Sealed Air Corp (SEE) — Q3 2022 Earnings Call Transcript

Thank you, and good morning, everyone. With me today are Ted Doheny, our CEO; Chris Stephens, our CFO; Sergio Pupkin, our Chief Growth and Strategy Officer; and Susan Yang, our Automation Finance Leader and Treasurer. Before we begin our call, I would like to note that we have provided a slide presentation to help guide our discussion. Please visit our website, where today's webcast and presentation can be downloaded from our IR website at sealedair.com. Statements made during this call, stating management's outlook or predictions for future periods are forward-looking statements. These statements are based solely on information that is now available to us. We encourage you to review the information in the section entitled Forward-Looking Statements in our earnings release and slide presentation, which applies to this call. Additionally, our future performance may differ due to a number of factors. Many of these factors are listed in our most recent annual report on Form 10-K and as revised and updated on our quarterly reports on Form 10-Q and current reports on Form 8-K, which you can also find on our website or on the SEC's website. We discuss financial measures that do not conform to U.S. GAAP. You will find important information on our use of these measures and their reconciliation to U.S. GAAP in our earnings release. In the appendix of today's presentation, you will find U.S. GAAP financial results that correspond to the non-U.S. GAAP measures we reference throughout the presentation. Before we start the call, I would like to highlight our press release on our exciting new acquisition of Liquibox, along with a separate press release for our Q3 earnings. For today's call, we'll include a summary of the Liquibox transaction and will have an extended call. I will now turn the call over to Ted. Operator, please turn to Slide 3. Ted?

Thank you, Brian, and thank you for joining our third quarter 2022 earnings call. Starting on Slide 3. The graphic is showing where we are taking packaging with automation, digital, and sustainable solutions. We start with our purpose. We are in business to protect, to solve critical packaging challenges and to make our world better than we find it. This enables our vision to become a world-class digitally driven company, automating sustainable packaging solutions. Our purpose and vision lay solid foundations to drive value creation for our people, customers, and shareholders. Moving to Slide 4. Today, we announced that we have entered into a definitive agreement to acquire Liquibox, a global leader in sustainable packaging for the fluids and liquids industry and the pioneer innovator of bag-in-box solutions. We're truly excited about this transaction. This highly strategic acquisition resonates deeply in the core of our transformation journey to provide market-driven solutions. Fluids and liquids have been the fastest-growing and most profitable area for CRYOVAC, growing more than 30% year-to-date. We are going to combine Liquibox development, innovation, converting capabilities, fitments, and dispensers' technology and strengthen it with CRYOVAC's broad portfolio of performance films, global operations, and barrier bag technology to partner with customers and create savings through innovative world-class solutions. During our call today, Chris and I will discuss the details of the transaction. Afterwards, we'll discuss our Q3 results and our updated 2022 outlook and initial thoughts for 2023. On Slide 5, we illustrate Liquibox business, its pioneering bag-in-box technology and broad solutions portfolio. Liquibox is a leader in the fast-growing fluids and liquid space, partnering with a diverse customer base by providing a full range of integrated solutions and systems. Its track record of innovation and sustainability has supported strong revenue and earnings growth while solidifying long-term loyal customers. Liquibox brings us valuable new capabilities with its expertise in fitments and dispensers' portfolio that are highly complementary to SEE Automation and CRYOVAC fluids and liquids business. On Slide 6, we outlined how this highly strategic acquisition fits into our vision of becoming a world-class digitally-driven company, automating sustainable packaging solutions. This combination brings together two leading innovators in sustainable packaging, disrupting rigid containers for the global fluids and liquids industry. Liquibox's expected 2022 full-year revenue is $362 million and adjusted EBITDA of $85 million, representing a margin of 23.5%. Secular trends in the fluids and liquid space like e-commerce and sustainability provide compelling new growth opportunities. Liquibox increases our exposure to attractive end markets like consumer packaging goods, wine and spirits, quick service restaurants, and enables us to create a new platform when combined with CRYOVAC. With the acquisition, SEE advances its commitment to sustainability and circularity, including key growth drivers with disruptive technologies like Liquibox's new innovation branded Liquipure. This is the first recycle-ready bag-in-box format. Liquibox's solutions and technologies are well aligned with SEE's net positive circular ecosystem strategy. Moving to Slide 7. With complementary operations and technologies, CRYOVAC's food packaging enters a new competitive arena while creating economic value through strong cost and growth synergies. CRYOVAC and Liquibox combined solutions will comprise automated selling equipment, best-in-class bag-in-box, and highly engineered fitments and dispensers. This will enable profitable growth into fast-growing categories, such as food service, fluids, and consumer goods. Liquibox's e-commerce-ready solutions will benefit from SEE's integrated approach to digital in the advancement of prismiq digital packaging and printing solutions. By expanding our fluids and liquids capabilities, we're broadening the scope of CRYOVAC solutions and making it more resilient to grow in a recessionary environment. Quick service restaurant customers will benefit from reduced waste and productivity benefits through CRYOVAC and Liquibox's automation and high-performance barrier bag solutions. When adding Liquibox's blue-chip customer base to CRYOVAC's global footprint, we will unlock geographic and cross-selling synergies to address a potential $7 billion in revenue opportunities. Now Chris will walk through the attractive financial case.

