Pete Watson - President and CEO Larry Hilsheimer - CFO Matt Eichmann - VP, IR and Corporate Communications

Ghansham Panjabi - Baird Gabe Hajde - Wells Fargo Adam Josephson - KeyBanc Ketan Mamtora - BMO Capital Markets George Staphos - Bank of America Merrill Lynch Justin Bergner - Gabelli and Company Dan Jacome - Sidoti and Company Kurt Yinger - D.A. Davidson

Good morning. My name is Sharon and I will be your conference operator today. At this time, I would like to welcome everyone to the Greif's Second Quarter 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. Matt Eichmann, Vice President, Investor Relations and Corporate Communications, you may begin your conference.

Thank you, Sharon. Good morning, everyone. Welcome to Greif's second quarter fiscal 2018 earnings conference call. On the call today are Pete Watson, Greif's President and Chief Executive Officer; and Larry Hilsheimer, Greif's Chief Financial Officer. Pete and Larry are available to answer questions at the end of today's call. In accordance with regulation fair disclosure, we encourage you to ask questions regarding issues that you consider material, because we are prohibited from discussing significant non-public items with you on an individual basis. Please limit yourself to one question and one follow-up question before returning to the queue. Please turn to slide 2; as a reminder, during today's call, we will make forward-looking statements involving plans, expectations, and beliefs related to future events. Actual results could differ materially from those discussed. Additionally, we will be referencing certain non-GAAP financial measures and reconciliation to the most directly comparable GAAP metrics is contained in the appendix of today's presentation. And now, I turn the presentation over to Pete on slide 3.

