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Berry Global Group Inc
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Good morning. My name is Angela, and I will be your conference operator today. At this time, I would like to welcome everyone to the Berry Global Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you.
I would now like to turn the conference over to Dustin Stillwell, Investor Relations. Please go ahead.
Thank you and good morning, everyone. Welcome to Berry's first fiscal quarter 2018 earnings call. Throughout this call, we will refer to the first fiscal quarter as the December 2017 quarter. Before we begin our call, I would like to note that on our website, we have provided a slide presentation to help guide our discussion today. After today's call, a replay will also be available on our website at berryglobal.com under our Investor Relations section.
Joining me from the company, I have Berry's Chief Executive Officer, Tom Salmon; and Chief Financial Officer, Mark Miles. Following Tom and Mark's comments today, we will have a question-and-answer session. In order to allow everyone the opportunity to participate, we do ask that you limit yourself to one question at a time with a related follow-up, and then fall back into the queue for any additional questions.
As referenced on slide 2, during this call, we will be discussing some non-GAAP financial measures. The most directly comparable GAAP financial measures and a reconciliation of the differences between the GAAP and non-GAAP financial measures are available in our earnings release and investor presentation on our website.
And finally, I remind you that certain statements made today may be forward-looking statements. These statements are made based upon management's expectations and beliefs concerning future events impacting the company, and therefore involve a number of uncertainties and risks, including but not limited to those described in our earnings release, our Annual Report on Form 10-K and other filings with the SEC. Therefore, the actual results of operations or financial condition of the company could differ materially from those expressed or implied in our forward-looking statements.
And now, I'd like to turn the call over to Berry's CEO, Tom Salmon.
Thank you, Dustin, and good morning, everyone. This morning, we'll be discussing several topics, including an update on the Clopay acquisition, our first fiscal Q1 results, highlights from our three operating segments, the impact of the recent U.S. tax reform and our expectations for the remainder of fiscal 2018. Afterwards, we'll be happy to answer any questions you may have.
I want to start the call off this morning by welcoming our nearly 1,500 new employees from the recently closed Clopay acquisition. Combination of Clopay with Berry's Health, Hygiene, and Specialties division strengthens our position within the attractive health and hygiene markets and broadens our presence as a global supplier to many of the leading consumer and industrial product manufacturers which we already supply. We continue to be excited about the new capabilities in the production of technical and innovative patent-protected breathable hygiene films. I'll come back towards the end of the call to discuss details of the acquisition.
Now turning to Berry's overall financial results for the December 2017 quarter on slide 3. I'm proud to report that we had another quarter of improved financial results. Milestones were achieved for both revenue and operating EBITDA for any December ended quarter of $1.776 billion and $310 million respectively. Our net income in the quarter increased to $163 million and our adjusted net income at $0.67 per diluted share was an increase of 34% from fiscal Q1 2017. Cash flow from operations improved by $10 million or 7% from the prior-year quarter. Our last four quarters' cash flow from operations was $985 million and our adjusted free cash flow for the same period totaled over $600 million, representing an 8% adjusted free cash flow yield.
Looking at our highlights by segments. We had another solid quarter in our Engineered Materials division with operating EBITDA improving 70%, compared to the prior-year quarter including the integrated results from our acquisitions and synergy realization. We remain positive about the fundamentals of our Engineered Materials segment as reflected by another outstanding quarter.
Our recent investments in value-added multilayer films is supporting our growth in e-commerce and packaging. In addition, we're collaborating with global food and beverage companies with product solutions that enhance load containment, ultimately reducing the breakage, damage and loss incurred in the transportation of goods.
Within our Health, Hygiene, and Specialties division, strong growth in our specialty products offset weakness in hygiene. Health and specialty wipe products continue to be a leading category for Berry. We are partnering with our customers to create innovative products to clean and protect against bacteria and virus in many environments.
Our innovative, Spinlace technology, which supports these wiping products uses a highly efficient process with flexible material inputs, combined with hydroentanglement, utilizing our proprietary (00:05:25) technology. This process is capable of imparting customizable three dimensional images into the fabric for both functional and aesthetic attributes.
We continue to be excited about the overall Asia market, where we believe we'll be experiencing growing demand in developing countries in high value added markets such as healthcare and hygiene, where expected per capita consumption increases should result in organic market growth. Our non-woven assets continue to operate at high utilization rates and as we've stated, to support this projected growth in Asia, we're in the process of installing our state-of-the-art non-woven line in China and the project remains on track.
In our Consumer Packaging division, volumes were relatively flat in the quarter. Overall volumes in the quarter outpaced the most recent Nielsen survey scanner data for food and non-food categories, primarily driven by solid organic volume growth from our household, personal care and food service products.
We're partnering with certain customers within our core food service product portfolio to address unmet needs and have made significant investment introducing a new proprietary technologically advanced solution to the market, at a lower cost, with improved functionality and sustainability. We expect these offerings to benefit the company starting in the back half of fiscal 2018 and into early 2019. And I look forward to providing more details in subsequent calls.
Before I turn it over to Mark, I would like to take a moment to discuss a few topics. First, as many of you know U.S. corporate tax legislation passed during the quarter. We're pleased to confirm that Berry will be a clear beneficiary of new tax reform. I'll remind you that approximately 80% of our revenues are in the United States. We estimate that the new legislation will provide a $50 million annual benefit to the company on an adjusted free cash flow basis. We feel the new legislation not only will provide additional capital to the company to create incremental shareholder value, but will also generate positive economic stimulus for our customers and consumers alike.
