Hello, and welcome to the Graphic Packaging Second Quarter 2022 Earnings Call. My name is Katie, and I'll be coordinating your call today. I'll now hand over to your host, Melanie Skijus, Vice President of Investor Relations, to begin. Melanie, please go ahead.

Good morning, and welcome to Graphic Packaging Holding Company's second quarter 2022 earnings call. Joining us on our call today are Mike Doss, the Company's President and CEO; and Steve Scherger, Executive Vice President and CFO. To help you follow along with today's call, we will be referencing our second quarter earnings presentation, which can be accessed through the webcast and also on the Investors section of our website at www.graphicpkg.com. Before I turn the call over to Mike, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, the factors identified in the release and in our filings with the Securities and Exchange Commission. With that, let me turn the call over to Mike.

Thank you, Melanie. Good morning to everyone joining us on the call and this webcast this morning. The second quarter of 2022 was a very strong quarter overall. We demonstrated clear progress on our Vision 2025 goals. During the quarter, we advanced our strategic objectives, building upon our 3-year track record of sustained net organic sales growth and delivered margin expansion. Financial results benefited significantly from a positive price to commodity input cost relationship, strong contributions from recent acquisitions, earnings on our organic growth and positive net productivity. Given strong overall performance and execution, we are upwardly revising our full year 2022 adjusted EBITDA guidance range today. Beginning on Slide 3 of the earnings presentation, we provide key highlights for the second quarter and a few comments related to the full year 2022 guidance. We achieved another quarter of 3% net organic sales growth, matching our year-over-year growth achieved in the first quarter. In addition, in line with our guidance to increase integration rates in 2022, year-to-date integration was up 300 basis points to 74% for the same period in 2021. Adjusted EBITDA moved higher to $396 million, an increase of 60% or $148 million from the prior year period. Adjusted earnings per share, excluding amortization of purchased intangibles, more than doubled from the same quarter last year to $0.60. We operated well in the quarter, servicing our global base customers. We continue to successfully ramp up our new K2 coated recycled board machine in Kalamazoo, Michigan. The startup has gone extremely well and full production capacity is expected by mid-2023. Accordingly, we closed the Battle Creek mill and have successfully sold the paperboard inventory. Returns on our transformational investment in Kalamazoo are on track, and I'm excited about the new opportunities we're seeing in packaging applications that will increasingly…

Thanks, Mike, and good morning. Before diving into quarterly results, let me provide an update on the converting operations we acquired in Russia as part of the AR Packaging acquisition. Production at the converting facility primarily serves multinational foodservice and tobacco customers. The business is relatively small, with roughly $100 million in sales and approximately $10 million in adjusted EBITDA. As we disclosed last quarter, we've been exploring multiple options for the two plants in Russia. The business is now classified as held for sale for accounting purposes. We took a charge of $92 million during the second quarter to write down the plant to an estimated value pending an expected sale. We are targeting year-end 2022 to complete the sale process. Moving to Slide 8, focused on key financial highlights. Net sales increased 36% or $621 million to $2.4 billion. The year-over-year increase in sales was driven by a second consecutive quarter of 3% net organic sales growth, higher pricing flowing through the business and contributions from acquisitions. Adjusted EBITDA margin expanded to 16.8%, reflecting an increase of 250 basis points from the same quarter of last year. The significant step-up in adjusted EBITDA to $396 million in the second quarter resulted from a combination of positive factors. We experienced an acceleration in the positive price/cost relationship as pricing actions taken over the last several quarters were fully realized. Higher volume mix from net organic sales growth materialized, earnings from acquisitions delivered as planned and strong operating performance continue. Adjusted earnings per share, excluding amortization of purchased intangibles, more than doubled from last year to $0.60 a share. As stated last quarter, we are including an adjustment for purchased intangibles in the adjusted EPS calculation, as it appropriately reflects the operating earnings and cash flow capabilities of the company.…

We'll take our first question from Mark Wilde from Bank of Montreal. Please go ahead, Mark.

Thank you. Good morning, Melanie, Mike, Steve. Mike or Steve, I'm just - you're deleveraging faster than expected. And I wondered if you could just help us with the implications of that for capital allocation over the next couple of years in terms of return of capital, acquisitions, maybe more organic investment?

