expense for stock incentive plans.
During 2016, 2015, and 2014, RSUs with an aggregate fair value of $32.0 million, $56.1 million and $38.1 million, respectively, vested and were paid out. The RSUs vested and paid out in 2016 were granted primarily during 2013.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 7.
PENSIONS AND OTHER POSTRETIREMENT BENEFITS
DEFINED BENEFIT PLANS
The Company maintains both defined benefit pension plans and postretirement health care plans that provide medical and life insurance coverage to eligible salaried and hourly retired employees in North America and their dependents. The Company maintains international defined benefit pension plans which are both noncontributory and contributory and are funded in accordance with applicable local laws. Pension or termination benefits are based primarily on years of service and the employees’ compensation.
Currently, the North American plans are closed to newly-hired employees. Effective July 1, 2011, the North American plans were frozen for most salaried and non-union hourly employees and replaced with a defined contribution plan. During 2015, the remaining union plans were closed to newly-hired employees. Also in 2015, the Company assumed defined benefit pension and postretirement benefit plans in the Cascades acquisition. These plans are closed to newly-hired employees. In 2016, the Company assumed a defined benefit plan in the WG Anderson acquisition, which was frozen for all participants on December 31, 2016.
During the fourth quarter of 2015, the Company partially settled obligations of certain of its defined benefit pension plans though lump sum payments to certain term-vested employees who were not currently receiving a monthly benefit. Term-vested employees whose future pension benefits were above an established threshold had the option to either accept the lump sum offer or continue to be entitled to their future monthly benefit. The impact of acceptance reduced the projected benefit obligation by $34.7 million and required cash payments from existing plan assets of $34.6 million.
During 2015, the Company settled obligations of a defined benefit plan associated with the Brampton, Ontario facility which was closed. The settlements resulted from lump sum payments to plan participants or the purchase of annuities.
During the fourth quarter of 2014, the Company also partially settled obligations of certain of its defined benefit pension plans though lump sum payments. The impact of acceptance reduced the projected benefit obligation by $42.0 million, required cash payment from existing plan assets of $40.2 million, and resulted in a settlement charge of $0.8 million.
Pension and Postretirement Expense
The pension and postretirement expenses related to the Company’s plans consisted of the following:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Certain assumptions used in determining the pension and postretirement expenses were as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Funded Status
The following table sets forth the funded status of the Company’s pension and postretirement plans as of December 31:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Accumulated Benefit Obligation
The accumulated benefit obligation, (“ABO”), for all defined benefit pension plans was $1,270.0 million and $1,226.2 million at December 31, 2016 and 2015, respectively. All of the Company’s defined benefit pension plans had an ABO in excess of plan assets at December 31, 2016 and 2015, except one of the U.K. plans in 2015.
Employer Contributions
The Company made contributions of $51.4 million and $53.4 million to its pension plans during 2016 and 2015, respectively. The Company also made postretirement health care benefit payments of $2.1 million and $2.8 million during 2016 and 2015, respectively. For 2017, the Company expects to make contributions of $30 to $50 million to its pension plans and approximately $3 million to its postretirement health care plans.
Pension Assets
The Company’s overall investment strategy is to achieve a mix of investments for long-term growth and near-term benefit payments through diversification of asset types, fund strategies and fund managers. Investment risk is measured on an on-going basis through annual liability measurements, periodic asset/liability studies, and quarterly investment portfolio reviews. The plans invest in the following major asset categories: cash, equity securities, fixed income securities, real estate and diversified growth funds. At December 31, 2016 and 2015, pension investments did not include any direct investments in the Company’s stock or the Company’s debt.
The weighted average allocation of plan assets and the target allocation by asset category is as follows:
The plans’ investment in equity securities primarily includes investments in U.S. and international companies of varying sizes and industries. The strategy of these investments is to 1) exceed the return of an appropriate benchmark for such equity classes and 2) through diversification, reduce volatility while enhancing long term real growth.
The plans’ investment in fixed income securities includes government bonds, investment grade bonds and non-investment grade bonds across a broad and diverse issuer base. The strategy of these investments is to provide income and stability and to diversify the fixed income exposure of the plan assets, thereby reducing volatility.
