Amcor Plc (AMCR) — Q3 2017 Earnings Call Transcript

Thank you. Good morning, everyone. Welcome to our third quarter 2017 conference call. Today is October 26, 2017. After today's call, a replay will be available on our website, bemis.com, under the Investor Relations section. Joining me for this call today are Bemis Company's President and Chief Executive Officer, Bill Austen; our Senior Vice President and Chief Financial Officer, Mike Clauer; and our Vice President and Chief Accounting Officer, Jerry Krempa. Following Bill and Mike's comments on our business and outlook, we will answer any questions you have. However, 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 question. At this time, I'll direct you to our website, bemis.com, under the Investor Relations tab, where you'll find our press release and supplemental schedules. On today's call, we will also discuss non-GAAP financial measures as we talk about our performance. Reconciliations of these non-GAAP measures to GAAP measures that we consider most comparable can be found in the press release and supplemental schedules on our website. And finally, a reminder that statements regarding future performance of the company made during this call are forward-looking and are therefore subject to certain risks and uncertainties. Actual results may differ materially from historical, expected or projected results due to a variety of factors. Please refer to Bemis Company's regular SEC filings, including the most recently filed Form 10-K, to review these factors. Now, I'll turn the call over to Bill.

Thank you, Erin, and good morning everyone. Our earnings this quarter improved sequentially, primarily on account of improving operational performance in our U.S. business and variable cost reductions in Brazil. Mike will review the financials in more detail, but I will start by discussing the progress we are making to align our business and cost structure for long-term success. During September, we announced the final details of our $65 million restructuring and cost savings plan. We are executing this plan to align our fixed manufacturing and administrative cost structures to the current environment and to position our business well for the long-term. Our comprehensive and thorough review of the business led to a decision to close four plants, reduce 500 administrative positions, consolidate office spaces and reduce a variety of other operational and administrative expenses. We have established and staffed an enterprise project management office, which reports to me, to enhance accountability and ensure results are delivered on time. Our restructuring and cost savings plan is front and center, and we're focused on delivering its benefit. In addition to the actions we're taking to align our cost structure, we're also deeply involved in efforts to position our resources for long-term strength and growth. Internally, we call this all-encompassing work, agility. I will turn it over to Mike to cover financials now, and I will come back to share my perspective on how agility is moving Bemis forward.