Great. Thanks, Ted. Turning to Slide 8. We outlined the transaction details. The purchase price for Liquibox is $1.15 billion on a cash-free, debt-free basis, representing an estimated enterprise value over 2022 adjusted EBITDA multiple of 13.5x at a multiple of 10x after including only cost synergies. We plan to execute cost synergies of at least $30 million on an annual run rate basis to be fully realized within three years, driven by our CRYOVAC footprint, joint resin purchases, and SEE operational excellence. At closing, we anticipate pro forma net leverage to be about 3.5x and expect to utilize our strong cash flow generation to quickly delever post-closing within 12 to 18 months. Subject to the receipt of applicable regulatory approvals, reviews, and other customary closing conditions, we expect closing to occur in the first quarter of 2023. We do not anticipate any changes to our corporate family ratings. While we acknowledge a challenging economic environment, we believe the opportunity presented to seize this transaction is unique and worth pursuing given the prospects of value creation outlined. Moving to Slide 9. Similar to our automated packaging systems transaction where we've reduced our purchase multiple by 6x the adjusted EBITDA in three years, we plan to reduce the purchase multiple of the Liquibox acquisition by at least 5x over a similar period. The significant growth synergies are likely going to bring this multiple down even further over time. This transaction checks all internal financial hurdles that we use to evaluate any investment. We expect the transaction to be immediately accretive to SEE earnings per share on an operational basis, excluding impacts of purchase accounting. The Liquibox acquisition brings a strong strategic business into the CRYOVAC portfolio. When combined with SEE, it creates significant top and bottom line synergies, helping raise SEE's valuation. We expect the acquisition to create a potential of over $1 billion in net incremental enterprise value by 2027. We are deploying our proprietary M&A playbook, developed and enhanced through several transactions in recent years, including the successful APS acquisition and integration. We are planning a seamless integration process, welcoming the Liquibox team while driving the SEE operating engine to create significant economic value for our shareholders. Ted?