Secondly, as you know, our primary raw material is plastic resin and we began our fiscal year with modest market price increases primarily in polypropylene. I'll remind you that about 75% of our of our resin pounds purchased have mechanical pass-through of plastic resin cost changes to our customers. These arrangements result in a modest short-term earnings headwind due to the timing lag when resin price increases and a tailwind when resin price falls. Further, I would like to emphasize our historical performance through various resin cycles.
Over the past two years, resin prices have fluctuated over an average of 30% and during that same time period, our LTM operating EBITDA margin have been in a steady range of 18% to 19%. These historic reference point demonstrate our ability to pass-through resin cost changes to our customers mitigating the impact on Berry's earnings. As we've always done, we will take the necessary actions to fully recover the resin cost increases in addition to recovering cost inflation in our other raw materials and transportation costs. Mark will further detail these impacts in his financial review.
Additionally, I want to remind our Berry investors, consistency and dependability as a cash flow generator irrespective of resin cost volatility, consumer demand or macroeconomic conditions, has been a cornerstone for our company.
We are seeing similar current pressures. I'm pleased to announce we have increased our guidance for adjusted free cash flow by $20 million to $630 million. We remain committed to being a low cost manufacturer with high quality products and service to our customers that are used every day in consumer-centric product categories such as diapers, personal care, health care, food and beverage. We believe plastics will continue to grow as it has for the past several decades with its clear cost and performance advantages. To support this expected growth, our suppliers are committing billions of dollars in capacity additions with the benefit of low cost raw materials in United States.
Now I'll turn the call over to Mark, who will review Berry's financial results in more detail. Then I'll come back and summarize our strategy and open the call for questions. Mark?
Thank you, Tom, and good morning, everyone. I would like to refer everyone to slide 4 now. As Tom previously mentioned, Berry posted record net sales for any first fiscal quarter of $1.776 billion which was up $274 million or 18% over the prior-year quarter, primarily attributed to the incremental sales from the AEP acquisition that closed in January of 2017.
From an earnings perspective, we also achieved a December quarterly operating EBITDA record of $310 million, an increase of $33 million over the prior year. Acquisition and organic sales volumes increased our operating EBITDA by $40 million, and lower SG&A expenses contributed an additional $11 million. These positive contributions were partially offset by an $18 million under recovery of higher cost of goods sold primarily in our Health, Hygiene, and Specialties segment.
Specifically during the quarter, each of the three business segments were affected by the hurricanes in the Gulf, impacting consumer demand in addition to increasing our costs and negatively impacting our manufacturing productivity. Additional unplanned production outages from our resin suppliers due to cold weather and equipment issues, as well as transportation challenges, further constrained the supply chain, resulting in resin price increases in each of the three months for polypropylene and two out of the three months for polyethylene in the December quarter. These resin price increases resulted in a modest resin lag headwind for us in the December 2017 quarter. And we expect another modest headwind in the March quarter.
Looking at the results of our operating segments starting on slide 5, net sales for our Engineered Materials division for the quarter was $648 million, compared to $333 million in the prior-year quarter. The increase of $265 million was primarily attributed to the AEP acquisition, along with an increase in selling prices, due to the pass through of higher raw material costs. Operating EBITDA in our Engineered Materials division was $119 million, representing an increase of $49 million or 70% over the prior-year quarter. Acquisition volume in the quarter contributed $45 million along with a $4 million improvement in price cost.
Turning to slide 6. Our Health, Hygiene, and Specialties division generated net sales of $577 million in the quarter, which was modestly higher than the December 2016 quarter. The division recorded $96 million of operating EBITDA in the quarter, compared to $110 million in the prior-year quarter. The decrease in operating EBITDA was primarily a result of higher raw material costs, increasing our cost of goods sold, partially offset by lower SG&A expenses of $4 million.
The primary raw material of this division is polypropylene. And with the recent cost increases noted earlier, we experienced an unfavorable timing lag in passing through these raw material costs, and expect this to continue in our March 2018 quarter. Additionally, as we have discussed on prior earnings calls, the combination of factors, including inflation, currency, and weak consumer demand, has continued to put pressure on our South American business. We expect these factors to sequentially improve as we anniversary the South America headwinds in the March quarter and as we continue to work with our customers to shorten the timing lag of passing through resin price changes. Despite these short-term pressures, we remain confident in the growth dynamics of the South American region in our entire Health, Hygiene, and Specialties segment.
Next, as noted on slide 7, net sales in our Consumer Packaging division were $551 million in the quarter, which was modestly higher than the December 2016 quarter. The modest improvement was attributed to an increase in selling prices due to the pass-through of higher raw material costs. Operating EBITDA was down 2% for the quarter at $95 million. Lower SG&A expenses contributed $5 million, offset by a $5 million increase in our cost in excess of selling prices.
A portion of our year-over-year cost increases included expenses incurred in the December quarter as we made substantial progress on the start-up of new business we have discussed on our prior conference calls. We anticipate these start-up costs as well as the unfavorable timing lag related to the pass-through of polypropylene cost increases will continue into the second fiscal quarter of 2018 and expect our results in Consumer Packaging will improve in the back half of the year.