Thanks, Bill, and good morning. Today I will start by discussing the financial details of the quarter followed by a review of our cost savings plan, and then I will close with outlook. In the U.S. Packaging segment, compared to the prior year, third quarter revenue was up 2.2%, driven by unit volume increases of 2%, primarily in the big middle category. The U.S. Packaging operating profit of $99.6 million this quarter was down from $108 million last year, due in part to the impact of previously negotiated contractual selling price reductions and partially offset by manufacturing efficiencies and the benefits of increased unit volumes. Our U.S. operations remained well during the third quarter with low waste and high throughput, which was particularly beneficial given the nice volume growth that we pushed through our plants this quarter. As compared to the second quarter, increased profits in the third quarter were due to strong operational manufacturing efficiencies during the current quarter, stabilization at one of our facilities in Wisconsin where we had ERP go-live struggles during the second quarter, and lower business incentives related to the customers unable to meet their commitments to new business volume. Turning to Global Packaging, compared to the prior year, third quarter sales were down 2.3%, currency impact was nominal, and volumes were flat, with mix continuing to trend down to less expensive packaging alternatives in Latin America. Regarding unit volumes, our business in Latin America saw a 7% decline in line with our expectations given the economic environment, partially offset by net growth in Asia, Europe, and healthcare. Global packaging operating profit of $24.6 million this quarter compared to last year's $36.2 million. Lower profit was driven by the continued challenging economic environment in Brazil that is putting pressure on unit volumes and mix of products sold. As compared to the second quarter, profits improved in global packaging as expected, due primarily to the variable cost reduction and actions in Brazil in response to the economic environment. Now onto the consolidated Bemis results: operating cash flow was slightly less than my expectations during the third quarter at $99 million. As anticipated, restructuring saw small use of cash during the quarter, about $3 million for the 2017 plan and another $3 million for the 2016 plan as we close out the final plants in Latin America that we had originally over from last year. Primarily, working capital as a percentage of sales is 15.2% at September 30, slightly improved from 15.5% one year ago. During the third quarter, we repurchased $1.2 million shares for a total of $54.9 million. We remain committed to maintaining a strong balance sheet and returning free cash flow to our shareholders. Briefly turning to our restructuring and cost savings plan: during September, we announced final details of our 2017 plan and increased our targeted pretax savings to $65 million when fully implemented. We have a variety of projects underway; we are closing four plants for savings of approximately $17 million. The performance at these facilities will be transferred to other Bemis locations. We are consolidating certain administrative offices in the U.S. and Latin America for savings of approximately $5 million. We are reducing a total of 500 administrative positions for savings of approximately $35 million. From a geographic perspective, approximately three-quarters of these positions are in the U.S., and the remaining are primarily in Latin America. And finally, we are reducing other fixed operational administrative costs for savings of approximately $8 million. Examples include optimizing costs related to travel and external warehouses. Related to the 2017 plan, total pretax costs will be between $100 million and $125 million, of which $70 million to $80 million is cash. As to the cash, approximately $10 million will impact 2017, about $40 million will impact 2018, and a reminder will fall into 2019. Turning to guidance, we are reducing the top end of our adjusted EPS range to $2.35 to $2.40 from a previous $2.35 to $2.50 primarily on account of lower unit volumes in the U.S. and also on account of hurricane impact. As to the U.S. volumes during the fourth quarter, which make up about two-thirds of our guidance change, we have aligned ourselves to our cash flows expectations and their ability to scale up new business. As for the hurricane, which makes up about one-third of our guidance change, the primary impact to our U.S. operations relates to global increases in raw material prices. To be clear, we expect to establish pass-through mechanisms in the U.S. to work as normal. In the third quarter, we limited volatility in earnings. However, in Latin America specifically, we will experience a raw material headwind during the fourth quarter due to the current economic environment, which has made passing increased input costs more challenging. To a lesser degree, regarding the hurricane impact, we anticipate fourth quarter earnings will be slightly hurt by low production levels at our healthcare packaging facility in Puerto Rico due to the aftermath of the storms. While we are able to run production from generators, our downtown facility is in line with our customers' needs in the region, so we anticipate that the fourth quarter production levels at our Puerto Rico facility will be low while our customers adjust to their own local needs. Our outlook does include the initial benefits associated with the restructuring and cost savings, as well as minor benefits from the acquisition of Vadex that we plan to complete during the first quarter. Turning to cash flow guidance, we are maintaining our guidance range of $400 million to $425 million and still anticipate working capital will show improvement for the full year 2017. This outlook includes approximately $30 million of cash expenditures related to the restructuring plans, $20 million of this was for the 2016 plan to close four plants in Latin America, and the remaining $10 million for initial steps taken in the 2017 plan. Turning to CapEx guidance, we anticipate 2017 spending of $185 million to $200 million. We continue to evaluate further spending levels as part of our comprehensive business review. In summary, we made progress during the third quarter; we continue to take actions through restructuring and cost savings plans to align our business to the environment we are operating in to create a lean, nimble business that is well-positioned for long-term. We will continue to use this platform to drive real change in the way our company acts and operates. With that, I will turn the call back to Bill.