The Company’s approach to developing the expected long-term rate of return on pension plan assets is based on fair values and combines an analysis of historical investment performance by asset class, the Company’s investment guidelines and current and expected economic fundamentals.
Since the plans are closed or frozen and as the funded status has improved, the Company is implementing a derisking or liability driven investment strategy. This strategy moves assets from return seeking (e.g. equities) to investments that mirror the underlying benefit obligations (fixed income).
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following tables set forth, by category and within the fair value hierarchy, the fair value of the Company’s pension assets at December 31, 2016 and 2015:
(a) The Level 2 investments are held in pooled funds and fair value is determined by net asset value, based on the underlying investments, as reported on the valuation date.
(b) The fund invests in a combination of traditional investments (equities, bonds, and foreign exchange), seeking to achieve returns through active asset allocation over a three to five year horizon.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
A reconciliation of fair value measurements of plan assets using significant unobservable inputs (Level 3) is as follows:
Postretirement Health Care Trend Rate Sensitivity
Assumed health care cost trend rates affect the amounts reported for postretirement health care benefit plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects on 2016 data:
Estimated Future Benefit Payments
The following represents the Company’s estimated future pension and postretirement health care benefit payments through the year 2026:
Amounts in Accumulated Other Comprehensive Loss Expected to Be Recognized in Net Periodic Benefit Costs in 2017
During 2017, amounts recorded in Accumulated Other Comprehensive Loss expected to be recognized in Net Periodic Benefit Costs are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Multi-Employer Plans
Certain of the Company’s employees participate in multi-employer plans that provide both pension and other postretirement health care benefits to employees under union-employer organization agreements. Expense related to ongoing participation in these plans for the years ended December 31, 2016 and 2015 was $2.7 million and $2.1 million, respectively.
Estimated liabilities have been established related to the partial or complete withdrawal from certain multi-employment benefit plans for facilities which have been closed. At December 31, 2016, and December 31, 2015, the Company has $30.4 million and $30.5 million, respectively, recorded in Other Noncurrent Liabilities for these withdrawal liabilities which represents the Company's best estimate of the expected withdrawal liability.
The Company's remaining participation in multi-employer pension plans consists of contributions to three plans under the terms contained in collective bargaining agreements. The risks of participating in these multi-employer plans are different from single-employer plans in the following ways:
a.
Assets contributed to the multi-employers plan by one employer may be used to provide benefits to employees of other participating employers.
b.
If a participating employer stops contributing to the plan, the unfunded obligation of the plan may be borne by the remaining participating employers.
c.
If a company chooses to stop participating in a multi-employer plan, a company may be required to pay that plan an amount based on the underfunded status of the plan, referred to as the withdrawal liability.
The Company recorded charges of $4.3 million in 2014 related to the sale of the multi-wall bag business for partial withdrawal from the PACE Industry Union - Management Pension Fund (“PIUMPF”). There were no similar charges recorded for the year ended December 31, 2016 and 2015. While it is not possible to quantify the potential impact of future actions, further reductions in participation or withdrawal from these multi-employer pension plans could have a material impact on the Company’s results of operations, financial position, or cash flows.
The Company's participation in these plans for the year ended December 31, 2016, 2015 and 2014 is shown in the table below:
(1) The facility associated with this plan was divested on June 30, 2014.
(2) In 2016, the WG Anderson acquisition included facilities with these plans.
(3) The facility associated with this plan was closed in 2016.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The EIN Number column provides the Employer Identification Number (EIN). Unless otherwise noted, the most recent Pension Protection Act (PPA) zone status available in 2016 and 2015 is for the plan's year-end at December 31, 2015 and December 31, 2014, respectively. The zone status is based on information that the Company receives from the plan and is certified by the plan's actuary. Among other factors, plans in the red zone are generally less than 65 percent funded, plans in the yellow zone are less than 80 percent funded, and plans in the green zone are at least 80 percent funded. The "FIP/RP Status Implemented" column indicates plans for which a Financial Improvement Plan (FIP) or Rehabilitation Plan (RP) has been implemented. The Company's share of the contributions to these plans did not exceed 5% of total plan contributions for the most recent plan year.