Yes. Thanks for that, Mark. Yes, our focus, as we headed into 2022, and we were pretty clear on that at our Investor Day in February, was to delever the balance sheet and get ourselves in a really good spot back down towards our historical goal of operating between 2.5 and 3x lever. And I'm happy to say that we're on that track. As you know, we generated disproportionate amount of our cash in the second half of this year. This year will be no exception. But as we model that out with the puts and takes we've given in, the materials we provided to you, we see ourselves getting in that 3 to 3.5x range, as Steve outlined in his prepared remarks. Once we get there, that does give us optionality to do a number of things. And I think our track record is quite good at finding good investments back into the business. Some of those are larger. A lot of those are kind of steady-state productivity, automation type projects that continue to help take cost out over time, which is one of our core operating principles as you well know, also gives us the optionality to look at high-return M&A. And then it also funds cash for us to look at ongoing dividends and repurchasing of shares. All of those things we've done historically, if you look back over the last five years in various tranches based on trying to create the greatest amount of value for our shareholders. So what we really want to do this year is get our balance sheet back to that point. And I think that's even underscored by the uncertain macro out there that we're dealing with, with interest rates starting to rise and really sets us up to be opportunistic as we round the turn into 2023 and beyond. So we like that. And I think, Steve, maybe you could just put a little color on kind of our debt stack and what that looks like here, as we finish this year and the next year for Mark, too, that would be helpful.

Yes. No. And thanks, Mike. And Mark, good morning. Just talking about that a little bit on the balance sheet, as Mike was saying, I mean we'll be down in the 3 to 3.5x range as we exit out of the year and by year-end, our debt will be 70% fixed, probably 30 - only 30% variable, which is in a good place. And so our ability to continue to have an interest rate portfolio that's down in that 3% range as we exit out of '22 into '23, we have no maturities coming of any substance over the next couple of years. We've got one that's $250 million bond that we're retiring this year that's just under 5%. So actually a net positive for us on an actual interest rate basis. So we feel good about that. The debt stack is in a good place. And to Mike's point, really, the window opens back up quite nicely for us to apply all the critical components of our allocation strategies that we've been deploying to put those back to work as we kind of exit out of '22 into '23. And of course, relative to - and sorry, Mark, just finally, as we've talked in the past, being a material cash taxpayer that isn't going to be in front of us until we get out into the '24, '25.

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

Hi, everyone, good morning. Thanks for the details. Steve, Mike, recognizing this is an official guidance, and it's the old saying, no good deed goes unpunished, right? If we look at the guidance this year at $1.55 billion at the midpoint, and we consider some of the things that you said in the past about K2 and what it could add next year, you have some remaining synergies from AR and some of the other acquisitions. And you gave us a point-in-time view on the roll forward. EBITDA For '23 is a couple of hundred million, whatever, somewhat higher than where you're targeting for this year. Recognizing you're not going to give us a point in time or a point forecast now, what are some of the things that we should be cognizant of as we're refining our forecast that could be headwinds relative to what would be a quick sort of buildup of EBITDA? And for that matter, was there anything that I missed in going through that sort of quick and dirty algorithm? My second question on Slide 12, we go to it. We noticed that volume has been doing a bit better than prior guidance, what's been driving that? And productivity performance is a little bit below where you had been previously. What's driving that?

I'll take the first part, George. This is Mike. And I'll let Steve kind of comment on the second part. Look, I think you've summarized what we put out there very well. I mean we've got, as we committed to, because of the lag that we have on pricing, we historically have given a look at a point in time into both pricing and kind of a mark-to-market, if you will, of what the carryover inflation would look like. Having said that, things that could impact us would be the fact that if I look at this year, every month, so I'm six for six on this coming into kind of the monthly review, we've seen our inflation go up. And while that's sequentially slowed down, it hasn't abated. And so while there are some things that you guys see like OCC that you point to that has gone down, if you look at the second quarter, we saw chemicals and resins continue to accelerate. And that was additional $50 million just in the quarter from where we thought it would be. So I caution everybody that Steve and I look at this, we're not saying that inflation is in our rearview mirror. As a matter of fact, we're planning for more inflation, because we don't know any different right now, and we think that's a prudent way to do it. And that's really why we've been so aggressive on the pricing side to make sure we're staying out in front of it. So when you think about '23, the things that you can count on are the ones you outlined. You talked about the second half of Kalamazoo, that $50 million. That start-up continues to go incredibly well. We're very pleased with the results. We talked Battle Creek down…