Thanks, Mike. Agility involves moving quickly and easily. I would view it as a mindset. During the last couple of months, we've spent time analyzing and urgently pursuing all options for improvement. For the properly considered many perspectives, our financial results are well-profitable and show strong cash flow; however, they are not satisfactory nor do they meet our expectations. Our customers have told us that we are an innovation leader and problem solver. We provide them with value-added products to help them succeed, and they support the steps that we are taking to enhance our quality and service and provide them with more fit-for-purpose solutions. Our employees and leaders recently completed an employee engagement survey. The results show they want to win, they want to be more competitive, they want to serve our customers better, and most significant in my mind, employees overwhelmingly indicated that they are willing to give extra effort to help our company succeed. I applaud our employees for being engaged and taking action. We recognize that our business model requires enhancement and change. We have stated that our approach to agility will strengthen and grow. High level fixes involve near-term profitability improvements and strengthening growth which creates the foundation for continued success of the company. Specifically with regard to fixing our business, our cost savings plan clearly defines a fast-forward in terms of appropriately aligning our cost structure. We are executing on this plan with clear direction and speed. Regarding strengthening our business, our approach involves simplifying and better managing our product portfolio and organizational structure, rebalancing our R&D efforts to focus on manufacturing improvements such as waste reduction, and leveraging the investments we've made in new converting equipment. As for growing our business, we are developing plans to more deliberately pursue pockets of growth in our market, such as small to mid-size customers and consumer and industrial applications. To be clear, we highly value our existing base of large CPG customers, which creates the backbone for our business. These customers provide us with large volumes and will always be part of our mix. However, as consumer preferences shift, the work we are doing to deliberately align portions of our production asset base and our people around small to mid-size customers and non-food applications should allow us to penetrate those pockets of growth. I don't anticipate growth in this area overnight, but the plan we are developing positions Bemis very well for the long term. As I reflect on the last couple of years, we've driven change and made progress. We've reduced over $125 million in working capital and implemented the right processes to hold it. We've established the framework to return free cash flow to shareholders, resulting in over $700 million of value returned through dividends and share repurchases. We've completed and implemented two strategic acquisitions, and we welcome new leaders to our Latin American healthcare and U.S. businesses. We've driven change, and we will continue to drive change in the future. We are taking actions to improve our cost structure and align our business strategically to be successful in a changing environment. The entire management team and I are confident that our efforts and actions will provide improvement. We have great people, great customers, and great products from which to build future success. We are determined and committed to transforming our business and positioning Bemis to provide a sound investment for our shareholders over the long term. With that, I'll turn the call over for questions.

Hi, good morning, guys.

Hi, Brian.

A couple of questions on my favorite topic, Latin America. We were a little surprised by the comments about not being able to pass through some of the resin movements. I thought most of that was contractually driven. I'm just wondering if that's not the case, and maybe it's more market-driven and less contractual than I thought, or is it a case where you're actually just having trouble enforcing the contracts due to the environment down there?

Yes, Brian, that's a good question. To provide some insight into LATAM, our volume decreased by 10%, with Q2 down 7%, which aligned with our expectations and planning. The impact of the hurricane in early October was substantial, especially concerning resin, a key material for our rigid business where we have a significant share of customers. The resin market has been unusual, primarily dominated by one supplier that has implemented a considerable price increase. Although we have contractual agreements to pass on costs, the magnitude of the increase is challenging, particularly in an environment where inflation has decreased significantly. Market demand and consumer interest in products have declined, though it's still better than in Q2. Consequently, there has been considerable resistance from customers in accepting this large rise in raw material costs. Our team on the ground is actively engaging with customers daily to advocate for these price increases, particularly concerning the resin used in our rigid business. The overall situation hasn’t changed much; as inflation has decreased, it complicates our ability to enforce those price adjustments.

It seems that the situation may be different from the usual delayed effects, which typically last for one quarter and may carry into 2018 if the price of this specific resin remains high and customer resistance persists. Are you anticipating that this resin price will decrease by the end of this year or early 2018?

Hi, Brian, this is Mike. Well, about half of our contracts in Latin America are on contractual pass-throughs; the others aren't. What we're attempting to do is not only pass through early on contracts as an exception, but once it recovers we would give back that price. On the rest of the business, we are going after price increases. It's challenging, but remember that we're also trying to get price increases outside of the normal pass-through.

Thanks. Good morning, Bill, good morning Mike.

Good morning.

I just wanted to clarify something you mentioned in your prepared remarks, Mike. I think it was related to U.S. volumes and the contribution margin from that volume in the quarter. The margins are still down, largely due to pricing actions taken earlier this year. When I look at EBITDA margins in U.S. Packaging, it appears they decreased by about 60 basis points year-over-year. Can you explain the year-over-year impact of pricing, and did I understand the volume leverage correctly?