Thanks, Chris. Now turning to Slide 10. Our SEE operating model highlights our sales, earnings, and cash profile for what we have done and where we are going. The model shows our specific financial targets built on our internal principle, you get what you measure. Subject to receipt of regulatory approvals in the first quarter of 2023, Liquibox will be contributing over 4% sales growth next year at greater than 30% operating leverage. Chris will provide more color regarding 2023 later in the call. Let's turn to Slide 11, which highlights how we are moving to be a market-driven company, fueled by our iconic brands. Our solutions create value for our customers, focusing on automation, digital, and sustainability, which will deliver growth faster than the markets we serve. We would like to highlight a change this quarter that we are leading with digital. Digital online sales are embedded in our three regions and will help streamline order processing, improving costs and creating growth by reaching new markets and customers. Our online sales now represent almost 5% for the quarter. Digital sales more than doubled compared to Q2 and we're making this happen by bringing online some of our largest customers and distributors. Despite numerous headwinds, we continue to perform and serve our customers across our diversified portfolio. We experienced very strong growth again in fluids and liquids this quarter. In fulfillment and industrial markets, we experienced reductions in wine as destocking efforts continued all along the value chain. Our diversified geographic footprint and portfolio allow us to adapt to changes in market conditions. At a global level, we have demonstrated our ability to grow through varying cycles. In food, we expect our business to be resilient to market conditions. Our largest market, fresh red meat, which makes up 22% of our sales, is expected to be stable. The softening of the cattle cycle in North America is expected to be balanced with the improvements of the cattle cycle in Australia and the continued drive of automation globally. As we enter the fourth quarter, normalization of supply chain shortages will represent an opportunity to regain share in our roll stock case-ready business and drive automation growth further. Our strategy is to create growth regardless of the headwinds by innovating with new products and expanding into new end markets and geographies as demonstrated with Liquibox through strategic M&A. I would like to highlight that with Liquibox, the pro forma impact between the two segments of Food and Protective would move to 60% food, with fluids and liquids becoming roughly 10% of the portfolio. Now let's turn to Slide 12 to discuss Q3 results. We delivered strong earnings in the quarter, exceeding our SEE operating model despite the impact of recessionary pressures on top line and a challenging global operating environment. Our SEE Operating Engine continues to perform. In the quarter, on a constant currency basis, net sales were up 5% and adjusted EBITDA was up 12%. Adjusted earnings per share of $0.98 was up 14% compared to a year ago and up 19% on constant currency. Free cash flow through Q1 was a source of cash of $137 million. We continue to invest in our people and our business as we accelerate our journey to world-class.

Great. Let's start on Slide 13 to review our third quarter net sales of $1.4 billion by segment and by region. In constant dollars, net sales increased by 5%, with 9% growth in Food, while Protective saw a decline of 2%. All regions showed growth: EMEA increased by 7%; APAC by 5%; and the Americas by 4%. On Slide 14, I want to emphasize a significant improvement in profitability with Q3 adjusted EBITDA of $293 million, which is $22 million or 8% higher than last year, achieving margins of 20.9%, up 170 basis points. This performance was fueled by positive net price realization, which we define as year-over-year price realization minus inflation on direct materials, non-materials, and labor costs, along with productivity gains that outweighed the effects of lower volumes and foreign exchange impacts during the quarter. We achieved productivity gains of $6 million in Q3 and expect around $30 million for the full year, down from earlier expectations of approximately $45 million due to supply disruptions, labor challenges, and lower volumes. Regarding adjusted net earnings in Q3, our adjusted tax rate was 25.6%, up from 24.9% in the same quarter last year. During this quarter, we actively repurchased approximately 114,000 shares at a cost of about $30 million. Our weighted average diluted shares outstanding in Q3 '22 were 146.6 million, compared to 151.4 million in Q3 '21. At the end of the quarter, we had $616 million remaining in our authorized share repurchase program. Turning to segment results on Slide 15, starting with Food. In Q3, Food net sales of $830 million increased by 9% on an organic basis, reflecting 13% price realization that helped counter inflation across all cost areas, despite volume declines of 4%. Volume decreased by 5% in the Americas and 2% in EMEA, which was partially offset by 3% volume growth in APAC, driven by strong demand for our automated solutions and market share gains in that region. In the Americas and EMEA, the volume decline largely stemmed from customers trying to dual-source our case-ready roll stock products due to supply constraints we faced in late 2021 and early 2022. We estimate this impact accounts for roughly a 3% sales decline compared to the previous year. Excluding this 3%, our Food business performed slightly better than the low single-digit overall decline in the Food retail market. Our team worked diligently to navigate the shortages, secure additional supply, and reformulate products as needed to satisfy customer demands. Thanks to our teams' efforts, we are progressing through the sales cycle and currently have the products and inventory needed to revive this business. Food automation sales, which include equipment, systems, parts, and services, make up about 7% of segment sales and increased by mid-single digits. Food adjusted EBITDA reached $185 million in Q3, marking a 14% rise in constant dollars compared to last year, with margins at 22.3%, up 110 basis points. Protective net sales of $571 million remained flat organically, as positive price realization was countered by a 12% decline in volume during the quarter. Market contractions and a negative economic outlook have and will continue to exert pressure on fulfillment in industrial end markets. Regarding Protective automation sales in the quarter, which represent about 9% of segment sales, they rose by mid-single digits driven by Auto Box placements. Despite the end-market weakness during the quarter, Protective adjusted EBITDA rose to $109 million, a 12% increase in constant dollars in Q3, with margins at 19.2%, up 230 basis points.