DEFINED CONTRIBUTION PLANS
The Company provides defined contribution plans for certain eligible employees. The Company’s contributions to the plans are based upon employee contributions, a percentage of eligible compensation, and the Company’s annual operating results. Contributions to these plans for the years ended December 31, 2016, 2015 and 2014 were $34.7 million, $29.0 million and $28.9 million, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 8.
INCOME TAXES
The U.S. and international components of Income before Income Taxes and Equity Income of Unconsolidated Entity consisted of the following:
The provisions for Income Tax (Expense) Benefit on Income before Income Taxes and Equity Income of Unconsolidated Entities consisted of the following:
A reconciliation of Income Tax (Expense) Benefit on Income before Income Taxes and Equity Income of Unconsolidated Entities at the federal statutory rate of 35% compared with the Company’s actual Income Tax (Expense) Benefit is as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During the second quarter of 2016, the Company executed an agreement with the Internal Revenue Service related to certain elections made on its 2011 and 2012 tax returns. As a result of the agreement, the Company has amended its 2011 and 2012 U.S. federal and state income tax returns resulting in the utilization of previously expired net operating loss carryforwards. The Company recorded a discrete benefit during the second quarter of 2016 of $22.4 million to reflect the federal and state impact of the amended returns as a reduction in its net long-term deferred tax liability.
During the fourth quarter of 2014, the Company completed a multi-year research credit study resulting in the establishment of deferred tax assets for U.S. federal and state research tax credit carryforwards of $20.1 million, for the years ended December 31, 2011 through December 31, 2014. These research tax credit carryforwards have been reduced by $4.5 million in accordance with the measurement criteria of the Income Taxes topic of the FASB Codification. The Company also established a valuation allowance against certain state research credit carryforwards of approximately $5 million. During 2016 and 2015, the Company established additional U.S. federal research tax credit carryforwards of $3.5 million and $5.5 million, respectively, which have been reduced by $0.7 million and $1.5 million, respectively, in accordance with the measurement criteria of the Income Taxes topic of the FASB Codification.
The tax effects of differences that give rise to significant portions of the deferred income tax assets and deferred income tax liabilities as of December 31 were as follows:
The Company has total deferred income tax assets, excluding valuation allowance, of $364.1 million and $437.2 million as of December 31, 2016 and 2015, respectively. The Company has total deferred income tax liabilities of $723.4 million and $655.5 million as of December 31, 2016 and 2015, respectively.
According to the Income Taxes topic of the FASB Codification, a valuation allowance is required to be established or maintained when, based on currently available information and other factors, it is more likely than not that all or a portion of a deferred tax asset will not be realized. The FASB Codification provides important factors in determining whether a deferred tax asset will be realized, including whether there has been sufficient pretax income in recent years and whether sufficient income can reasonably be expected in future years in order to utilize the deferred tax asset. The Company has evaluated the need to maintain a valuation allowance for deferred tax assets based on its assessment of whether it is more likely than not that deferred tax assets will be realized through the generation of future taxable income. Appropriate consideration was given to all available evidence, both positive and negative, in assessing the need for a valuation allowance.
The Company reviewed its deferred income tax assets as of December 31, 2016 and 2015, respectively, and determined that it is more likely than not that a portion will not be realized. A valuation allowance of $45.5 million and $44.8 million at December 31,
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2016 and 2015, respectively, is maintained on the deferred income tax assets for which the Company has determined that realization is not more likely than not. Of the total valuation allowance at December 31, 2016, $31.0 million relates to net deferred tax assets in certain foreign jurisdictions, $5.1 million relates to a deferred tax asset related to a U.S. federal capital loss carryforward, $6.0 million relates to research credit carryforwards in certain states, and the remaining $3.4 million relates to net operating losses in certain U.S. states. The need for a valuation allowance is made on a jurisdiction-by-jurisdiction basis. As of December 31, 2016, the Company concluded that due to cumulative pretax losses and the lack of sufficient future taxable income of the appropriate character, realization is less than more likely than not on the net deferred income tax assets related primarily to the Company’s Brazil, Canada, China, France and Germany operations.