The volume leverage was a comment, Scott, more having to do with manufacturing. As they start operating better and they get the volume in, we just see enhanced profits in the business. But your comment is absolutely correct that we still have some pressures year-over-year from the contractual reduction in selling price.

Okay. When you lowered those prices during your pricing analysis, part of it was to generate some new business as well. And Bill, you mentioned some of that having come through. Are those two related or are they just similar comments that you mentioned today?

Yes, Scott. As Mike mentioned in his remarks, we had 2% volume growth in Q3. Some of that was from the contractual commitments that we received from customers. If you look at the drop in volume in Q4, it's because some of those customers that contractually committed to volume increases are not able to provide that business to us in Q4, so our volume is down in Q4 for that reason. Additionally, the seasonality of a normal Q4 is always lower, where volumes are softer and weaker. It also has to do with us talking and aligning with our customers around what their Q4 volumes are going to look like. That’s all a function of where the holidays fall, what plants they’re going to shut down, what plants they’re going to run. So we don’t receive some of that contractual commitment in Q4 that we had anticipated. Some of it is just customers realigning their production schedules; others have not delivered on some of the contractual commitments of volume that they had promised.

Good morning. Thank you for taking my question. I wanted to revisit the restructuring and the various components of the plans to get a clearer understanding. What is the baseline we are starting from? I understand you're expecting a $65 million improvement in profit. In 2016, you achieved about $600 million in EBITDA. Looking at the trailing three quarters since the restructuring began, from the first or second quarter of '16 through the first quarter, it's also around $600 million. I'm assuming that's the baseline. Could you provide some clarity on where we are starting from, Bill and Mike?

Look, Scott, what we did is we took a hard look at Q1 of '17 and annualized it, which would put us in the zip code you just commented on.

The basis is $550 million. Thank you. The second question is about the softness observed in Brazil, although you mentioned that other regions, such as Europe and Asia, are performing well, and Mexico likely is too. Additionally, you completed an acquisition in Europe. Can you share more about what you’re seeing in those other regions? Is the difficulty primarily isolated to Brazil, while performance in the other areas remains strong? Could you provide some insights into customer adoption and volumes in those regions, even if just anecdotal?

Sure, Chris. This is Bill. Let’s start with the healthcare business. Healthcare is performing well. The issue we’re having in healthcare right now is the Puerto Rico environment. If you're not familiar with our business in Puerto Rico, it’s a three-building site, and one of those buildings, which is a thermoforming facility, was completely destroyed. The other two buildings are fine; the employees came back to work. Fortunately, all of our employees are in good shape. They immediately started showing up. We can run those other two buildings on generators, which we are doing. We are providing November and December volumes to our customers in Puerto Rico that are giving us demand triggers. So healthcare continues to perform well; they have performed well through this downturn. We have moved the thermoforming equipment out of Puerto Rico back to the United States, but we can fulfill orders to customers with that equipment from the U.S., so we're doing well in the healthcare business. As for Bemis Europe, even though the economic environment is challenging, we are seeing growth. There have been raw material increases, particularly in nylon affecting our product base. We are pushing through these nylon increases as quickly as possible in a stable environment, but it is highly competitive in Europe. We're seeing nice growth in the U.K., Spain, and Italy. We’ve made some new wins in high barrier materials as well as high barrier shrink films. If you look at the CapEx that we've put into Europe in the past 12 to 18 months, we’ve installed a new press, and that new press is up and running in one of our facilities in the U.K. with very nice improvement coming out of that asset. If you move on to Asia Pacific, third quarter revenue was up mid-high single digits, good growth in China, Malaysia, and Australia, and we launched new products into the electronics market for new projection films. We talked about Latin America, with Brazil taking the front seat, but other areas like Argentina and Mexico are faring better. Mexico has a stable environment now, and we’re also transitioning the business from commodity type products to more higher value products with one of the seven-layer assets we installed there in the last 12 months. As for Argentina, its economy is recovering, and inflation remains high. The CapEx investments we made a few years ago, about 12 to 18 months ago, are now driving productivity. The economy is opening up, and we made the right moves by putting in newer, more productive assets in that region. We talked about Brazil, which was an earlier consolidation effort, and we now have only three facilities for our rigid business in Brazil. As the economy starts to turn, we will be well-positioned to generate improving profitability in that region. We have taken out fixed costs, and as the economy improves, it will be beneficial for us. So that’s where we are; things are moving ahead and the company is totally focused on this agility project and how we are removing costs in the near term while positioning ourselves for the long-term.