Yes. And thanks, George. I think just kind of ticking through the EBITDA guidance, just some of the movement in the range is as we typically do in the middle of the year here, we kind of refine things, narrow ranges where we can, which we've done with the overall range now at $1.5 billion to $1.6 billion. Volume mix is up a bit. We feel really good about two things. One, we're earning on the organic sales growth to 3%. So it gives us confidence that we're earning on organic sales, and the acquisitions are performing very, very well, embedded in our year-to-date results, AR Packaging's EBITDA, the acquired business, $80 million, which is really at above our expectations at this point. So the acquisition is performing exceptionally well, even in the face of some FX headwinds. And so that gives us confidence on the volume mix. Net performance, very modestly down. That's just us mark to marketing some of our variable compensation and kind of where we are relative to on the variable side of our compensation, which we put into productivity and net performance. And so we just refined that. Labor benefits up a little bit, and our other inflation, a little bit of inflation on the labor and benefits side, obviously, attracting retaining talent and continuing to build out our workforce effectively in an inflationary environment. But also the other inflation, insurance premiums, for example, just continue to be up. So we've refined those numbers up modestly. We've refined FX, more of a headwind at current rates. And so we've put the range more balanced around what we're actually experiencing and then price costs you've seen. So we've kind of refined all the numbers. The net of it all is that performance on price, organic sales growth, execution, Kalamazoo gives us confidence that we were able to actually overcome some of the headwinds we've seen in things like FX and some of the realities of some of the other inflation.

The next question comes from Mark Weintraub from Seaport Research Partners. Please go ahead, Mark.

Thank you. So I appreciate all the color. And as you know, there's this uncertainty about where inflation goes, which has been the case for a while, and you've been getting out in front with pricing. There's a little pause now on pricing. Can you sort of explain perhaps a little bit why there would be a pause now? And are you at a point where the - it gets harder just because the prices have gone up as much as they've gone up? Or if you - can you give any kind of color on what's the desire to keep getting out in front in case inflation keeps going?

Yes. Thanks, Mark. So I don't want to speculate about what we would or wouldn't do in terms of pricing on a go-forward basis. But I will tell you this, we look at a wide variety of factors when we look at making our pricing decisions and what we decided to do on the various substrates. And one of the biggest ones is around operating rates. And when you look at the operating rates that we've seen on these substrates and how they've been very firm actually at the high end of the range from a historical standpoint over the past few years, that's informed a lot of our decision-making process, along with the backdrop of inflation that's been really unprecedented in terms of what we've seen. So we want to stay out in front of that. We're assessing that. We look at it on a routine and regular basis, as you can imagine. And beyond paperboard, we're looking at our existing contracts we have with customers. You heard Steve talk about modification of certain business terms and conditions. We continue to look for opportunities to refine that, particularly in a market like the one that we're in now because it makes sense for us to do that on contractual renewals. So hopefully, that gives you a little bit of color of what we're looking to do and how we do it.

That does. Very helpful. And just one quick follow-up. You talked about there continue to be inflation you saw in the second quarter. If you look sequentially, third quarter versus second quarter, are you anticipating that there will be much additional inflation? So I'm not talking year-over-year, but if we just think about it sequentially or have things - because you did say there is more, but at the same time, you suggested it was abating. Maybe a little bit more specificity on - if we think about 3Q v 2Q?

Yes, Mark, it's Steve. I think from a sequential Q2 to Q3, we'll see probably a little bit of abatement there. I think we were $185 million of inflation. The guide that we provided is more in the $140 million, $150 million, probably heavily driven by the reality of inflation starting to materialize last year in Q3. But yes, sequential Q2 to Q3 should be down modestly, certainly at the midpoint of the guide that we provided around $600 million for the full year.

Okay. So just to clarify, so it will abate year-over-year, but still, if we were just to think about sequentially, you were expecting essentially costs to be higher in the third quarter of this year than the second quarter of this year. Is that correct? Not year-over-year, just - if we just were to take prices of things for the third quarter of this year versus price of things...