Slide 8 provides a summary of our income statement for our fiscal first quarter. Overall, operating income increased by $17 million or 12% over the prior-year quarter. This increase was due to the items previously discussed that drove the $33 million operating EBITDA improvement, partially offset by higher depreciation and amortization expense from recent acquisitions along with higher restructuring costs associated with cost reductions.
Interest expense was $62 million compared to the prior year expense of $68 million. This $6 million decrease is primarily a result of interest rate reductions we have achieved from proactive actions to lower our interest costs from completed refinancings. We have continued our efforts to refinance our debt to reduce interest expense when opportunities are available to lower our interest costs and strengthen our balance sheet.
We are pleased with our progress and have increased our interest coverage ratio, calculated as adjusted EBITDA divided by annual interest expense to 5.3 times from 2.4 times at IPO. Additionally, we have continued to strengthen our balance sheet over the same time period by reducing our leverage ratio of net debt divided by adjusted EBITDA from 5.2 times to 3.8 times.
As Tom highlighted in his opening remarks, U.S. corporate tax legislation was passed during the quarter, and we are pleased to confirm that Berry will be a clear beneficiary with approximately 80% of our revenues in the United States. For the December quarter, income taxes was a benefit of $71 million. This included $139 million of benefit from adjusting our deferred tax balance sheet items due to the recent reform, partially offset by recognizing an expense of $44 million related to the one-time foreign earnings repatriation tax. We estimate that the new tax legislation will provide a $50 million annual benefit to the company on an adjusted free cash flow basis, and accretive to earnings by approximately $0.35 per diluted share. These tax changes also provide us greater flexibility to utilize global cash to invest in the most optimal locations.
From an income statement perspective, we are reducing our estimated effective tax rate from 32% to 25%, excluding the one-time income tax reform adjustments. To further explain the significance of this reform to our company, this tax savings is equivalent to the addition of $350 million of annual revenue at our average margin without the need for any additional investment.
In wrapping up the income statement, our net income for the quarter increased to $163 million, compared to $51 million in the prior-year period. Diluted earnings per share increased from $0.40 per share to $1.20 per share in the December 2017 quarter. Adjusted diluted earnings per share increased to $0.67 in the current quarter, a 34% improvement from the December 2016 quarter of $0.50.
Next, on slide 9, the company generated $153 million of cash flow from operations in the quarter, up $10 million or 7% from the prior-year quarter, primarily attributed to our improved operating results. As a reminder, our weakest seasonal quarter for operating EBITDA, as well as cash flow from operations is our first fiscal quarter.
Net capital expenditures in the quarter were $91 million, as we incurred spending on cost reduction initiatives, as well as the growth projects Tom referenced earlier. Our adjusted free cash flow defined as cash from operations less capital expenditures and payments made under the tax receivable agreement for the last four quarters was $606 million, which represents an adjusted free cash flow yield of 8% using our December 30 market capitalization.
Our updated financial guidance including underlying assumptions for fiscal year 2018 is shown on slide 10. Taking into consideration the new tax legislation, along with our recently closed acquisition of Clopay, we are increasing our fiscal 2018 adjusted free cash flow to $630 million. The $630 million includes just over $1 billion of cash flow from operations, partially offset by capital expenditures of $340 million and has been reduced by the $37 million tax receivable agreement payment that was made in the first quarter.
Our fiscal year 2018 cash taxes estimate including the $37 million as well as federal, state and international taxes is now $160 million. Cash interest is still estimated to be $250 million, which assumes debt pay down throughout the fiscal year and we are also assuming working capital usage of $40 million in fiscal 2018 related to the raw material price increases referenced earlier, as well as other cash costs to be $50 million related to acquisition integration costs and cost to achieve synergies from recent acquisitions.
Looking ahead toward the March 2018 quarter, we expect that we will have an earnings headwind due to the timing of passing through resin, other raw material and freight increases, primarily driven from the end of the year hurricanes and resin production outages. We are taking steps now to increase productivity and reduce our costs. Additionally, as we have successfully demonstrated in the past, we have implemented price increases to fully offset these inflationary pressures as well as work with our customers to shorten the lag of contractual pass through arrangements on resin. As Tom highlighted, while resin prices have fluctuated over the past couple of years, we have demonstrated our ability to maintain operating EBITDA margins in a range of 18% to 19%.
This concludes my financial review, and now I will turn it back to Tom.
Thank you, Mark. On slide 12, I'm pleased to announce that yesterday on February 6, we closed the recently announced acquisition of Clopay Plastic Products Company, Inc. a subsidiary of Griffon Corporation. Clopay is a leader in the global supply of printed breathable films as well as in innovative development (00:22:04) of elastic films and laminates, with product offerings uniquely designed for applications used in a number of markets including hygiene, healthcare, construction, and industrial protective apparel.
As a reminder, the purchase price for this business was $475 million and Clopay's fiscal 2017 results delivered $461 million in sales and $53 million in operating EBITDA. Together, we'll be able to optimize complementary production capacity, share technical resources, reduce material and converting costs and better serve and innovate with our domestic and international customers from an expanded footprint.
We estimate we will achieve annual cost synergies of approximately $20 million, which should be realized over the next two years. The purchase price including our expected cost synergies along with the tax base, the step-up value represents an adjusted EBITDA multiple of approximately 6 times.
With respect to further acquisition opportunities, our pipeline continues to be very robust with global opportunities in each of our three operating segments. The overall global packaging space remains fragmented with Berry, at $8 billion in pro forma annual revenue, is one of the largest in the world. With our leading portfolio of products touching consumer and industrial market, we feel there is and will be ample opportunity to continue to find accretive acquisitions while applying our proven, conservative and disciplined approach.