Thank you, Matt. Good morning everyone. I will begin today's call by providing a summary level preview of our quarter, and then our CFO, Larry Hilsheimer, will expand on the financial results and discuss our outlook and after our prepared remarks, we will conduct a question-and-answer period. Let me start with the key takeaways. We continue to make steady improvements in our customer service journey. Our trailing four quarter customer satisfaction index score continues to improve and was boosted by the significant improvement in our flexible products and services segment. Operating profit before special items and Class A earnings per share before special items, both recorded solid improvement versus the prior year quarter. Our Rigid Industrial Packaging Segment continues to experience significant raw material inflation, in part, due to Section 232 tariffs that are being passed along via contractual mechanisms. The segment was also impacted by choppy year-over-year volumes, driven by customer operational interruptions, weather, and our focus on margin management. Our Paper Packaging and Flexible segments, both recorded strong quarterly performance. Transportation still remains a significant headwind across much of our business that we are working actively to abate. Finally, we increased our fiscal 2018 Class A earnings per share before special items guidance range, but have maintained our free cash flow guidance due to higher profitability related to cash flow offset by the addition of several growth oriented CapEx projects that has recently been approved. I will now review Greif's most recent business performance by segment, please turn to slide 4. For Rigid Industrial Packaging, our second quarter is impacted by the continuation of raw material headwinds, higher transportation costs, and by lower than anticipated volumes tied to weather trends in Europe, customer operational interruptions, mainly in U.S. and continuing market challenges in China. Our second quarter sales were $38 million higher year-over-year, due to higher selling prices, stemming from index price increases, strategic price decisions and favorable foreign exchange tailwinds. RIPS gross profit was lower versus the prior year quarter, primarily a result of lower volumes. Continued raw material cost inflation, and the timing of contractual pass-through price adjustments, and a $3 million transportation headwind. RIPS raw material cost per steel unit, were up roughly 12% versus the prior year quarter, while our transportation costs per steel drum unit were up 10% versus prior year. Our operating profit before special items decreased by $8 million year-over-year, primarily due to the same factors impacting gross profit, but partially offset by lower year-over-year SG&A expense. The North America second quarter intermediate bulk container and steel drum volumes were up 3% and1% respectively, versus the prior year quarter. While fiber and plastic drum volumes were lower versus the prior year. Volumes in the U.S. were impacted in the Gulf Coast, due to customer operational supply chain disruptions, at the end of February and March. Latin America delivered 17% steel volume growth in Q2 versus the prior year quarter, thanks to an improving Brazilian economy and better demand for tomato paste in Chile. In EMEA, intermediate bulk container volumes grew by more than 10%, while steel drum volumes were down 2.9% versus the prior year quarter. EMEA is really a mixed volume story, and let me give you a few examples. We continue to see very strong demand in unit growth in Eastern Europe and the Middle East, which includes 12% steel volume growth in Russia versus the prior year. In the Middle East, our steel drum volumes were up 51% versus the prior year, based on a specially strong performance, as we ramp up our Jubail, Saudi Arabia operations. In Southern Europe, our volumes were negatively impacted by lower conical demand, due to severe drought conditions that impacted planning in our agricultural markets. And in Central Europe, volumes were lower, as we advanced our efforts to restore margins, while we optimize our German footprint to improve profitability. Finally, APAC second quarter steel volume fell year-over-year. Demand remained solid in Southeast Asia, while volumes increased 4.7% versus the prior year. But China continues to experience lower volumes, as a result of the ongoing competitive market conditions, our strategic pricing decisions, and a plant closure of a significant customer. We are recently encouraged with new business wins. However, we are currently examining our strategy in China, and are considering rationalizing our operational footprint, if we are unable to secure additional volume. Please turn to slide 5; our Paper Packaging business delivered exceptional second quarter performance, with improved sales and margins. PPS generated second quarter revenue of almost $214 million, thanks to higher selling prices and strong demand across our entire network. Second quarter operating profit before special items grew by 60% versus prior year, boosted by containerboard price increases, strong unit volume growth of 6.4% and favorable OCC cost. This improvement comes, in spite of continued transportation headwinds, of roughly $4 million versus the prior year. Finally, we recently announced the expansion of the core choice sheet feeder network, with a new facility to be located in the Mid-Atlantic region. That operation will include a high speed corrugator, and an [offset rod] [ph] that produces litho laminate sheets. This will enable us to grow with committed strategic customers, expand our specialty business model, and improve our mill integration level. We expect the new facility to be operational in Q4 of fiscal 2019. Please turn to slide 6; the Flexible products team delivered a strong second quarter performance, with sales up roughly 14% on a currency neutral basis. Higher sales were driven by higher selling prices and strong unit growth of 8.4% across the network, especially in our four loop bulk bags. Stronger sales and solid operating performance helped expand FPS' operating performance before special items by $3 million versus the prior year. Finally, I'd like to credit the FPS team for its exceptional turnaround in customer service. The team recorded a 27% improvement in its Customer Satisfaction Index Score versus the prior year, and a 12.5% in the most recent Net Promoter Score. High levels of service and consistent operating fundamentals are helping FPS accelerate its performance trajectory. Please turn to slide 7; one year ago at our Investor Day, we outlined our path to growth strategy, which includes capital expansion projects and acquisitions. Over the last year, we have advanced that plan, and I want to quickly highlight some of the efforts we have underway. We expect those projects highlighted in the slide to generate approximately $35 million of operating profit before special items per year, for a collective initial investment of over $100 million. And their impact would be blended into our financial results over the next several years. In Rigid Packaging, we recently commissioned our New Kaluga Steel Drum Plant in Russia, which further strengthens our presence in the country and partnerships with our strategic customers. We continue to expand our global IBC footprint, with recently commissioned new lines in Spain, Houston, and new lines being added in Chicago, Russia and the Netherlands. We are also expanding our plastics offering by adding several new blow molders in the U.S., and new small plastics lines in Israel. In Paper Packaging, our triple wall bulk packaging expansion Multicorr is complete and operational in time for the agricultural season. We are also expanding our sheet feeder model network with a new facility in Mid-Atlantic, as I previously mentioned. These capital projects and expansions, all aligned to strategic customer needs, have demonstrated appropriate returns as required by our capital risk framework, and are oriented towards serving higher margin markets. Now I'd like to turn the presentation over to our Chief Financial Officer, Larry Hilsheimer.