Good morning, Bill. Good morning, Mike.

Good morning, Mark.

Hi, Mark.

I just want to revisit the fourth quarter volume weakness in North America. As I listen to you guys over the last year or so, it sounded like you made that trade-off late last year, early this year, where you gave up some price to pick up incremental volume for some of those customers. We don’t like what we're seeing now of being flat to negative in the fourth quarter. Do you view this as a one-quarter event? Are there still these volume commitments rolling in? Or is some of this business just not going to materialize?

Mark, these contracts are in place. We anticipate receiving this volume, but some customers have not been able to transition out or whatever reason that might exist from some of their existing suppliers. We are receiving some of the volumes but we are not transitioning all of it yet across all the customer base. These contracts are in place and they are going to roll forward.

Can you help us think about what we should expect as we move through next year in terms of the competitiveness? A lot of us had assumed that we would see some momentum in the second half of the year and that the momentum would actually pick up as we move into next year.

Mark, we will be discussing that on the January call as we provide guidance for '18.

Hi, this is actually Brian Maguire speaking in for Anthony. I was thinking over the last five years, Bemis anticipated slow progress on the corporate expense line and that expense line came up once again today. I was just wondering if you have any thoughts on that trajectory with the upcoming model for 2018 and a little more detail would be great as you're restructuring the program?

This is Michael. Agility and the initiatives will not only affect U.S. and global, but they will also impact the corporate allocated line that you are referencing. I would expect to hold the ramp and to see continued decline.

Thanks. That is helpful. And then, in terms of 4Q, with U.S. packaging margins, margins hold up pretty well in the quarter, and then in 4Q you are going to have lower volumes, but you are going to have restructuring savings. Do you have any primary thoughts on how margins could shape up in the fourth quarter for that segment?

As Bill mentioned earlier, Q4 is historically our lowest volume quarter. Kind of year-over-year perspective margins will decline naturally due to that. However, some of the improvements we saw in the quarter related to manufacturing efficiencies will hold. You have to factor in sequentially the volume drop. We will take out cooling labor as we normally do for that quarter, but we still have a significant fixed cost that gets absorbed during that time.

Hi, guys, good morning.

Good morning, Ghansham.

Good morning, Bill. So first off, Bill, on your comments, you also target smaller customers and some of the non-food categories. How are you specifically changing your manufacturing footprints to be able to adapt to this in light of the plant closures that you've observed currently?

Yes, Ghansham. We talked over the last couple of years about the investments we have made in our North American and now the businesses as well, most recently Europe to recapitalize some of the older presses and laminators that we have in the business that didn’t necessarily have the ability for quick change, shorter run, higher speed, and lower waste. What we’ve been putting into the business over the last few years with our asset recapitalization program is now making the deliberate shift in the way and what business we schedule and plan using most of our equipment. So as we move to the smaller and shorter runs of smaller to mid-size customers, their volumes are not necessarily as large as a long run or a campaign on a press or a laminator. Therefore, we need to deliberately move shorter run business from these smaller to mid-size customers to utilize that equipment. We have $0.5 billion of this business today already. We have $500 million of what we would call shorter run, quicker change types of business from smaller customers. It’s not that we don’t do this already; the key here is the deliberate shift in not just how you run the assets, but in how you staff, plan, and crew them to get the mindset to actually run that business. Just think about getting in and getting it off quickly.

Okay. Then as a follow-up, if you step back and think about the supply chain and customer consolidation we've seen over the years in food and consumer products, what do you think about your scale currently relative to that dynamic? Do you see the need for further consolidation and flexibility, and also how do you think about your capabilities at this time to be able to drive some of that consolidation? Thanks so much.

Ghansham, this is Mike. We are evaluating as we do this shift, because it is not only about how we operate but how we approach the market. We have $0.5 billion of business already. We're going to be a lot more deliberate in changing our go-to-market strategy. We might also consider acquiring some capabilities in certain areas.