The key component of this strategy is being very diligent and methodical in evaluating opportunity and determining which acquisitions are the best fit for our company. Our successful track record and strategy to uncover and acquire businesses with light materials along with our ability to successfully integrate these businesses in a timely manner and efficiently realize maximum synergies, is a core competency of Berry.
We work to identify the best people and best practices of each acquired business and apply those resources and practices to the entire enterprise. Accordingly, Berry represents the integrated processes, people and physical assets of the 44 acquisitions completed to date. In terms of valuation, if you looked historically at our past 15 acquisitions, we've averaged a 5.2 times post synergy multiple with cost synergies averaging 5% of revenue of the acquired business. This historical disciplined track record is the foundation of what has led Berry to where we are today; providing consistent 10-year compound annual growth rates of over 20% on revenue, EBITDA and shareholder return, and why we believe we have a bright future ahead.
Now, across the company, and as we look forward, our teams continue to be focused on integrating recent acquisitions, optimizing our cost structure and fully passing through the recent cost inflation along with managing the investments and growth initiatives in each of our divisions. We have strategically diversified our product portfolio over the last several years into higher growth markets and regions increasing our stability and resistance to recessionary markets.
Going forward, we will continue to focus on locating and identifying both organic growth and accretive acquisition opportunities within the highly fragmented markets in which we operate while continuing to target investments in select markets with advanced innovative solutions to provide high quality products and services to our customers.
As mentioned, we increased our 2018 adjusted free cash flow to $630 million. Again, this includes an increase of $50 million related to tax reform, as well as the inclusion of our Clopay acquisition, partially offset by a working capital use of $40 million, due to higher resin costs. We're extremely proud of our history and predictability, as we've exceeded our free cash flow targets every single year, as a publicly traded company.
Finally, Berry will continue to take the steps necessary to remain a leader in the markets where we participate through a relentless focus on building and strengthening our competitive advantages, to ultimately maximize shareholder value. I'm confident that the people at Berry will continue to drive positive results and achieve our goals and mission of always advancing to protect what's important.
I thank you for your continued interest in Berry. And at this time, Mark and I'll be glad to answer any of your questions. Operator?
Your first question comes from Chris Manuel with Wells Fargo.
Good morning, gentlemen. Wanted to kind of center in for a moment, if I could, on the HHS business. If we look back, and I kind of look back in the model and your results for the last – it's been four quarters in a row that you've been negative with price cost to the tune of – and volumes to the tune of $15 million to $20 million. And this largely offsets a lot of what you got in synergies. Can you kind of give us a sense – I know you mentioned that you'll catch up on escalators – but can you give us a sense two-fold – one, what the volume outlook is going forward? Does it flip to positive? And then two, are the pass-throughs really kind of a (00:27:39) in that business that it takes this long to catch up or how should we expect this? Thank you.
Hey, Chris, good morning. It's Mark. The South America lag, we referenced that for the last several quarters, and as you mentioned, that portion of it will be anniversaried in the March quarter. So we do expect that to again not continue, as we move forward. The remaining portion – because they cycle through resin a little quicker than the other businesses, we just have less inventory. Their lag tends to be a little more prevalent, I guess, when resin prices increase and resin prices drop. That portion we're working. Again, we're working with customers to shorten that timing lag on the pass-through. But we do expect some component of that to continue in the March quarter, with the recent polypropylene increases.
Chris, if you go back in history, you'll also note that in some of our other businesses, we had similar longer lags that we addressed and worked collectively with our end customers to reduce. We're confident that we can do the same inside of the HHS business. And frankly, if you look at the business performance for HHS, a key driver was really around the hygiene space. There was a tremendous amount of reduced promotional activity in the December quarter, when also some destocking that took place. And we believe as we migrate towards the back half, you'll see an increase around the promotional activity, and the inventory levels will be low, where end customers begin to replenish those.
So just to be clear then, this flips beginning kind of March quarter going forward, to be at least a $15-ish million positive, or is it just that the – that your short goes away, how should I think of that?
The negative would go away, Chris.
Okay. Thank you.
Your next question comes from Arun Viswanathan with RBC Capital Markets.
Hi, good morning. Just wondering if you could characterize the performance in Engineered Materials. You're a little below on sales. Is that mainly because of the lags in the pass through? And then how is AEP doing up to your expectations? Thanks.
AEP continues to meet our expectations and the Engineered Materials business continues to be a business that delivers for our company and our franchise. The primary driver for the weaker volumes, we did make some decisions relative to volume and price in the quarter to maximize earnings. And you know, I think it was a solid decision as your saw our opportunity EBITDA increasing 70% compared to the prior-year quarter. But this is a diversified business, a business that ultimately is taking full advantage of the robustness of its portfolio around protective solutions, load management, to give us better entry points into the e-commerce channels and space and we're very bullish about that right now. So AEP has been a tremendous acquisition. The integration of the people, of the processes, our businesses, we're very pleased with. And again, it's just made an already strong franchise that much stronger.
Great. Thanks. And just as a quick follow-up, can you give us some update on the deal pipeline? I know you just got finished with Clopay here, but are you still looking at other opportunities? And how much do you expect to deploy over the next couple of years in acquisitions? Thanks.