The following table represents a summary of the valuation allowances against deferred tax assets as of and for the three years ended December 31, 2016, 2015, and 2014, respectively:
The U.S. federal net operating loss carryforwards expire as follows:
The amounts above exclude $107.1 million of U.S. federal net operating loss carryforwards generated through excess tax benefit deductions claimed on the Company's 2011-2016 U.S. federal income tax returns, which are prohibited from being recognized currently. In accordance with ASU No. 2016-09, Compensation-Stock Compensation (Topic 718), the Company will recognize the cumulative federal and state income tax effects of these unrecognized net operating loss carryforwards in accumulated deficit upon adoption of ASU 2016-09 in the first quarter of 2017.
U.S. state net operating loss carryforward amounts (excluding prior year excess tax benefit deductions noted above) total $262.9 million and expire in various years through 2031.
International net operating loss carryforward amounts total $102.6 million, of which substantially all have no expiration date.
Tax Credit carryforwards total $35.3 million, of which approximately $8.7 million have no expiration date, and the remainder expire starting in 2020.
As of December 31, 2016, the Company has only provided for deferred U.S. income taxes on $4.9 million of undistributed earnings related to the Company's equity investment in the joint venture, Rengo Riverwood Packaging, Ltd. The Company has not provided for deferred U.S. income taxes on approximately $17.5 million of undistributed earnings of international subsidiaries because of its intention to indefinitely reinvest these earnings outside the U.S. The determination of the amount of the unrecognized deferred U.S. income tax liability on these unremitted earnings is not practicable because of the complexities associated with the hypothetical calculation.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Uncertain Tax Positions
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
At December 31, 2016, $10.1 million of the total gross unrecognized tax benefits, if recognized, would affect the annual effective income tax rate.
The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits within its global operations in Income Tax Expense. The Company had an accrual for the payment of interest and penalties of $0.1 million and $0.6 million at December 31, 2016 and 2015, respectively.
The Company anticipates that approximately $1.2 million of the total unrecognized tax benefits at December 31, 2016 could change within the next 12 months.
The Company files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local tax examinations for years before 2012 or non-U.S. income tax examinations for years before 2007.
NOTE 9.
FINANCIAL INSTRUMENTS, DERIVATIVES AND HEDGING ACTIVITIES
The Company enters into derivative instruments for risk management purposes only, including derivatives designated as hedging instruments under the Derivatives and Hedging topic of the FASB Codification and those not designated as hedging instruments under this guidance. The Company uses interest rate swaps, natural gas swap contracts, and forward exchange contracts. These derivative instruments are designated as cash flow hedges and, to the extent they are effective in offsetting the variability of the hedged cash flows, changes in the derivatives’ fair value are not included in current earnings but are included in Accumulated Other Comprehensive Loss. These changes in fair value will subsequently be reclassified to earnings, contemporaneously with and offsetting changes in the related hedged exposure.
Interest Rate Risk
The Company uses interest rate swaps to manage interest rate risks on future interest payments caused by interest rate changes on its variable rate term loan facility. These changes in fair value will subsequently be reclassified into earnings as a component of Interest Expense, Net as interest is incurred on amounts outstanding under the term loan facility.
The following table summarizes the Company's current interest rate swap positions for each period presented as of December 31, 2016:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
These derivative instruments are designated as cash flow hedges and, to the extent they are effective in offsetting the variability of the hedged cash flows, changes in the derivatives’ fair value are not included in current earnings but are included in Accumulated Other Comprehensive Income (Loss). Ineffectiveness measured in the hedging relationship is recorded in earnings in the period it occurs. During 2016, there were no amounts of ineffectiveness. During 2015, there were minimal amounts of ineffectiveness. During 2016 and 2015, there were no amounts excluded from the measure of effectiveness.
Commodity Risk
To manage risks associated with future variability in cash flows and price risk attributable to certain commodity purchases, the Company enters into natural gas swap contracts to hedge prices for a designated percentage of its expected natural gas usage. The Company has hedged a portion of its expected usage for 2017. Such contracts are designated as cash flow hedges. The contracts are carried at fair value with changes in fair value recognized in Accumulated Other Comprehensive Income (Loss), and the resulting gain or loss is reclassified into Cost of Sales concurrently with the recognition of the commodity purchased. The ineffective portion of the swap contract’s change in fair value, if any, would be recognized immediately in earnings.