Yes. The actual price of things in the third quarter of this year will be higher than the price of things in the second quarter of this year. And then on a year-over-year basis, it will be modestly lower on a year-over-year basis, which is why you get sequentially the increase from Q2 to Q3 on relative to last year is modestly lower, but actual prices Q2 to Q3 and 2022 are up on a quarter-to-quarter basis, which is what Mike was talking about. We haven't seen a quarter yet where our full year expectations of the inflation for the year hasn't moved up modestly.

Understood. And is it - and I know you look at it seasonally, so it's usually the year-over-year comparisons you focus on. Could you quantify - is there a way to quantify that the cost from 2Q to 3Q would...

Say that again, Mark. I'm not sure I'm following your balancing ball.

Yes. So if we were to look at the business sequentially, not year-over-year, and we look at the types of buckets, price, cost, et cetera. If you were to try and quantify the input cost bucket, how much might that be up? I realize that's not how you normally are presenting it. So it may not be a fair question, but if you had that handy.

Well, I think the way to think about it, Mark, is that sequentially, price/cost, which is really the critical relationship, were $93 million favorable in Q2, will be a little over $100 million favorable in Q3. And so the relationship is in a similar place Q2 to Q3 as we execute on our pricing initiatives that you would expect similar in Q4. And so we're now in a place where we're in that $100 million plus or minus range on a price cost basis per quarter for Q2, Q3, Q4.

We now move on to Ghansham Panjabi from Baird. Please go ahead.

Hi guys, good morning. Thanks for fitting me in. I guess, Mike, just going back to the inflation question, many commodities have pulled back just given the weaker macroeconomic backdrop. And there's a good chance that some of this might lead to some level of deflation, just given the very high levels we're coming off of. If investors - as they sort of evaluate paperboard as a commodity as well, how should we think about a deflation cycle if one were to manifest in terms of maybe the industry structure having changed in the U.S. over the last three years or since the previous deflation cycle?

Yes. Thanks, Ghansham. And again, we're being cautious here around making sure that we're not trying to predict what's going to happen from an inflation standpoint because as you well know, things change real time as recently as yesterday relative to what that gas was doing. Here it's a big spend for us, and it shot up pretty good with the news coming out of Europe. So that's why we do what we do. But having said all that, I mean, if that was to occur, and we started to see input cost deflation, what we'd have to look at is to take a look at the operating rates on paperboard, and how well that's holding up. And I think as you look at what we've been able to do, we've grown our top line here, our organic volumes now for the past three years at a 3% level. And so that's chewing up a lot of paperboard that we're making and also that we're buying on a geographic basis. And so that really informs the overall pricing of box board globally is how well operating rates are and what's going on with inventory. So that's what I would say that needs to be monitored and launched. And coming out of the second quarter, as Steve said, our backlogs on all our substrates are unmoved at 10 weeks. So we're actually above historically where we have seen them to service customers. We used to think about a very balanced and strong market being six to eight weeks that allow us to service our customers real well, but this growth has consumed a lot of that. It's put pressure on it. And to be fair, we actually have some customers that we're not able to service quite as well as we'd like to right now, because of the fact we don't have enough paper board available to us to process. So that is all part of the calculus of how we look at it.

That's very clear. And then for my second question on elasticity, I mean, three months ago, many of your customers downstream from you, including the retailers, we're talking about record low consumer elasticity and that has clearly changed very quickly, including Walmart yesterday and Conagra last week and so on. How do you see that impact from an end market perspective across - I know you're exposed to consumer staples, but the consumer is pulling back. And so just your thoughts in terms of product development, has that - have you seen any changes there? Have you seen any inventory reduction efforts at your customer levels, anything you can share?