Yes. The pipeline of opportunities from an M&A perspective, it's very robust. It's robust on a global basis. And I think, clearly what you can expect, we'll continue to deploy a very conservative regimented approach on how we look at deals, but needless to say, we feel it's a core competency of our company and we will continue to take advantage of the fragmentation inside the space to find deals that ultimately maximize shareholder value.
Great. Thanks.
Your next question comes from Brian Maguire with Goldman Sachs.
Hi. Good morning, guys.
Hi, Brian.
Mark, I was hoping you could just spend a minute to try and bridge the free cash flow guidance from the prior $610 million to the new $630 million, and I think Tom gave a bunch much of the components of the plus $50 million on taxes, the minus $40 million on working capital, the minus $20 million on CapEx. But I was hoping to get a sense of what Clopay might contribute to it. And I guess I wasn't coming up with much contribution given I think it did $50 million of EBITDA for a full year, you're only owning it for about two-thirds of the year. It sounds like some of the CapEx and restructuring coming up are going to offset some of the contribution there. But I was hoping you could just take a minute to kind of bridge from the prior guidance to what you're now laying out and kind of get to the bottom of it all. I was trying to get a sense of has the base business assumptions changed much from where we were three months ago?
Yeah. Sure. Good morning, Brian. Thanks for the question. I guess I would think of it as, we got a benefit of $50 million from the tax reform. We've utilized part of that to offset the resin inflation headwind on working capital of $40 million, obviously, to the extent that comes down that would be an opportunity for us and that's not something we would expect going forward certainly. Flat is typically our assumption but just due to the inflation we've experienced, we have a $40 million offset there. So, the $50 million tax benefit that is recurring.
And then with respect to the remaining $10 million increase, that's basically the contribution of Clopay for the fiscal year. And it's very typical that in the first year due to the cost associated with getting the acquisition completed, as well as synergy-related costs that the accretion on free cash flow is relatively modest in the first year. And the capital increase is also associated to Clopay and getting projects that they've started, getting it completed under our ownership period.
Okay, thanks. And then one just specific to the 2Q outlook. Mark, just wondered if you could kind of size the expected raw lag impact relative to the $18 million number in 1Q? And just so I understand if we're thinking about it on a quarter-over-quarter basis assuming it's lower than the $18 million number, it would be sequentially a good guide, right, because you're going to have maybe the $18 million from 1Q go away and you're going to have an incremental negative, but net-net thinking about it sequentially, how should we think about that?
Yeah. I think the approach you're taking is reasonable. The lag we had in the first – well, first of all, I'd step back and tell you that our first quarter is our weakest seasonal quarter and that just happens to be followed by the second quarter is typically our second weakest seasonal quarter, so our EBITDA will certainly we would expect to increase sequentially.
With respect to the year-over-year comparison, which is I think the right way to look at it and the way you're looking at it, in the December quarter, we really had three large components to that lag. One was just timing of pass through; two was the hurricane-related cost that we had; and then three was South America, the situation there that we talked about again for several quarters. Two of those three go away in the year-over-year comparison. So, yeah, just one of those remains, which is again the timing lag, just related to primarily polypropylene-related increases, so in HH&S, as well as our Consumer business, which consume over 90% of our polypropylene. So, yeah, two of those three components I would expect to not continue in the year-over-year comparison.
Okay. I'll turn it over. Thanks.
Your next question comes from Ghansham Panjabi with Baird.
Good morning, guys. This is Ghansham. How are you?
Hi, Ghansham.
Hey, just going back to HH&S, just to clarify, is the competitive pressure you're seeing in South America incrementally worse than you've seen previously? And is the $17 million under recovery in that segment purely from South America or other regions also?
So two things. I think South America continues to bounce along the bottom. I don't think the pressure's any more significant than it has been. Clearly, we saw just a softening of demand across multiple end-user comps out there. And as a result, they've reduced the promotional activity.
I think the "under recovery" it's really a timing lag on both contractual and non-contract businesses where we're going out and fully offsetting that raw material inflation. So we wanted to give a historical perspective because this isn't the first time we've been through this. We've demonstrated the ability to offset this inflation and we expect to do it in this circumstance as well. You know, as you heard from Mark, the polypropylene pressure primarily resided in HH&S with a portion in CP as well.
And I would say, the second part of your question, Ghansham, good morning.
Good morning.
It's not isolated – the polypropylene related increases were not isolated to South America. So that timing lag we had was certainly relevant in the other regions as well.
Okay. That's helpful. And just, Tom, maybe just give us some more color on the initiatives to capitalizing growth in e-commerce. How far along are customers in redesigning product packaging, some of which you referenced? And which of the operating segments do you think will benefit from growth going forward there? Thanks so much.
I appreciate. Yeah, I'll start with Engineered Materials. You know we have had an increased focus on films, both around protective packaging and load management. As you think about the growing trends and the increase in the amount of shipments being made to resins, our ability to ultimately protect packages is that much more important. So that investment is benefiting us in our core shrink and stretch product line, but also e-commerce has become, I think, not only perfect opportunity for our flexible business and Engineered Materials, but also on the rigid space.
First, we benefit from Amazon, as we market various products through them today, but more importantly, we're working very closely and collaboratively with specialty equipment manufacturers on proprietary technology, provide unique solutions for their film that actually makes the shipping process that much more efficient. You may have read in some periodicals, the FedExs of the world, the UPSs, United States Postal Services, they're changing how they ultimately calculate cost of a shipment based on the dimensional weight. So, the more efficient and customized you make a package, the lower cost it will ultimately be. And it's ultimately going to drive people away from over packaging, large bulk containers to specialized packaging substrates, which we are, as I said, working very closely with specialty equipment manufacturers to be a supplier of those films to be specially converted.