During 2016 and 2015, there were minimal amounts of ineffectiveness related to changes in the fair value of natural gas swap contracts. Additionally, there were no amounts excluded from the measure of effectiveness.
Foreign Currency Risk
The Company enters into forward exchange contracts, designated as cash flow hedges, to manage risks associated with foreign currency transactions and future variability of cash flows arising from those transactions that may be adversely affected by changes in exchange rates. The contracts are carried at fair value with changes in fair value recognized in Accumulated Other Comprehensive Loss and gains/losses related to these contracts are recognized in Other Expense (Income), Net or Net Sales, when appropriate.
At December 31, 2016 and 2015, multiple forward exchange contracts existed that expire on various dates throughout the following year. Those purchased forward exchange contracts outstanding at December 31, 2016 and 2015, when aggregated and measured in U.S. dollars at contractual rates at December 31, 2016 and 2015, had notional amounts totaling $55.9 million and $65.2 million, respectively.
No amounts were reclassified to earnings during 2016 and 2015 in connection with forecasted transactions that were no longer considered probable of occurring and there was no amount of ineffectiveness related to changes in the fair value of foreign currency forward contracts. Additionally, there were no amounts excluded from the measure of effectiveness during 2016 and 2015.
Derivatives not Designated as Hedges
The Company enters into forward exchange contracts to effectively hedge substantially all of accounts receivable resulting from transactions denominated in foreign currencies in order to manage risks associated with foreign currency transactions adversely affected by changes in exchange rates. At December 31, 2016 and 2015, multiple foreign currency forward exchange contracts existed, with maturities ranging up to three months. Those foreign currency exchange contracts outstanding at December 31, 2016 and 2015, when aggregated and measured in U.S. dollars at exchange rates at December 31, 2016 and 2015, respectively, had net notional amounts totaling $68.1 million and $45.5 million. Unrealized gains and losses resulting from these contracts are recognized in Other Expense (Income), Net and approximately offset corresponding recognized but unrealized gains and losses on these accounts receivable.
Foreign Currency Movement Effect
For the year ended December 31, 2016, net currency exchange losses included in determining Income from Operations was $4.8 million. For the years ended December 31, 2015 and 2014, net currency exchange gains included in determining Income from Operations were $4.7 million and $1.4 million, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 10.
FAIR VALUE MEASUREMENT
The Company follows the fair value guidance integrated into the Fair Value Measurements and Disclosures topic of the FASB Codification in regards to financial and nonfinancial assets and liabilities. Nonfinancial assets and nonfinancial liabilities include those measured at fair value in goodwill impairment testing, asset retirement obligations initially measured at fair value, and those assets and liabilities initially measured at fair value in a business combination.
The FASB’s guidance defines fair value, establishes a framework for measuring fair value and expands the fair value disclosure requirements. The accounting guidance applies to accounting pronouncements that require or permit fair value measurements. It indicates, among other things, that a fair value measurement assumes that the transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The guidance defines fair value based upon an exit price model, whereby fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The guidance clarifies that fair value should be based on assumptions that market participants would use, including a consideration of non-performance risk.
Valuation Hierarchy
The Fair Value Measurements and Disclosures topic establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:
Level 1 inputs - quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2 inputs - quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
Level 3 inputs - unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value.
An asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
The Company has determined that its financial assets and financial liabilities include derivative instruments which are carried at fair value and are valued using Level 2 inputs in the fair value hierarchy. The Company uses valuation techniques based on discounted cash flow analyses, which reflects the terms of the derivatives and uses observable market-based inputs, including forward rates and uses market price quotations obtained from independent derivatives brokers, corroborated with information obtained from independent pricing service providers.
Fair Value of Financial Instruments
As of December 31, 2016 and 2015, the Company had a gross derivative liability of $0.8 million and $14.2 million respectively, and a gross derivative asset of $7.7 million and $0.4 million respectively, related to interest rate, foreign currency and commodity contracts.
As of December 31, 2016, there has not been any significant impact to the fair value of the Company’s derivative liabilities due to its own credit risk. Similarly, there has not been any significant adverse impact to the Company’s derivative assets based on evaluation of the Company’s counterparties’ credit risks.