Thank you. Good morning, guys. Just one follow-up on trying to penetrate the smaller customers. Does the sales force need to be incentivized differently from what’s going on right now, and also, how long do you think this process will take? Are we talking about a one-year, two-year, or longer timeline?

Yes, good question. We have thought about this and have brought on some of these different types of salespeople, and yes, the incentive plans are different than those for national accounts. So yes, that is true. As we look at it, it’s a 12 to 18 month process to bring people in and start to see progress. We’ve already brought people in, and we’ve already seen progress among these smaller to mid-size accounts that we refer to as regional accounts. You may not sell directly through the account but you sell through a third-party co-packer channel. We’re already experiencing good business coming through the co-packer channel, with quite a few SKUs within that channel which will lead to private label opportunities, and that’s where a lot of the small to mid-size accounts reside. It is a different philosophy and approach, and we are already in motion on it.

The question on U.S. packaging to start off: the improvement you saw sequentially, would you say that any of that is related to any stabilization in the center of the aisle or do you think that is still deteriorating?

I don't have any data to support whether it’s stabilizing in the aisle, but we saw volume increases in what we call the big middle part of the portfolio, which some of it would be impacted by technical difficulties.

I'm sorry, so then on the margin side, there was a nice recovery in U.S. packaging as well. I think earlier you said it would take a little bit longer to get back to that 15% level. Do you think margins stabilized back here in the normal levels is what you’re expecting for next year? Similarly, on global, you're below your targets there, so how does that play out in the future? Thanks.

As I said earlier, just as it relates to Q4, sequentially with the volume way down, margins will decline from Q3. But I believe we should continue to see improvements over the prior years adjusted for the pricing decisions made last year. The $65 million cost take out will show continued improvements in our margin profiles in both U.S. packaging and global as we continue into next year.

Hi, thanks for taking the questions. This is actually Kyle White going in for Debbie. I wanted to go back to Latin America; it sounded like things got a little better considering last quarter had a large drop-off at the end. Just want to know if that’s true and are you seeing any type of increase in optimism in terms of the economic environment there as we head into 2018?

Yes, good call out. Q2 volumes were down 10%, Q3 was down 7%, but that was in line with what we had expected, so yes, we did see a slight improvement there. Regarding optimism in Brazil, business leaders believe that the politics and economy are becoming bifurcated; they previously tied together but now see a separation, which is good. They don’t expect a large pickup as they head into 2018, but they see stability. They expect improvements in 2019 as a new president takes office in October 2018. There’s a breath of stability, but I wouldn't say that people are jumping up and down with optimism.

Thank you for that, and then my next question is just on, understanding that you guys probably don't comment on market speculation, but I'm curious about your thoughts on the concept of potentially merging with another large packaging company in terms of the strategic opportunity for Bemis, or do you think that’s more distracting from your cost reduction efforts and the EBITDA statement you can generate from that?

Yes, we wouldn’t speculate on any rumors that might be out there. As we've said and I mentioned in my prepared remarks, agility is front and center for Bemis Company. We are focused across the organization on executing this cost-out plan and driving profitable growth and profitability improvements through this effort.

Mike, good morning.

Hey, Adam.

Mike, just one for you, and then one for Bill. I know you bought stock, and you weren't in Q2; the average share price wasn't much different in Q3 versus Q2, so just wanted to know about the timing of these buybacks?

To be honest, part of Q2 was the fact that we were working through the restructuring program, and I was trying to get a grip on what my potential cash needs were going to be. Once we finalized that situation, it put me in a position to authorize another repurchase plan.

Okay, Bill, regarding one of the savings programs, if we look back at last year, you announced a restructuring program in Latin America which was expected to yield annualized savings of $16 million by 2018. However, due to the downturn in Brazil, seeing those savings this year has been challenging. Additionally, at the start of 2012, the company initiated a significant restructuring program, but it was difficult to realize the savings from that due to pressures on volume, pricing, and rising inflation. How should we evaluate the success or lack thereof of this latest program, especially considering that in the past we've not observed any improvement in EBITDA from these savings initiatives?