I think similarly as well, inside our Consumer Packaging business, there's an opportunity for both, I think a rigid substrate as well as a flexible substrate, around e-commerce, and we're real bullish in terms of working with our end customers, make certain that their packages are properly packaged and housed, to take advantage of the potential dinging it might go through in transportation to the end customer. So, very favorable and for both of those spaces right now.
Thanks so much.
Your next question comes from Adam Josephson with KeyBanc Capital Markets.
Tom and Mark, good morning.
Morning.
Morning, Adam.
Just a couple about resin, Tom or Mark, specifically regarding your working capital expectation. Polypropylene prices are now expected to fall quite a bit in February, while polyethylene is expected to go up, up to $0.04 or so in February. Is either one of those contemplated in that working capital guidance, or if not, what exactly is contemplated in that working capital assumption?
Yeah, no, again, good morning, Adam. Yeah, I would say, look, with respect to resin, both materials are up significantly starting off the year. The math for us, what we've communicated in the past is still a fair way to think about it, which is if all materials go up a $0.01 it's roughly a $7 million impact. So both polypropylene and polyethylene to the extent, they don't, you basically have to take it in half.
The math would tell you that so far with the increases that we've incurred through the year that would indicate a slightly larger headwind than $40 million. So to the extent that doesn't happen, that it doesn't subside a little bit, we'll have to take actions and we're prepared to do that to ensure that we hit our guidance for fiscal 2018 just as we have in the past.
So even if the polypropylene goes down $0.07 times, $40 million is still a reasonable expectation?
I think that's fair.
Okay. And just one other on resin, and you've talked in the past about your resin buying scale really helping you combat resin price fluctuations and distinguishing you from your competitors in terms of your ability to do so. Given the extent to which you've talked about these resin fluctuations affecting you at least short-term, can you just remind us where your scale plays into all this in your ability to offset these fluctuations?
Well, I'd go back to just the consistency that we've delivered over the last 10 years. Our scale's allowed us to generate significant growth rates on revenue, EBITDA, shareholder return for our 50-year history, but we're not going to talk specifics in terms of what we believe the exact competitive advantage is, but clearly scale's important. We're fortunate to be residing in, with 80% of our business in North America. Our resin suppliers have invested billions of dollars to ultimately provide low cost materials to North America, which we'll take full advantage of and providing what we think is a premier substrate to meet the needs of a demanding marketplace.
So, it's important to us. Scale does matter, clearly in terms of the opportunities it provides to satisfy more customers. So, we're pleased about the prospects going forward. And we think frankly we're located in a low-cost region of the world right now reside in (00:43:17) North America as we do.
Thanks, Tom. And just one on South America, some of the rigid packaging companies are talking about steadily improving demand in Brazil. It sounds like you're not really seeing that. Can you just help us with what exactly you are seeing if anything in terms of improving demand in South America?
Yeah, I think as we've characterized in the past, we believe we're bouncing around the bottom right now and each quarter you see different ebbs and flows. I don't think by any means there is anyone in a position to declare a victory that it's fully recovered. But clearly our belief is with a robust global economy, that's advantageous to all parties in terms of promoting general consumption. And the dynamics which – South America for us is primarily an HHS business, the rise of the middle-class, rising wages for that region ultimately will increase the usage of personal hygiene products and diapers in a region that is less indexed, for example, than the United States. So fewer people are using those products, so the opportunity to grow is exponentially better.
Thanks so much, Tom.
Your next question comes from Scott Gaffner with Barclays.
Thanks. Good morning guys.
Good morning.
Good morning, Scott.
Tom, if I – obviously we're sitting here on the outside. You gave your guidance for the full year I think on the last earnings call. You don't give quarterly guidance. So, I guess my question is really you know – and we already knew about the hurricanes, how much of these headwinds were really known to you headed into the quarter and how much of it was more surprising given especially the hurricanes in the Gulf?
Yeah I think frankly the industry would articulate that the negative ramifications of the hurricane far outpace what people's expectations were. And the pace for a lot of the resin companies to get reactors back up, running as they have at their name capacity rates was slower than expected. Coupled on top of the hurricane, the impact of cold weather outages exacerbated the problem.
Okay. And when we look at it a lot of this, you mentioned was timing issues especially, the issues in South America. When you look at sort of your expectations for EBITDA, I mean obviously gave us the free cash flow, but have your expectations for full year EBITDA changed significantly excluding Clopay?
Hey Scott, its Mark. Good morning. Excluding Clopay, they have not, and so the change would just be with respect to including the contribution from Clopay for our period of ownership for the eight months of the year.
Okay. All right. I appreciate it.
Your next question comes from Debbie Jones with Deutsche Bank.
Hi. Good morning.
Good morning.
I think you've been pretty consistent in flagging some of the challenges in Brazil, but I'm just curious if we look at other substrates they seem to have benefited from the economic improvement that you've seen cans, glass, even paper and the paper-based packaging grades. What is it about the industry in Brazil for your exposure that kind of delays that response to the improvement in the economy?