The fair values of the Company’s other financial assets and liabilities at December 31, 2016 and 2015 approximately equal the carrying values reported on the Consolidated Balance Sheets except for Long-Term Debt. The fair value of the Company’s Long-Term Debt (excluding capital leases and deferred financing fees) was $2,132.7 million and $1,891.2 million, as compared to the carrying amounts of $2,112.8 million and $1,876.6 million. The fair value of the Company's Long-Term Debt, including the Senior Notes, are based on quoted market prices (Level 2 inputs). Level 2 valuation techniques for Long-Term Debt are based on quotations obtained from independent pricing service providers.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Effect of Derivative Instruments
The pre-tax effect of derivative instruments in cash flow hedging relationships on the Company’s Consolidated Statements of Operations for the year ended December 31, 2016 and 2015 is as follows:
The effect of derivative instruments not designated as hedging instruments on the Company’s Consolidated Statements of Operations for the years ended December 31, 2016 and 2015 is as follows:
Accumulated Derivative Instruments (Loss) Income
The following is a rollforward of pre-tax Accumulated Derivative Instruments (Loss) Income which is included in the Company’s Consolidated Balance Sheets and Consolidated Statements of Shareholders’ Equity as of December 31:
At December 31, 2016, the Company expects to reclassify $6.9 million of pre-tax gains in the next twelve months from Accumulated Other Comprehensive (Loss) Income to earnings, contemporaneously with and offsetting changes in the related hedged exposure. The actual amount that will be reclassified to future earnings may vary from this amount as a result of changes in market conditions.
NOTE 11.
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
The changes in the components of Accumulated Other Comprehensive (Loss) Income attributable to Graphic Packaging Holding Company are as follows:
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The balances of Accumulated Other Comprehensive Loss, net of applicable taxes are as follows:
NOTE 12.
COMMITMENTS AND CONTINGENCIES
The Company leases certain warehouses, operating facilities, office space, data processing equipment and plant equipment under long-term, non-cancelable contracts that expire at various dates (some of these leases are subject to renewal options and contain escalation clauses). Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) and the future minimum lease payments at December 31, 2016, are as follows:
Total rental expense was approximately $35 million, $29 million, and $30 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The Company has entered into other long-term contracts principally for the purchase of fiber and chip processing. The minimum purchase commitments extend beyond 2021. At December 31, 2016, total commitments under these contracts were as follows:
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 13.
ENVIRONMENTAL AND LEGAL MATTERS
Environmental Matters
The Company is subject to a broad range of foreign, federal, state and local environmental, health and safety laws and regulations, including those governing discharges to air, soil and water, the management, treatment and disposal of hazardous substances, solid waste and hazardous wastes, the investigation and remediation of contamination resulting from historical site operations and releases of hazardous substances, and the health and safety of employees. Compliance initiatives could result in significant costs, which could negatively impact the Company’s consolidated financial position, results of operations or cash flows. Any failure to comply with environmental or health and safety laws and regulations or any permits and authorizations required thereunder could subject the Company to fines, corrective action or other sanctions.
Some of the Company’s current and former facilities are the subject of environmental investigations and remediations resulting from historic operations and the release of hazardous substances or other constituents. Some current and former facilities have a history of industrial usage for which investigation and remediation obligations may be imposed in the future or for which indemnification claims may be asserted against the Company. Also, potential future closures or sales of facilities may necessitate further investigation and may result in future remediation at those facilities.
The Company has established reserves for those facilities or issues where a liability is probable and the costs are reasonably estimable. The Company believes that the amounts accrued for its loss contingencies, and the reasonably possible loss beyond the amounts accrued, are not material to the Company’s consolidated financial position, results of operations or cash flows. The Company cannot estimate with certainty other future corrective compliance, investigation or remediation costs. Some costs relating to historic usage that the Company considers to be reasonably possible of resulting in liability are not quantifiable at this time. The Company will continue to monitor environmental issues at each of its facilities, as well as regulatory developments, and will revise its accruals, estimates and disclosures relating to past, present and future operations, as additional information is obtained.
Legal Matters
The Company is a party to a number of lawsuits arising in the ordinary conduct of its business. Although the timing and outcome of these lawsuits cannot be predicted with certainty, the Company does not believe that disposition of these lawsuits will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
NOTE 14.