Right, let’s look at Latin America. We received and did what we were supposed to do on the synergies; we did what we said we would do with plant closures on time, and as that economy turns and consumption moves back into the marketplace again, and market demand resurges, we will derive increased benefits from Latin America. Let’s talk about what we’re doing in U.S. packaging and across the entire company with our agility focus. The difference is that we’ve actually put an organizational structure around an enterprise-wide project management office that allows us to track work streams across the globe weekly. We measure them, monitor them, and have project management offices in each of the P&Ls dedicated to accountability. We have leaders in charge, teams in place, and we monitor our progress as we move forward. That’s a much different approach than we’ve ever had at Bemis Company before, and we’re trying to implement rigor and intensity to achieve these savings.

I just wanted to come back to the smaller mid-size customers. It seems like you're trying to reconcile a slightly more complex organization in terms of sales force, production, etc. with a downsizing and streamlining of capacity. Can you put some color on how you can combine the two, being somewhat more complex and yet needing to be simpler?

Actually, Laura, that’s a good question. We have a diverse product portfolio that allows us to leverage existing resources without needing to develop new technologies or products. This enables us to offer packaging solutions to small and mid-size customers in a less complicated manner. We already serve several regional accounts and co-packers with SKU portfolios that were originally intended for larger consumer packaged goods customers. This process is not as complex as it may seem; it involves effectively selling what we have and utilizing suitable solutions to meet the needs of small to mid-size customers and address their challenges.

Okay. So if we think about the plugouts, it’s going to be somewhat lower margins there. Can you confirm that? And then second point, how big is your wallet today, and what do you think will be three years from now? How big an exposure would you take on small to mid-size customers?

We have roughly half a billion dollars in this space today, Laura, in North America. The margin profile is higher than what we would see from larger accounts. This is good business, and we are targeting it. We aim to attack this segment, knowing it will take 12 to 18 months to gain traction, but there’s significant work being done. It involves bringing more salespeople on the street to drive that business.

Hi, everyone, good morning. Thanks for taking my questions. Bill, I want to ask a question around the contracts in North America. I know there’s no such thing really as a take-or-pay contract in the packaging business, but you have these contractual commitments, and I’m still not clear what it is that has not allowed them to hold up their end of the bargain. It doesn't sound like it’s just their own volume at retail; it seems like they are struggling to extract themselves from their contracts. If you could provide some color on that, I’d appreciate it. I also had a follow-on.

George.

Hi, Mike. How are you?

Good. When many of these contracts were renewed last year, part of the pricing was linked to the delivery of new goods. These new goods were specifically designed and are not innovative; they are simply with other suppliers. We established timelines with our customers, but in some cases, they underestimated how quickly they could manage the shipments. They aligned the contracts with the expiration dates of other suppliers. I’ll say that while they are not trying to back out of their agreements, the rate at which shipments can occur is slower than anticipated. To put it another way, this year they were expected to provide us one, next year two, and in the third year three, but they are currently struggling to deliver even one. The contract still stands for next year, where they are expected to bring us two.

Okay, fair enough. Now the other question I had was based on my interpretation, which may be incorrect, that the new contracts and pricing resets were all around more high barrier products. If that’s true, I wonder why the volume pickup we saw in the third quarter seemed to be more in the big middle as opposed to some of the higher-end. Has the higher-end volume been coming through as you would have expected, aside from these contractual issues? Thank you.

George, this is Bill. It's a cross-section of products; some high barrier, some big middle. Some of the high barrier has shifted; some of the big middle has shifted over to us. It's a mixed bag across the portfolio.

Hi, good morning.

Hi, Jason.

What is the primary change in the competitive environment over the last couple of quarters that has motivated Bemis to expand into the smaller niche consumer product company segment? Has it been driven by a view that the large consumer product companies are languishing and may not recover, or are you just becoming more opportunistic for growth?

Jason, this is Bill. It’s a combination of both. Some of the larger CPG companies are losing share to smaller to mid-size companies. We’ve done extensive work on this, and if you look at over the last few years, the share that has shifted from large CPGs to the middle to smaller price customers amounts to about $21 billion, which is business we have fit-for-purpose solutions for; we just need to go get it. It’s not necessarily a reflection of the competitive nature of our business. Our business is competitive and will always be. However, there are pockets of growth that exist for solutions we already have in the portfolio, and we need to pursue and capture that.