Well, I'll start with the inventory reduction question, of course, we've got limited visibility into that. But we've been hand-to-mouth with most of our customers. So I don't expect that there's been a big inventory build of any appreciable nature, given the supply chain and the things we provide to our customers. Having said that, elasticity rates have adjusted, we have had a couple of customers that have reported here recently. And I think what you're referencing is their core volumes were down 1% to 2%. And yet, when you look at us, we performed at 3%. So the question is why. Well, what we've been trying to do is provide detailed examples, like I said in my prepared remarks, seeing is believing, we've been showing the types of single-use plastic replacement options that we've got, new product development activities that are underway and commercial. And that's really on the margin, what's driving our demand; Ghansham, and it's real. Europe is kind of ground zero for that. That's why we took on our Slide 5 that you see there, all the examples we listed there. The vast majority of those things were in plastic and now they're fiber-based paperboard. And we talked about our punted trays, continuing to penetrate the retail outlets, we've profiled paper seal, replacing polystyrene trace, we've talked about foam to paper conversions that are ongoing. And of course, our KeelClip and some of the things we're doing on the beverage business. Our machine sales for beverage in Europe are at a record pace this year, really substituting not just KeelClip, but fully enclosed baskets and wraps. And so when you put that all together, the end result of that is we're bullish on our goal of 100 to 200 basis points of true organic growth year-on-year as part of our Vision 2025. And the key component of that is single-use plastic replacement, and we're winning.

The next question comes from Cleve Rueckert from UBS. Please go ahead.

Great, thanks very much for taking my questions. Good morning, everybody. I just have two on organic growth. I just sort of wanted to dig into the very strong organic growth that we've been talking about. And I'm just curious, if you can give us a sense of whether that's coming from all the new product launches that we've been discussing over the last couple of quarters. You sort of laid them out in the slide deck every quarter. Or if it's sort of like accelerating adoption of products that you've already brought to the marketplace?

Yes, Cleve, it's Steve. I think one of the things we're very pleased with is that a lot of the net organic sales growth has come from new-to-the-market products, things like Mike was just referencing on his comments and in his prepared remarks. These are new products, whether it's punted trays, whether it's paper seal, KeelClip, real trays, bowls, other plastic conversions. And it's clearly for us consistently been 100 to 200 basis points of our organic sales growth. And as we've talked in the past, we track that on a new product basis, every month, every quarter. And it's an important part of why we've been fundamentally outperforming the broad-based markets because of the conversions to fiber-based. So it's heavily around the new side in terms of new conversions. If you kind of go underneath at the market level, the good part of the portfolio functioning as it has been, is that our traditional beverage consumer food business has consistently been growing 2% to 3% and our foodservice business, particularly this year, has rebounded quite materially on the volume front, growing closer to 10%. And so the portfolio of products that we've kind of built over the last several years, both regionally as well as from a market participation strategy has held up very well in terms of where the growth is actually coming from.

Got it. That's very clear. And then just sort of building on the success of the new product launches that you have - how should we think about market penetration, adoption, and then maybe whether there's like an economies of scale, margin opportunity behind the recent success? I mean, is that sort of like the next phase of this 2025 journey that we've been talking about for a couple of years now?

Yes, Cleve, I'll start and Mike can add on. I think one of the near positives of our Vision 2025 is that our addressable market is, in fact, quite large. And so when the addressable market is measured in mid-teen billions, and we're putting up $100 million, $200 million of organic sales growth on an annualized basis, I think it does show the runway that's available, particularly in plastic replacement, which is the largest of the components of our - of the addressable markets that we've talked about. So I think that's why, as Mike just said, our confidence in the 100 to 200 basis points on a sustained basis over a multiyear journey, it gives us confidence that it's there because of just really the question that you're asking, I don't know, Mike, anything to add?

No. I think Steve, look, the other part of that is we're earning on it. I mean, when you look at the margin profile of the new products that we've launched, and you see that, Cleve, in the waterfall that we presented there, here for the second quarter is not only are we growing the top line, we're growing the bottom line. The steps in our wheelhouse as part of our integrated packaging platform that we have, and so it's kind of a virtuous cycle we continue to work on where we find these opportunities and really fit what we do.

Next is a question from Kyle White from Deutsche Bank. Please go ahead, Kyle.

Hi, good morning. Thanks for taking the question. I wanted to just quickly go back to George's question and ask it again in a little bit different way. I appreciate the price/cost outlook for 2023, with the caution on commodity costs as well. But when you think about the other buckets, is it fair to assume that performance should mostly offset labor and currency? And so really only other wildcard that we have for next year is what happens on volume?