Thank you, Pete. Good morning everyone. Please turn to slide 8 to review our second quarter financial results. Second quarter net sales on a currency neutral basis, were 4.5% higher year-over-year due to strategic pricing decisions, index price changes, and year-over-year containerboard price increases. Second quarter consolidated gross profit rose by roughly 7%. Year-over-year gross profit expansion was generated by higher sales, partially offset by dramatically higher raw material costs and higher transportation costs. Gross profit margin declined by 30 basis points versus the prior year quarter, primarily due to raw material inflation, lower volumes, the timing of contractual pass-through adjustments and transportation headwinds. Second quarter SG&A expenses were roughly 6% higher versus the prior year quarter, but SG&A as a percentage of sales improved by 30 basis points versus the prior year. SG&A was higher, due primarily to increased depreciation and amortization related to our ERP system implementation and higher forecasted incentive payments, related to improved company performance over the past three years. Second quarter operating profit before special items rose by almost $8 million versus the prior year quarter, due to the reasons I previously mentioned. Higher year-over-year operating profit, partially offset by higher SG&A, resulted in Class A earnings per share, before special items, that were 13% higher versus the prior year quarter. Our second quarter non-GAAP tax rate was 34.2%, was impacted by increased reserves for uncertain tax positions and out of period adjustments that added roughly $3 million to our second quarter tax expense. Excluding those two items, our non-GAAP tax rate would have been closer to 30% for the quarter. We continue to expect our full year non-GAAP tax rate to range between 28% and 32%, as we expect the discrete expenses that impacted our second quarter results, will be offset by tax benefits, booked ratably later this year. We also continue to assess our provisional estimate for the Tax Cuts and Jobs Act. During the second quarter, we booked a $4.3 million increase to the provisional net tax benefit that was recorded during the first quarter. This benefit was excluded from our non-GAAP earnings for the second quarter. Finally, second quarter free cash flow was roughly $30 million or $11 million lower than the prior year quarter. Lower free cash flow resulted in part from roughly $10 million of higher year-over-year capital expenditures for growth related projects, such as our bulk packaging expansion at Multicorr and the new Houston IBC facility currently being constructed. Last, our cash conversion cycle continues to improve, despite increasing inventories for steel, and the anticipation of cost increases and regular mill maintenance in PPS. Working capital days decreased from roughly 59.4 to 54.5 days on a trailing 12 month basis, year-over-year, while operating working capital as a percentage of sales improved by 30 basis points to 10.5%. I will now review our updated fiscal 2018 guidance. Please turn to slide 9. We are modifying several aspects of our fiscal 2018 guidance. First, we are increasing our fiscal 2018 Class A earnings per share before special items guidance range to between $3.45 and $3.70 per share to reflect our fully implemented $50 a ton containerboard price increase. Our revised fiscal 2019 OCC cost assumption and the accelerated performance we are seeing out of FPS, offset by the negative headwinds created by transportation and steel cost increases. Our revised Class A earnings per share before special items, includes our estimate of the impact of those continually increasing steel costs. It also includes our estimate of the impact of the Brazilian trucker strike today on our operations in the country. Our capital expenditure guidance range has been increased to between $120 million and $140 million, as a result of the investments in profitable growth described by Pete, and including the recently approved Mid-Atlantic sheet feeder expansion and the expansions supporting our global IBC and plastic strategy. Higher anticipated earnings netted against higher capital expenditures, results in us maintaining our free cash flow guidance of $200 million to $220 million for fiscal 2018. We are extremely confident in that forecast. We would be making a onetime discretionary pension contribution to our U.S. plant of roughly $70 million later in June. We elected to make the contribution based on our strong cash position and to take advantage of a 35% tax deduction benefit that remains open until the filing of our 2017 tax return, versus a 21% benefit that would have been obtained in the future, as we had to catch up that pension shortfall. Following this contribution, our U.S. pension plan will be essentially fully funded. Furthermore, the discretionary contribution will reduce our annual pension expense by roughly $4 million, decrease our annual cash contribution and save us roughly $1.5 million on current annual PBGC premiums. I remind you, that the PBGC premiums are also expected to increase in the coming years. This funding will mitigate substantially, that impact to us. I will close with a final few words on guidance and our key assumptions. First, as is generally the case for Greif, we expect our consolidated financial results to be stronger in the second half of fiscal 2018 than the first half, due to agricultural customer activities. Although RIPS usually has its strongest operating profit before special items result in our fiscal third quarter, this year, we expect the fourth quarter to be the strongest, due to the timing of raw material pricing adjustments. Second, PPS will also deliver its strongest operating profit before special items performance in our fiscal fourth quarter, benefitting from three months of fully realized $50 a ton containerboard price increases. We assume OCC costs of $73 a ton in June, $95 a ton for July-August and September, and $110 a ton in October. This is in line with the latest RISI forecast. Finally, please keep in mind, that the improvements in our Flexible Packaging business are also reflected in increased non-controlling interest, as the segment is a joint venture. Turning to capital priorities on slide 10; you have seen our capital priorities slide numerous times on previous calls, so I won't go into great detail here. I will highlight that at the end of the second quarter, our leverage ratio stood at 2.1. At the low end of our targeted leverage ratio of 2 to 2.5 times net debt-to-EBITDA. We intend to maintain our targeted leverage ratio, but we consider temporarily exceeding it, if a compelling growth opportunity emerge. Last, additional potential shareholder returns beyond regular dividends are not expected to occur this year, due to the increased CapEx we plan to spend on profitable growth opportunities, and the discretionary $70 million pension contribution we plan to make. We will consider additional returns in future years, as our EBITDA increases and our debt levels decrease, and absent the existence of compelling growth opportunities. And now, I turn back the call to Pete, for his closing comments.