Yeah. I would look at the "improvement in Brazil" over a longer-term time horizon. I wouldn't look at it over a quarter or two. We're a leading player inside that economy right now. Again, as we consider our end use base, there was softness across the end use base, where they significantly reduced their promotional activity. The promotional activity is a key component to sell through. And along with that they reduced their stocks of available inventory. We continue to be really bullish on the space around health and hygiene in general, but South America has been a drag. There's no doubt about it. But we do believe we're at the bottom, bouncing around the bottom right now. And I think as you heard from Mark, clearly, as we ultimately lap some prior year headwinds, after the March 2018 quarter, I think you'll see some improvement.
Okay. Thanks. And then you called out some weather impacts, I think you said in Q4 and expectation for Q1. Are you able to quantify those?
Debbie, good morning, it's Mark. Just I guess depending on how you define weather, certainly the hurricane was a component and we expect those costs to decrease to a very insignificant number in the March quarter. The other component of weather I think was more around just again as Tom just referenced the resin suppliers and the challenges they had with their equipment, and just the impact that had on resin prices in general. We were fortunately able to do the most important thing which is continue to keep our customers and supply through all those difficulties, including, again, the hurricanes and the outages on the resin side. But it certainly did have a modest impact on the pricing environment.
Okay. So you're referencing like a production impact?
Correct.
Correct.
Thank you.
Your next question comes from Edlain Rodriguez with UBS.
Thank you. Good morning.
Good morning.
Quick question on Engineered Materials. I mean, in the past, you've talked about walking away from some low margin volume. I mean, this appears to still be ongoing. I mean, the question is like how much of that type of low margin business is still left in that portfolio?
I think most of that will be behind us after the March quarter and we'll be working on a year-over-year positive comp. So, you've got basically through the March, at the end of the March quarter you'll see that lead through.
Okay. And last one maybe I missed it, I mean can you talk about like your volume expectation for the three segments going forward?
We've budgeted in for our full year 2018 guidance, basically flat volume across the business right now, in aggregate for the three businesses in total.
Okay. Thank you.
Your next question comes from George Staphos with Bank of America.
Hi, everyone. Good morning. Thanks for the details. I wanted to just confirm what I thought I heard. So, Tom and Mark, are you out with non-resin based price increases? Are you out with non-contractual price increases resin or otherwise? And if so, is there a way to size either magnitude in terms of percentage of your business or percentage of increase? And then I had a bigger picture follow on.
We are offsetting inflation resin, non-resin, freight on both contractual and non-contractual accounts presently. And our expectation is to fully offset that inflation that we've incurred.
Recognizing it may be a bit of a sensitive subject, can you discuss what average or range of price increases you're out with in the market where it's non-contractual?
I would not discuss it, no.
Okay. I understand. But I figured it was worth a shot. One question larger picture, one of your peers recently I think last week put out a discussion to the investment community about what it sees as some of the attributes, positive attributes and misperceptions for that matter around plastic packaging. I think today there was an announcement from one of the larger food service companies that they're moving to a multi-wall paper cup for coffee. You've mentioned that you're a leader and clearly are in terms of revenue and profitability. What are you doing to change the view in the market about plastics, if you believe there's something of a negative perception about it right now? And what do you think some of the fair points that have been raised on plastics are that the industry and that you will work to correct? Thanks, guys. Good luck in the quarter.
Great question, George. I want to remind the audience on the phone, we've also talked about, this isn't in terms of recyclability, in terms of being environmentally conscious. This isn't just a short-time project. Berry has made significant investments around those areas over the years. We noted in our call script, new business in our Consumer Packaging business represent over $50 million of annual revenue that we expect to start ship in the last half of 2018, tied to our food service space, with product that improves functionality as well as sustainability. That's real time.
But relative to your question in terms of plastic packaging, I applaud it. We, inside this industry, have to take a bolder stance in terms of how we promote and think about this business that provides for us. It has an economic impact of a $0.5 trillion in United States. The third largest manufacturing industry in the United States, plastics provides lower CO2, consumes half the energy of known alternatives. That's a quarter of a weight of alternatives and it provides probably the easiest substrate to recycle. It's a function of the availability of those streams. So George, to your question, we are a leader. We're active in these conversations. And I think frankly for all of us inside the industry, it is time that we actually talk about the positive attributes on how plastics packaging and plastics in general is making people's lives better every single day, whether it's in healthcare, medicine, food storage, spoilage protection, it is the ultimate and optimal substrate for our world today. And clearly, every industry has its opportunities to improve, but I'm proud of the industry that provides for the close to 25,000 employees inside of Berry.
All right. I had some follow-ons, but I'll turn it over. Thanks, Tom.
Your next question comes from Anthony Pettinari with Citi.
Good morning. I just had a couple of follow-on questions on HH&S. You've announced some non-woven capacity projects in North America and Asia. In terms of CapEx, is it possible to say how much spending on new non-woven capacity is baked into the 2018 CapEx guidance? And then, just separately, there's a leading diaper producer that's announced a pretty major global restructuring program after some share loss. Is it possible to say whether that's potentially positive for you? Is it an opportunity? Is it something that's negatively impacted you? Any thoughts there?
I'll answer them in reverse order. Relative to any communications by end users in our space, wouldn't comment on the pros and cons. We still believe our hygiene and healthcare business with HH&S and specialties business are attractive spaces. Mark will walk you through the details in terms of CapEx by space, but I would remind, yes, we have and we're proceeding with new capacity additions in China and that's totals CapEx of around $70 million and the project remains on track.