Look, Kyle, from an intellectual standpoint, you're right. When you look at it that way, all I'll say is that six months between now and the end of the year is a long time. So things can come up. But directionally, our track record about being able to offset our labor and benefit inflation with our productivity is solid. Our confidence you're hearing from us relative to Kalamazoo is very high, based on what you've seen us do to date. And as Steve mentioned, our AR Packaging acquisition is performing quite well. But, look, don't forget, Europe's got a war going on in the Ukraine. And that's got other implications that could happen here relative to big geographies where we participate like Germany, as an example, with nat gas prices going up. So there are variables here that could hit us and we're watching those, and trying to make sure that we countermeasure those. As an example, we're putting LNG capability into a number of our factories in Europe to allow us to kind of mitigate and continue to operate under those kind of scenarios, if you can't get natural gas. But they're out there. And so that's the caution that we're providing here.

Yes. And just adding on to that, Kyle, I mean, obviously, we're not providing guidance on '23 today in the middle of '22, but we'll also dial in things like our traditional maintenance downtime. We do have years where it's plus kind of $20 million on a year-over-year basis. And so we'll dial that in, obviously, as we move out into early next year. But fundamentally, the model for the business really hasn't changed based upon the key components and the confidence we have in the items, if you will, that offset inflationary. But the volatility in Europe that Mike is referencing is important.

Got it. That makes perfect sense. And then just a follow-on. I think a lot of investors in the paperboard space are concerned about potentially being at peak pricing with potential for pricing cuts later on. Maybe can you just talk about some of the levers that you have to keep your markets in balance if demand were to soften? I know you have some options on the CRB side following the Kalamazoo project. And then kind of what's the latest with Texarkana investing for flexibility to switch between CUK and SBS there?

Yes. Thanks for that. So we continue to look at all those projects. We look at Texarkana as a swing machine to CUK, right now. As I've indicated here, we're very busy on our SBS needs and requirements, both our internal and external customers that we have to service. And we continue to look at FBB options. For Augusta, we told you some trials we were running. They will continue to work on those kind of things. So those are options for us. But the biggest thing, Kyle, we need to do is to continue to drive our organic growth profile here. And we've been doing that now for over the last three years. Now if that was to change, our confidence is high that we'd be able to outperform in a market. But we've also shown a proclivity in the past to make sure that we're matching our supply with our demand. And this would be no different, if we got into that kind of a situation because we want to make sure that we've got the material we need to service the demand that we have, and that's how we operate the company.

And Kyle, just to add to Mike's comments, I think one of the things you've seen us do a lot of over the last couple of years, particularly as the - particularly as COVID played out, was to move products between and among all three substrates where we needed to. And it's really given us the visibility into really a 4 million-ton production capacity that we can move between and among where necessary. And to your question and an economic slowdown to match supply and demand, we have the levers to pull between and among our facilities. Our flexibility today, I think, Mike, we'd probably argue the size has been on our ability to take those kind of decisive actions on supply/demand, if we see that as something that's required to uphold good appropriately balance supply and demand environment.

Absolutely correct.

Sounds good. Congrats on a strong quarter.

The next question comes from Gabe Hajde from Wells Fargo. Please go ahead.

Mike, Steve, good morning. I was curious - there's been a lot of ground covered here. But if you were to force rank kind of the variables that would cause you to be at the low end of your guidance for 2022 and/or at the high end, I'm picking a few out here; 1, being price/cost relationship; 2, kind of volumes in Europe, maybe foreign exchange as a related item there, and the Kalamazoo ramp-up and/or productivity. Are there other factors that we should be mindful of number one. And then number two, just like I said, the order priority or where you see the biggest risks to those.

Yes, Gabe, it's Steve. I'll start. I mean I think based upon the last 18 months, the most volatility and variability has been in inflation. And so that's the one that can move materially. Here in the quarter, we're probably not seeing much movement, but we've got another quarter beyond that. And so over the last 18 months, inflation has clearly been the most volatile, which would be both high end and low end to your question. FX has more variability here in the short term, which means that it has the ability to move. We've certainly seen a strengthening dollar, which increased our range and that tends to be measured in low tens of millions, but that is something that's not in our control. Obviously, our line of sight to our volumes and at this point, labor and benefits inflation. And generally, volumes is pretty accurate. So I'd say probably those two are the least controllable for us, and as such, would probably have the highest degrees of potential variability.