Thank you, Larry, and please turn to slide 11. In closing, we are encouraged by the overall performance for our business. One of the benefits for our global portfolio, is exposure to a variety of substrates end markets. Outperformance in some segments helped counter challenges experienced in others, and we have seen that scenario play out this quarter, with strong performances in both our paper and flexible businesses, helping to offset challenges in our Rigid business. We remain very confident, the business will achieve its stated commitments for fiscal 2018. We thank you for participating this morning. Sharon, please open the line for questions.

[Operator Instructions]. Your first question comes from Ghansham Panjabi with Baird. Please go ahead. Your line is open.

Hey guys. Good morning.

Hi Ghansham. How are you?

Hi Pete. Good morning. I guess, starting with RIPS in North America, you called out weather disruptions in February and March. You mentioned that on the previous call as well. Can you give us some more color on that? How did sort of volumes in North American RIPS track during the quarter on a monthly basis, and how did it shake out for the month of May as well?

Yes so, thanks for the question. So North America, with one exception, I was really encouraged by the volumes, specifically in steel. The Gulf Coast, which is our largest steel drum producing unit, and is predominantly Houston, was down 5.5% on steel drum year-over-year quarter, and that was really relative to some disruptions with some major customers in their supply chain and transportation. If you look at the rest of our portfolio, the Midwest was up 8%, Mexico was up 7%, which we include North America and the East and Southeast, at 5% growth. If you look at after those disruptions occurred in the Gulf Coast, Houston -- our Gulf Coast business, starting to bounce back to have similar growth rates, as I just talked about. And in May, our steel business in North America across the whole portfolio, we are seeing approximately mid-single digit growth. I will also point out, that our IBC business also showed good growth, 3%, and in May, much larger growth, as our capacity on our blow molder IBC expansion in Alsip, Chicago, is taking hold.

Okay, that's super helpful. And then, for my second question, obviously a lot has changed, between when you last gave guidance in your revised outlook. Can you help us bridge some of the various pieces, as it relates to the guidance raise? How much is the contribution from the containerboard price increase, lower OCC, and what are you assuming for RIPS volumes in the back half of 2018 as well?

Hi Ghansham. Thanks for the question. So let me just run through the ups and downs in the guidance change. So we have about a $28 million improvement related to OCC costs. The assumptions that I ran through versus the assumptions that we had previously. About $18 million more from the containerboard price increase, that includes some that we already had before June, slight amount. And then we have about an $11 million reduction that relates to just sort of RIPS underperformance volume, and just the lag in our ability to catch-up to the continually escalating costs on our steel side. And then, about $9 million related to non-volume related transportation headwinds, just rates and related items. About $8 million reduction from tariffs, delays in us getting delivery on equipment, on blow molders and new projects, a little bit related to the Brazilian truck strike, which was about $1 million worth. And then, we also have some things that are related to incentive increases, accruals for significant increase in our performance that's projected for the year, as well as the impact that has on our full year EBITDA based LTIP plant and the increasing stock price. So that ends up driving an additional accrual. And then, that's netted with improvement from other marginal gains, just PPS volumes, the flexible business improving, and those type of items. So all of that nets to generally in the $15 million range of a net increase. So hopefully that's helpful.