We have additional investments that we've made of approximately $50 million in Spinlace technology in North America. This will support applications for us like gowns, drapes, disinfecting wipes with microbial control chemistry. So this is a great opportunity, it supports to a large extent consumer industrial wipes in a space that we're strong today. And we've also made an investment in our specialty space specifically around room air, purification, filtration for Asia of around $10 million that'll be operational in mid-2019.
Yeah. Anthony, it's Mark. Good morning, and the capital portion of that question, the specific numbers, our plan for 2018 is, as we stated $340 million. Roughly $100 million of that is committed towards our non-woven assets and we remain on track for that for fiscal 2018.
Okay. That's very helpful. And then, Tom, you mentioned your expectation that Consumer results should improve in kind of second half of the year. Is it possible to quantify or maybe put a finer point in terms of maybe the volumes you expect to get as project investments ramp up or the costs that might roll off as some of these investments are completed? Just any kind of color you could give would be helpful.
First and foremost, we still have ways to go. Our CP business has done, I think, a very, very good job in terms of focusing on advantaged products in targeted markets. So we're being very judicious with our use of capital and where we spend our time and money. It's impacting positively the hit rates on new quotes inside that business. We're taking advantage of using demographics and tying our connectivity with millennials and seniors, to make certain that we've got products that meet the needs of those marketplaces, whether it's transparency, sustainability, soft touch, safer, cleaner, fresher, themes and mentalities.
But if you look over all of the business, it made good sequential improvement in the December quarter from an overall demand. We expect that to continue to ramp and improve in the back half. As you've heard from, Mark, we have kind of a flip-flop with our third fiscal quarter being our strongest and the back half in general, I think pretty well poised to see an improvement in the demand outlook for CP. I would note that overall for both the food and the non-food category, from a Nielsen scanner perspective, is about minus 1.3%. And when you incorporate, we were minus 1% and you assume 1% for lightweighting, basically flat, inside the space. So I think the team has done a really nice job. I think it's also important to remind everyone that, our food business is a great business. We've done a very good job, I think, to become a little more focused there, in that space, but the products that we've produced are reliable. They're everybody products and it provides very strong and dependable cash flows for the company.
Okay. That's helpful. I'll turn it over.
The next question comes from Mark Wilde with BMO Capital Markets.
Morning, Tom. Good morning, Mark.
Good morning, Mark.
I wondered, either of you, if you can just touch on the topic of kind of capital return to shareholders, whether it's through buybacks or dividends and maybe you can help us think about sort of how you think about those two alternatives?
Certainly, happy to. Listen, we meet with our board on a quarterly basis. We review different levers that we can pull relative to capital allocation. We're very fortunate to have a company with the kind of free cash performance that we have. We always focus on those things that we believe is going to generate the greater shareholder value. And clearly we continue to believe that not only now, but through our history there's been more shareholder value created for our shareholders at Berry based on our ability and proven track record and disciplined approach on identifying and acquiring acquisitions, but more importantly successfully integrating them and generating the synergies that we commit to than any other possible allocation strategy we could deploy. We continue to believe that at the current market conditions, the optimal net debt-to-adjusted EBITDA is 3 point something, but feel very good about where we're at. We believe the M&A environment has been mostly accretive for our shareholders and we'll continue to discuss those options with the board based on M&A environment. And what we think, as I said, is going to create more shareholder value every quarter with our board.
Okay. And then if I could just as a follow on. Mark, what are you expecting just in terms of overall inflation this year? And it seems like we've talked a lot about resin, but trucking prices going up, things like that?
Yeah, sure. Thanks, Mark. Yeah, look, I would say in general there certainly has been some inflation. Resin is tough to predict. Obviously, it's been volatile here starting off the year. I'd like to say I had a crystal ball to predict resin. But the good news is it doesn't matter for Berry. Again, through various cycles, our performance is very consistent, but you know hard to predict.
I think the point, Mark, always is going to be as we see inflation, both contractually and non-contractually with customers, we're going to offset that inflation through price and productivity enhancements.
All right. Very good. Thanks.
And your last question comes from Chip Dillon with Vertical Research.
Hi, guys. This is Salvator Tiano filling in for Chip. How are you?
Doing well. Yourself?
Good. Great. Thanks for taking my question. So the first part on interest rates and interest expense. Can you tell us a little bit what's your thinking? What's included in your guidance with regard to interest rates for interest expense? And how much of your debt is fixed versus floating for 2018?
Sure. Yes, Mark, good morning. Yeah, I don't have the exact number in front of me but it's over three quarters of our debt is fixed and the remaining portion, we do have a modest increase in LIBOR rates assumed in our guidance.
Okay, perfect. And the second is with regard to debt refinancing, we see the spike in interest rates and I know starting 2020, you should have substantial debt maturing. So how are you thinking and planning ahead for the I guess debt that's maturing from 2020 I guess until 2022, 2023?
Sure, yeah. We're continuing to look at our capital structure and optimizing debt maturities, as well as interest costs and we'll continue to assess that on a regular basis. We think we're well positioned now, but we'll certainly continue to assess that.
Okay, perfect. Thank you very much.
And you do have a follow-up question from George.
George? George, are you there?
And it looks like there are no further questions.
Thank you, operator. Appreciate everyone's interest in Berry Global. We look forward to our next earnings call. Take care.
That concludes today's conference call. You may now disconnect.