Now let's turn to free cash flow on Slide 16. September year-to-date free cash flow was $137 million, compared to $223 million in the same period a year ago. The $86 million decline was mainly driven by higher use of cash for inventory as compared to 2021, given raw material cost inflation and stock builds to mitigate potential future supply disruptions. We are expecting inventory levels to normalize over time as we win by gaining share and growing our business globally. On Slide 17, we outline our purpose-driven capital allocation strategy, focused on maximizing value for our shareholders. We maintain a strong balance sheet while driving attractive returns on invested capital and supporting portfolio growth initiatives. We have highlighted fluids and liquids on the slide in the past as an attractive opportunity. We are now actioning with the Liquibox transaction. Let's turn to Slide 18 to review our updated 2022 outlook and our initial thoughts for 2023. We now expect our 2022 net sales to be $5.65 billion to $5.75 billion, down from $5.85 billion to $6.05 billion previously. At the midpoint, this assumes a 3% growth on a reported basis and an organic growth of 8%, driven by 13% growth from positive price realization, partially offset by 5% volume declines. Full-year adjusted EBITDA is now expected to be $1.21 billion to $1.23 billion, down from $1.22 billion to $1.25 million, and assumes adjusted EBITDA margin of approximately 21%, in line with prior estimates despite the top line pressures. Full-year adjusted EPS of $4.10 at the midpoint assumes depreciation and amortization of approximately $245 million and adjusted effective tax rate of approximately 25.5%, net interest expense of approximately $165 million, and 147 million shares outstanding. And lastly, we now expect full-year free cash flow in the range of $460 million to $500 million, down from $510 million to $550 million. This represents a cash conversion range between 77% and 82%. As we look ahead to 2023, with the anticipated addition of the Liquibox transaction, we expect to be in line with our SEE Operating Model despite headwinds we faced in several of the end markets we serve. So to summarize, we had a solid quarter from a profitability perspective, working through the challenges and opportunities in our control. This is a testament to the SEE team as we are focused on executing our growth strategy, driving productivity, and generating world-class cash performance and executing our SEE Operating Model as we go. With that, let me pass the call back to Ted for some closing remarks. Thanks, Chris. And let's move to Slide 19. Before we open up the call to questions, I would like to highlight that our 2021 Global Impact Report was published last week and can be found on sealedair.com. I'm very excited about the report because we've expanded the breadth and quality of our disclosures by referencing global standards and frameworks and illustrated this with powerful examples of how our people are leading the way in sustainability. These are exciting times for SEE. The Liquibox acquisition is highly complementary to the SEE Operating Model. Together, we're determined to drive value for our people, customers, shareholders, and society. As is customary, we plan to provide our full 2023 financial outlook during our Q4 call in February next year. With that, I'll open up the call for questions. Operator, we'd like to begin the Q&A session.

My question is about the long-term outlook and how Liquibox fits in. Liquibox has been established for several years, featuring a box with a flexible bag inside and various fitments. At first glance, this may not appear to be the most sustainable packaging option. Can you explain how this aligns with the sustainability narrative? Additionally, could you discuss Liquipure and its role in driving growth? On a related note, I've noticed that the automation expectations in your presentation seem to have been lowered this year. What are the reasons behind this, and how does it impact the long-term outlook for automation?