BUSINESS SEGMENT AND GEOGRAPHIC AREA INFORMATION
Prior to the sale of the multi-wall bag business on June 30, 2014, the Company reported its results in two reportable segments: paperboard packaging and flexible packaging. During 2015, the Company reevaluated the aggregation of operating segments into reportable segments in accordance with FASB ASC 280 Segment Reporting, and concluded there are three reportable segments:
Paperboard Mills includes the seven North American paperboard mills which produce primarily CUK and CRB. The majority of the paperboard is consumed internally to produce paperboard packaging for the Americas and Europe Paperboard Packaging segments. The remaining paperboard is sold externally to a wide variety of paperboard packaging converters and brokers. The Paperboard Mills segment Net Sales represent the sale of paperboard only to external customers. The effect of intercompany transfers to the paperboard packaging segments has been eliminated from the Paperboard Mills segment to reflect the economics of the integration of these segments.
Americas Paperboard Packaging includes paperboard folding cartons sold primarily to Consumer Packaged Goods ("CPG") companies serving the food, beverage, and consumer product markets primarily in the Americas.
Europe Paperboard Packaging includes paperboard folding cartons sold primarily to CPG companies serving the food, beverage and consumer product markets in Europe.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company also allocates certain mill and corporate costs to the reportable segments to appropriately represent the economics of these segments. The Corporate and Other caption includes the Pacific Rim operating segment and unallocated corporate and one-time costs.
These segments are evaluated by the chief operating decision maker based primarily on Income from Operations as adjusted for depreciation and amortization. The accounting policies of the reportable segments are the same as those described above in Note 1 - Nature of Business and Summary of Significant Accounting Policies.
The Company did not have any one customer who accounted for 10% or more of the Company’s net sales during 2016, 2015 or 2014.
Business segment information is as follows:
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(a) Includes Loss on Sale of Assets of multi-wall bag business of $171.1 million in 2014.
Business geographic area information is as follows:
(a) Includes North America and Brazil.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 15.
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Results of operations for the four quarters of 2016 and 2015 are shown below.
(a) Does not cross foot due to rounding.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 16.
EARNINGS PER SHARE
NOTE 17.
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
The following represents changes in Accumulated Other Comprehensive (Loss) Income by component for the year ended December 31, 2016 (a):
(a)
All amounts are net-of-tax.
(b) See following table for details about these reclassifications.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following represents reclassifications out of Accumulated Other Comprehensive Income for the year ended December 31, 2016:
(c)
These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note 7 - Pensions and Other Postretirement Benefits).
NOTE 18.
GUARANTOR CONSOLIDATING FINANCIAL STATEMENTS
This disclosure is required because certain subsidiaries are guarantors of GPII debt securities.
These consolidating financial statements reflect GPHC (“the Parent”); GPII (the "Subsidiary Issuer"); and the Subsidiary Guarantors, which consist of all material 100% owned subsidiaries of GPII other than its foreign subsidiaries; and the nonguarantor subsidiaries (herein referred to as “Nonguarantor Subsidiaries”). The Nonguarantor Subsidiaries include all of GPII's foreign subsidiaries and the immaterial domestic subsidiaries. Separate complete financial statements of the Subsidiary Guarantors are not presented because the guarantors are jointly and severally, fully and unconditionally liable under the guarantees.
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
GRAPHIC PACKAGING HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Graphic Packaging Holding Company
We have audited the accompanying consolidated balance sheets of Graphic Packaging Holding Company as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Graphic Packaging Holding Company at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016 in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Graphic Packaging Holding Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 8, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Atlanta, Georgia
February 8, 2017
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Graphic Packaging Holding Company
We have audited Graphic Packaging Holding Company’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). Graphic Packaging Holding Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of G-Box, S.A de C.V., Walter G. Anderson, Inc., Metro Packaging & Imaging Inc., and Colorpak Limited, which are included in the 2016 consolidated financial statements of Graphic Packaging Holding Company and constituted 11%, and 34% of total and net assets, respectively, as of December 31, 2016, and 6%, and 0% of net sales and net income, respectively, for the year then ended. Our audit of internal control over financial reporting of Graphic Packaging Holding Company also did not include an evaluation of the internal control over financial reporting of G-Box, S.A de C.V., Walter G. Anderson, Inc., Metro Packaging & Imaging Inc., and Colorpak Limited.