Okay. And then my second question: have you experienced any initial reactions from your current customer base regarding the restructuring initiatives? Have they expressed any concerns about the production or delivery of their products as you consolidate your footprint?

No, we have not.

Hi, guys. This is Salvator Tiano filling in for Chip. How are you?

Good. How are you?

Great. So I just want to clarify a couple of things on the Brazilian and U.S. contracts. Firstly, in the U.S. you’re offering these price concessions. As you mentioned, customers have trouble shifting volumes in Q4. How should we think about the pricing specifically for them in Q4 going forward? Every time they fail to shift the required volumes, should we expect lower volumes and potentially an uptick in price versus your existing assumptions?

I think the way to look at it is that this is not a general statement about all new goods. Some of the price reductions were tied not to the entire portfolio, but to deliver portions of it, they had to first deliver the new goods.

Yes.

So that's how you think about it. But once you recall that as we come into '18, those contracts remain intact, and once they deliver the new goods, which I fully expect them to do, those same incentives will kick back in and benefit customers, while we also receive the new volumes.

Okay. To clarify the situation in Brazil with the contractual pass-throughs, you mentioned you have the contracts in place, but it’s somewhat hard to enforce the price increases. One main reason you stated was that inflation in Brazil was going down. Considering resin inflation is a very specific item, especially in packaging, and Brazil has high labor inflation, isn’t it reasonable to expect that you should be able to increase your prices regardless of other inflationary items in the country?

The short of it is that our customer base doesn’t see that they can push the price onto the consumer, as inflation has come down. When inflation was higher, it was easier for our customer base to pass that along. We have about 50% of the business under contract in Brazil, and we are pushing these price increases through contracted and non-contracted customers across the line. But it’s getting harder and harder; there’s a fatigue within the customer base regarding inflation, which causes it to be difficult to enforce.

Yes, Bill, I’d like to come back on the potential avenues for growth here in North America. One would be the topic of pouches: how big is your pouch business, and how much growth do you see there? The other would be the grocery market moving to direct-to-consumer marketing. What’s your suite of products or play into that?

Yes, that’s a great question, Mark. We would look at the pouches; they’re split into various areas: dry goods and liquid goods. In liquid, our business is growing quite nicely and that is largely tied to pouches, which are performing well. This segment is positively influenced by the ecommerce channel as it’ll make it easier to ship. In terms of direct-to-consumer for groceries, your pouches do fit nicely into that. Regarding the pouch business overall, I don’t have the specific numbers, but it’s largely incentivized, and it’s positioned well for future growth as consumers seek more sustainable packaging options.

Hi, thanks for my follow-up. I’d like to discuss the new customer opportunities among small mid-size customers that you’ve shared as representing about $0.5 billion in size right now. I forget if I nearly asked a similar question, but I want to dig into this a little more. If you offer a more standardized product portfolio, it sounds like you provide fewer SKUs, selling to co-packers can often make that tougher and not as margin accretive business. Can you help me understand why you believe the margins are higher, especially since you have to optimize some production to accommodate quicker changes and more frequently changing runs on that business?

The small mid-size and larger customers are all part of our regular business. It’s not the case that we don’t do this; it’s just a shift in how we target these shorter runs. We have a distinct margin profile with those smaller customers that is higher than we would see with larger accounts. This is good business, and we will pursue it actively.

Okay. As we think about pricing resets, and volumes are coming in through the current quarter, have we essentially seen the negative effects of pricing reset as we sit here today? Are there potential for pricing to further drop beyond contractual triggers?

We concluded that 2016 was an unusual year. We did proactively protect a lot of business but in return we picked up some new contracts. We will always experience pricing pressures in the market, and have historically offset that with productivity initiatives and acknowledged cost reductions in packaging. I remain hopeful that the risks seen will return to normal as we progress throughout the year.

Thank you. Thank you everyone for joining us today. This concludes the conference call.