Looks like you were ready for that question. Thanks so much.

Your next question comes from Chris Manuel with Wells Fargo Securities. Your line is open.

Good morning gentlemen. This is actually Gabe sitting in for Chris. I guess if I can piggy back a little bit, on that question, Larry, when I look at a couple of those different components, the $11 million reduction of lower volumes, I don't envision something -- that's something you can get back necessarily. But the $9 million in transportation headwinds and then the $8 million on -- it sounds like you guys are making some investments, most of the equipment isn't coming on time. Is some of that -- would it be reasonable to assume that some of that you guys might be able to capture in fiscal 2019 -- not looking for fiscal 2019 guidance, but just trying to understand, which pieces of those you might be able to recover, if that make sense?

Yeah. I think a very good question Gabe. Clearly, on the delayed improvement, because of the -- and it's primarily blow molders on the delivery of equipment. Those things, every month you push back, you are losing obviously, on the bottom line, and that will come back and be in line with what we expect for 2019. So yeah, that will be caught up. Relative to the transportation issue, we have a lot of different activities that we have going on, trying to mitigate the impact of it. And obviously, working through that with customers on pricing initiatives. So we expect our teams to be able to mitigate that substantially, but it is a challenge in the market, particularly, you think a big piece of that comes in the paper business, and obviously, there have been a lot of price increases in that business already. So the teams are working hard at it. We expect to recover some of it. I don't think we will probably recover all of it, but I don't have a number for you at this point in time. I guess, those were the two, I guess, you primarily asked about.

Yes. And then the lag in steel, part of that maybe coming this year and then some component of it next year?

Yeah. Outside of the U.S., we -- our thoughts on steel costs are that they are at sort of peak and should be leveling off, and maybe even slightly decreasing. And so, a lot of the benefits of our price adjustment contracts will start to play through the remainder of this year. In the U.S., every time there is a tariff action, steel companies are continually pushing their price up, as more people move to buying domestic steel. The Canadian change was not what I think most people expected, we didn't, and we do buy just from a logistics standpoint, through Canada, that's about $1 million roughly hit to us, if you looked at it -- what we might expect. So we do anticipate though, that at some point this year, the cost in the U.S. will begin to mitigate, and at that time, then we will get to capture the benefits of the price adjustments. And obviously, we expect that to play through more fully in 2019.

Okay. That's helpful Pete or Larry, sorry. In China, can you provide a little bit of color I guess, in terms of -- is this local competition? Presumably, it's some incumbent players that you are dealing with, in terms of heightened competitive activity, and is there something that we can look for, from the outside to maybe understand what might be a trigger point for you guys to pursue some rationalization there?

Yeah Gabe. So this is a very fragmented market, in regard to supplier base and steel drums, and that's our predominant business in China. It is very hyper competitive right now. Mostly our independently owned, privately held companies, and because of the high inflation on steel costs, that is fairly predictive of behavior in that market. When it goes the other way, behavior tends to change. But from our perspective, we are soliciting a little commercial strategy, with a new commercial director, we just recently won a new contract. But by the end of this year, we will have either increased our volume in that country, or we will reduce and rationalize our operational footprint. So it will be no later than the end of the year, maybe sooner, but it most likely will be in our fourth quarter call, we will have something to report on that. And also, just as a reminder Gabe, China represents only 5% of our total revenue in RIPS. So while it kind of has a glaring spotlight on volume losses there, in the big picture, it's not as impactful to the overall profitability. But still an important market for us.

Understood. Thanks for the visibility there, Pete.

And one more comment, just so everybody understands. If you take out China from the equation, which you certainly can on a rational basis. But just to give you perspective, our steel volumes across the world in steel would have been higher year-over-year. That was the impact of China to our global steel portfolio.

The next question comes from Adam Josephson with KeyBanc. Your line is open.

Pete and Larry, good morning.

Good morning Adam.