And maybe just to add on, Gabe, I think price/cost, obviously very important, it comes from some of the swings that Steve just talked about, and I think he's bounded those properly for you. But what I really am excited about for us is - we've got a fair amount of self-help in going into an uncertain macro with the things that we've done in the past. I mean, when you look at Kalamazoo, that will deliver the better part of $130 million over the next 2.5-year period of time, which is huge, right? So kind of - you kind of bring that on and fully integrated into our supply chain, the way that we plan to do it. And then we've got the AR Packaging acquisition, which referenced a couple of times here, it's going well, but our confidence in that $40 million in synergies that we outlined is incredibly high. So in addition to kind of pricing and kind of managing the inflation side of this, the best degree we can. We've got these self-help opportunities, and that gives our team something to grind on, something to really focus on. And you want that as a CEO going into this kind of environment so that everybody can stay heads down and really focus on execution, which is what in fact they're doing.

I appreciate that. The second one and real quick on the Kalamazoo project. I think when that kicked off, it was meant to be capacity neutral. You mentioned in your prepared remarks that Battle Creek had come offline. So I guess the question is, you're still running Middletown and the other mill up there in the Northeast. And despite that, you're still at 10 weeks of backlogs and CRB as it sits right now?

That's correct. Yes, that's correct. That's our - that's the supply side of it is - you've accounted for it. It's our mill in Quebec, in East Angus, and then the Middletown mill, and then obviously, Kalamazoo with machine online. So the net of that on a net basis is an incremental, call it, 180,000 tons, and that's factored into the 10 weeks of backlog and the growth that we're seeing here, over indexed really to CRB in '22 and heading into '23.

We have a question from Adam Samuelson from Goldman Sachs. Please go ahead.

Yes. Thanks. Good morning everyone. A lot of ground has been covered. I wanted to maybe go back to Europe a little bit. And you alluded to industry operating rates in North America, we'll get the official data for the second quarter later this week. What's your sense about industry operating rates in Europe? And you talked through about kind of looking at gas supply kind of mitigation and contingencies for some of your plants over the next few months given gas prices in Europe. And what's your sense on kind of what your paper suppliers and board supplier - or your board suppliers in Europe, what they are able to do from a contingency perspective to deal with the really dramatic energy price moves there?

It's a great question, Adam. I appreciate you asking it. If you take a step back and think about North America here this morning, nat gas, the exchange is around $9 a MMBtu. On the European exchanges, that number hit $55 a MMBtu overnight into this morning. Just to put that in perspective a little bit for you, what that means, that $9 a MMBtu at our most efficient CRB mill in Kalamazoo, Michigan, that would equate to roughly $50 a ton. So nat gas would cost, in terms of our overall cost, around $50 a ton. So if you do the math on that, you've got - and assuming that a GD board or a CRB manufacturer in Europe was as efficient as Kalamazoo, which most are not, that'd be $275 a ton on an equivalency basis. So just put that into perspective. So when you think about cost structures and trade flows and like FBB and virgin paperboard and where it goes and what people would have to do over the short and medium term, that's a challenge for the CRB manufacturers in Europe for sure. Now we don't make any board over there, on CRB or any other substrate, as you know. So we're insulated from that. We're obviously paying higher prices for the paperboard that we buy from them. But it creates some interesting trade flow opportunities. If you look at kind of the FBB board and what that could potentially replace in terms of the higher cost producers of GD or CRB board in Europe. And so that's on our minds. I can't speak to what they could do from a contingency standpoint if they can run LNG. That would be an awful lot of LNG, you'd have to procure at a converting plant, it's obviously much smaller. So those are the types of things that will play out over the next six to nine months. And we're watching that and making sure that we've got clear line of sight to that. So hopefully, that gives you a little color.

Yes, Adam, it's a great question. To Mike's point, I mean as we look at it, as Mike has just outlined, I think the broader implications are, yes, relative to our buying of paperboard, but also the trade flows from an import/export perspective, just given the realities of right now, costs moving up in Europe pretty significantly. We're obviously taking the price actions necessary to offset that with our customers. But I think the trade flow components are actually probably is equally important.

Okay. Well, and maybe just as a follow-up to that, just how do you think about kind of your own contingencies on a surety of supply of some of your suppliers in Europe have to make some tough choices on operating given energy constraints?

Yes. So the primary market, we want to supply our low-cost, high-quality CRB out of Kalamazoo is North America, hard stop. Having said that, we have had several customers that from a contingency standpoint, really want us to qualify some of our material in Europe. And we will do that. That isn't a market we're looking to necessarily penetrate. But for security supply, for some of our largest accounts, we will look to find a way to make sure that, that is done.