Thanks, George. I will address your question in three parts. First, let's discuss Liquibox and its connection to sustainability. Looking at Slide 6, we see our CRYOVAC brand, where we lead in tomato paste and condiments, particularly in the rapidly growing QR segment. Liquibox specializes in bag-in-box solutions, notably for QSRs, using bags for syrups, among other products. The sustainability advantage of a bag-in-box system lies in its lighter weight and significantly reduced CO2 footprint compared to rigid containers. In terms of business, we produce about 1.5 billion bags and less than 10 million fitments for our fluids. In contrast, Liquibox produces hundreds of millions of bags and over 1 billion fitments, which are crucial for dispensing from the box. Their Liquipure product addresses sustainability by eliminating metal from the packaging, which is problematic for recyclability, similar to our high-recycled content bags with CRYOVAC. Now, combining this with the question about equipment, our Fluids business is our fastest-growing area. The equipment we have fills pouches, leading to millions produced through our form, fill, and seal process. Liquibox also uses similar equipment, but their filling technology is a much smaller portion of their operations. This presents a significant growth opportunity for us. Looking at Slide 30 in the appendix, we remain enthusiastic about automation, which we believe is our highest growth area. Labor shortages are driving customer demand for this technology. Despite ongoing supply disruptions, particularly in electronics, our backlog remains strong, and we projected it to reach $0.5 billion this year, currently at about 4.75%. Our excitement for automation is especially pronounced in the fresh red meat market, where it is growing rapidly. A quote from one of our major converted customers emphasizes this: "We're moving the business to you because of where you're taking the business and what this will mean for us." Automation is crucial for packaging now, and we are very optimistic about the investments we are making to accelerate growth in both this area and the liquid space. Next question.

Congrats on the transaction. I guess, first off, on the 23% plus or so EBITDA margins for Liquibox based on the numbers you shared with us, how has that progressed over time, especially during periods of incremental economic weakness? I know it's a relatively small asset. And then just given that it increases the proportionate EBITDA percentage for Food to over 60%, is the acquisition part of an initiative to sort of lower portfolio cyclicality? Or is it just more opportunistic just like APS was?

If we move to Slide 9, this is exactly why we're excited about Liquibox and its relevance to your question. When examining its role in our model, we are acquiring a business that currently represents 5% of our portfolio, up from 3% last year. It has been experiencing strong growth and is significantly more profitable than the rest of our portfolio, being the most profitable segment of our CRYOVAC line. Consequently, we are integrating a business that generates a 23% operating profit with $362 million into our pro forma, making it account for 10% of SEE. Regarding your second question about the growth profile, last year it was over double digits, with historical growth averaging around 7%. As for the markets it serves, it includes large segments such as quick service restaurants. We see the bag in the box as a strong productivity and environmental solution, making it appealing even in recessionary conditions, similar to our liquid business during COVID. While we felt the impact of QSRs shutting down, we have experienced a rebound with the return of high customer traffic in these establishments. Liquibox is well-positioned to enhance productivity in beverage services. We view this acquisition as a solid growth opportunity in challenging economic times and anticipate even higher growth in the future. Looking ahead to 2027, we expect this segment to exceed $1 billion in our portfolio, which is a target we are quite eager about.

Congratulations to everyone. You mentioned some points about 2023 in the SEE Operating Model, which suggests a 10% EPS growth. It might appear ambitious given the current recession and a softer exit run rate alongside easier comparisons from this year. What gives you the confidence to achieve those figures, particularly the 10% EPS and the increments? What steps are you taking to instill that confidence in the participants on the call? Additionally, this positions you at either #1 or #2 in bag-in-box technology, which is already a significant asset, yet you didn't execute on it earlier this year. Why does this acquisition align better now? What advantages does it provide compared to the previous one?