In our opinion, Graphic Packaging Holding Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2016 of Graphic Packaging Holding Company and our report dated February 8, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Atlanta, Georgia
February 8, 2017
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s management has established disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within time periods specified in the Securities and Exchange Commission rules and forms. Such disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management to allow timely decisions regarding required disclosure.
Based on management’s evaluation as of the end of the period covered by this Annual Report on Form 10-K, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) were effective as of the end of the period covered by this Annual Report on Form 10-K.
Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company, as such term is defined in Exchange Act Rule 13a-15(f). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only with proper authorizations; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management, under the supervision of and with the participation of the President and Chief Executive Officer and the Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 based on criteria for effective control over financial reporting described in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this assessment, the Company’s management concluded that its internal control over financial reporting was effective as of December 31, 2016.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2016 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which appears herein.
Changes in Internal Control Over Financial Reporting
None.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Pursuant to Instruction G(3) to Form 10-K, the information relating to Directors of the Registrant, compliance with Section 16(a) of the Exchange Act, compliance with the Company’s Code of Ethics, and certain other information required by Item 10 is incorporated by reference to the Registrant’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders, which is to be filed pursuant to Regulation 14A within 120 days after the end of the Registrant’s fiscal year ended December 31, 2016.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Pursuant to Instruction G(3) to Form 10-K, the information required by Item 11 is incorporated by reference to the Registrant’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders, which is to be filed pursuant to Regulation 14A within 120 days after the end of the Registrant’s fiscal year ended December 31, 2016.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Pursuant to Instruction G(3) to Form 10-K, the information required by Item 12 is incorporated by reference to the Registrant’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders, which is to be filed pursuant to Regulation 14A within 120 days after the end of the Registrant’s fiscal year ended December 31, 2016.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Pursuant to Instruction G(3) to Form 10-K, the information required by Item 13 is incorporated by reference to the Registrant’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders, which is to be filed pursuant to Regulation 14A within 120 days after the end of the Registrant’s fiscal year ended December 31, 2016.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Pursuant to Instruction G(3) to Form 10-K, the information required by Item 14 is incorporated by reference to the Registrant’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders, which is to be filed pursuant to Regulation 14A within 120 days after the end of the Registrant’s fiscal year ended December 31, 2016.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
a. Financial statements, financial statement schedule and exhibits filed as part of this report:
1.
Consolidated Statements of Operations for each of the three years in the period ended December 31, 2016
Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2016
Consolidated Balance Sheets as of December 31, 2016 and 2015
Consolidated Statements of Shareholders’ Equity for each of the three years in the period ended December 31, 2016
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2016
Notes to Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm
2.
All schedules are omitted as the information required is either included elsewhere in the consolidated financial statements herein or is not applicable.
3.
Exhibits to Annual Report on Form 10-K for Year Ended December 31, 2016.
____________
* Executive compensation plan or agreement
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
GRAPHIC PACKAGING HOLDING COMPANY
(Registrant)
/s/ Stephen R. Scherger
Stephen R. Scherger
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
February 8, 2017
Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Michael P. Doss
Michael P. Doss
President and Chief Executive Officer
(Principal Executive Officer)
February 8, 2017
/s/ Stephen R. Scherger
Stephen R. Scherger
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
February 8, 2017
/s/ Deborah R. Frank
Deborah R. Frank
Vice President and Chief Accounting Officer
(Principal Accounting Officer)
February 8, 2017
POWER OF ATTORNEY
Each of the directors of the Registrant whose signature appears below hereby appoints Stephen R. Scherger and Lauren S. Tashma, and each of them severally, as his or her attorney-in-fact to sign in his or her name and behalf, in any and all capacities stated below, and to file with the Securities and Exchange Commission any and all amendments to this report on Form 10-K, making such changes in this report on Form 10-K as appropriate, and generally to do all such things on their behalf in their capacities as directors and/or officers to enable the Registrant to comply with the provisions of the Securities Exchange Act of 1934, and all requirements of the Securities and Exchange Commission.