The next question comes from Mike Roxland from Truist. Please go ahead.

Thanks guys. Good morning, Mike, Steve, Melanie. Appreciate you take - allow me to take some questions here. Just real quick, just on - just on Middletown, obviously, at one point, you were expecting the mill to be closed. You decided to keep it running given the demand that you're experiencing, once the K2 is that nameplate capacity, is Middletown something that you would again consider closing? And can you also give us a sense of maybe the profitability differential between K2 and Middletown, just roughly speaking?

Yes. So we factored the nameplate capacity and when we made the decision to say we're going to continue to operate Middletown. We have that demand, Michael, Again, as I just kind of outlined, there's uncertainty on geography base that we want to keep our options open as possible we can. In terms of differential in cost, obviously, the new equipment consumes significantly less electricity, uses less gas, all those things that we've talked to you about. But the biggest difference is, we make 1 million tons of material in Kalamazoo, we make 180,000 in Middletown. So it's really from a fixed cost standpoint, quite different. So I think I'd point to - if you look at the cash cost curves, we estimate that we've got the better part of $100 a ton advantage in Kalamazoo versus the balance of the industry and Middletown would be in that balance of the industry on an aggregated average.

Got it. That's helpful. And then just one quick follow-up. Just on the - you mentioned the FBB, I'm just wondering if you have any update on the thermomechanical pulp production that you were contemplating at your Augusta mill? I think as you mentioned, Mike, you were doing - to do trials in March and April. How do they progress? And do you have any increased confidence that at some point, you might actually proceed with FBB production?

Like I said at the Investor Day, Michael, we're going to run trials. We're going to look at a bunch of different things. That's what we do, to make sure that we've got optionality. But we don't have a project that we're ready to talk about with FBB right now. And we like kind of the optionality that we've got with our existing mill footprint that we have, and as Steve alluded to, we've got a lot of levers that we can pull here depending on how things develop over the next year or 2.So you can count on us, continue to look at those types of things. If we ever do conclude that it makes sense to do so, we'll obviously roll it out. But right now, we're just doing internal work on studies.

The last question comes from Arun Viswanathan from RBC Capital Markets. Please go ahead.

Great. Thanks for taking my questions, including me in here. So two quick ones. So first off, I guess, just on the operating rate side, do you expect operating rates to kind of maintain in this kind of mid-90s level for all three substrates, as you go into '23? And just given that the demand has actually been a little bit better than expected, would you expect any kind of debottlenecking projects or increase to capacity as we look out a couple of years? And then secondly, that's somewhat related. Do you expect CapEx to remain kind of in the $450 million to $500 million range? Or maybe you can just comment on those two items.

So Arun, good to hear from you. Thanks for the question. I'll take the operating rate. I guess, look, we're not going to speculate on what's going to happen on operating rates in '23 now right now, but with our 10-week backlogs, we'll get the full look on that from the FP&A here on Friday after market closed, and that will be another data point that's out there. I expect it to be solid given what we're seeing, and we're a large component of that, as you well know. And what - in regards to debottlenecking projects, I think, look, everybody works on every year, and that number tends to be somewhere between 0.5% or 1%, maybe 1% that people look to. But the only major new capacity that was coming online in the near term was our mill in Kalamazoo and it's up and operational, and we're ramping it up rather quickly, as I alluded to. The next major tranche of anything domestically if they end up doing it is what Billerud announced, and that won't come online until probably '26 based on their most recent comments. So that's what we know.

And Arun, on CapEx, as we've talked CapEx in the 5% of sales, so $450 million to $500 million is clearly good baseline CapEx that allows us to maintain our assets appropriately as well as invest for kind of core productivity, any projects that would be beyond that we would call out very specifically with identifiable returns as part of our overall approach to capital allocation. So the fundamentals of the kind of 5%, doing what it's doing and anything above that if we chose to be called out separately is how we continue to operate.

I'll now hand the call back over to Mike Doss for any closing remarks.

Thank you, operator, and thanks for joining us on the call this morning. We look forward to updating you next quarter on the progress towards achieving our Vision 2025 goals. Have a great day.

Thank you all for joining. This now concludes today's call. Please disconnect your lines.