Thank you, Larry. Chris, I'll address your second question as well. Referring to Slide 18, we've outlined our operating model, which I appreciate you asking about. As I mentioned earlier, measurement is key. Our model indicates our plans and allows us to compare our actual performance in sales and earnings, and how we convert that into cash. For 2023, our aim is to outperform the markets we are involved in. The model suggests we should exceed the GDP growth of 1% to 3% in a stable environment. Next year, as you've pointed out, there are challenges regarding GDP and global markets, so we anticipate a possible decline to between minus 2% and 1%. This is already incorporated into our model. Additionally, we are aware of our 4% acquisition with Liquibox, which will positively impact our performance. We believe that with our upcoming innovations and sustainability solutions, we can still achieve growth of 1% to 2% next year. We also expect to gain market share, particularly in the Food business, where shortages of specialty resin led to lost opportunities, as Chris mentioned. We now have the necessary materials to recapture that business. The Food segment is showing resilience through these cycles, and we are exploring growth avenues beyond the acquisition, particularly with our automation initiatives. In terms of earnings, we have maintained over 30% leverage in our operating engine for nearly five years, which supports our price realization. However, we do expect to encounter pressures in the industrial and fulfillment markets in the third and fourth quarters, as well as potentially in the first half of 2023. When these conditions improve, we will be a more efficient company with enhanced products. Overall, we believe we can achieve the targets set in our model for 2023. Did I cover the second part of your question?

Yes, pretty much. I would just add maybe to Ted's comments, just to kind of talk about the value creation. Within this portfolio, we identified the cost synergies kind of within our control, very specific to what we've been able to do, building off the APS success, as we mentioned in our prepared remarks, as well as in the Q&A. But the opportunity for us to just grow on a global scale given the CRYOVAC footprint and capability and the opportunities for the end market where as we see it move to bag-in-box is tremendous, and that's where we're really excited. So on Slide 9, we lay out that financial profile.

Yes. So regarding the model, I apologize for the condensed version on Slide 18, but it was presented earlier, and you can see it there. We're running the business according to what's in the model. As we mentioned, the markets we are targeting should remain stable, with a diverse market range of 1% to 3%. However, in the short term, we anticipate market pressures, specifically towards the end of 2022 and into 2023, which could shift that range to negative 2% to plus 1%. In terms of M&A activity, our model indicates a 2% to 4% contribution, and we haven't made significant acquisitions in the last two years; instead, we’ve had divestitures. You can observe from our model below our performance over the past four years as we project forward. I want to emphasize the innovations in automation, digital aspects, and share gains that will impact our trajectory through 2025. We believe in measuring what matters, and that is what our focus is geared towards. In response to Chris' comment about earnings, we expect margin expansion, and we're demonstrating how we achieve that, with operating leverage exceeding 30%. We spent considerable time discussing our fluids and liquids business, which exceeds the average of 30% and is closer to 40% in terms of leverage. This operating engine influences the entire portfolio, though certain segments are advancing at higher rates. Additionally, margin expansion is also driven by price realization throughout this inflationary period, which has significantly contributed to our margins. Moving forward, we are committed to providing the best products at competitive prices while ensuring sustainability. Lastly, I'd like to highlight the prospects of digital growth and the increasing efficiency in our operating leverage that will lead to margin expansion. Your figures align with the model. Operator, is there one more question?

Just one quick one, I guess, on M&A with Liquibox. Does this take you out of the market for other transactions? Or do you feel like there's still more opportunity out there or assets coming to the market that you guys would be looking at?

Yes. In terms of our capital allocation, we have been closely examining potential opportunities and are quite focused on this area. We take it seriously. Our current leverage ratio is 3.5x, and we aim to reduce that quickly. The model is expected to generate over $2 billion in cash over the next two to three years, as mentioned in the previous question. For the short term, we will prioritize paying down debt to lower our leverage ratio. Regarding additional opportunities, we have explored more than 100 different deals over the past four years, completing 14 of them, including significant divestitures like APS and now Liquibox. We remain cautious and financially prudent, monitoring the market carefully. The cash generated by our business will allow us to pursue other identified opportunities that could enhance our business moving forward. Thank you all for joining the call today. We are enthusiastic about the potential of Liquibox and believe it will significantly foster our growth in the future. Thank you.