Thanks for taking my questions. Larry, a couple on the guidance and then I have got one other question. On the guidance, one on OCC, so if I heard you right, your OCC price in June, you are assuming $73, and then you are assuming that it's going to go up to $95 thereafter and then $110 in October. I guess, why, if anything, I would think the OCC prices are going to be heading downward in July, given what China just implemented. So why would you be assuming a spike in OCC prices in July? And what is your full year OCC price expectation compared to the $137 that you were assuming three months ago?

Yeah. The current average for the full year is now at $93, Adam, and relative to the assumption, obviously, if China opened the floodgates, we all know what might happen. I don't expect that to happen. You have obviously published pieces that you don't either. We decided to just go with RISI's forecast, that's exactly what we matched. We had our team independently come up with what they thought and it was relatively close to that, and we just decided to go with that, and it's an outside independent thing you can just look at.

Okay. But do you have any reason to expect the OCC prices to spike in July, just given that China is really cracking down on U.S. imports?

No I don't. And I also -- particularly given what's going on in the whole trade situation, I don't at all. So I don't -- and even in that, if they did, I think we'd be looking at something a lot higher than even the $110 in October. So I don't see that happening. I agree with you generally, but we just -- anything we put out there, somebody is going to say how did you get to it. So we just said, let's pick the RISI forecast. So I am like you. I am hopeful it's lower the rest of the year. Obviously, it would just drive our results up.

Right. And then just relatedly, I think either you or Pete said you are extremely confident in your revised EPS guidance range. Can I interpret that to mean that, you are thinking it will be at the higher end of that $345 to $370, or is that not necessarily right?

We are -- I think what I said -- maybe I said that, I think I said free cash flow. But we are really-really confident in it. But yeah, we are confident in our range, but I'd say, there is things that there is so much volatility right now going on, that it's hard to squeeze that range down. I mean, like the topic we just talked about, I mean OCC, I think we have upside, because of what we have built in our assumptions. What's going to happen in the tariffs in the steel world, I don't have a really clear vision of that. I told you what our expectations are. But so there could be downside, if for whatever reasons, steel costs continue to go up instead of matching our expectations that they are going to flatten, tail down in the rest of the world and start to flatten out in the U.S. So that's why the range.

Got it. Okay. And then just one on RIPS volume, I know you talked about China being a particular problem. But obviously, the weather has been an ongoing problem. Not just for you guys, but for many companies. Companies seem to be calling out weather with increasing frequency, such that it's a recurring issue, it's not a non-recurring issue. And as a result of this weather, you have had basically flat volume over the last couple of quarters, in terms of the company as a whole, and really for the last year and a half, your volumes have been flat, and what has been a pretty robust global economy, or so it would see, based on what we read. So I mean, do you have any reason to expect your volume trends to accelerate any time soon, such that the total company would have volume growth? Or is that perhaps an unreasonable expectation, given the weather problems, given the China issues, etcetera?

Yeah Adam, this is Pete. So weather, that's a really fair statement. But in our portfolio, we are globally -- obviously, we are in 44 countries, and we do have exposure, ag and every single business, FPS, PPS, and RIPS, and what we try to do, is just report the actual gains and shortfalls and try to be transparent. In the past, two and three years, we have had exceptional strength in Southern Europe on the conical business. We are comparing now, that performance for its record highs. So we just try to be transparent. It's part of our business. There is ups and downs, and that's how we look at it. We can't control the weather, but we can control how we manage our inventories and how we manage our reaction to markets and to customers. So that's our view on that. And then in terms of your question on volumes versus the global macroeconomic view, especially in Rigid. So our steel business is the largest part of that -- percentage of the business, and it's a low single digit growth business, GDP driven. So -- and the reason why we have some choppy volumes in steel, is we have large market shares and we are trying to drive improved profitability, and part of that is margin management. So as an example, we talked about Central Europe, we are not trying to go out and do volume grabs, we are trying to improve the profitability of that region, and by doing that, we have optimized our footprint operationally, and we are looking to restore margins by our behavior. So you are going to see parts of that, that don't relate to global macroeconomic conditions. But the other thing I will say, because the steel business is a low single digit growth, that's the reason why strategically, we are investing in IBC and plastic business, because that business has high single digit to low double digit growth, which we are experiencing. That's why, it's important that we diversify our Rigid packaging business portfolio, and in vesting in higher growth and uses. And so, what we would expect to see in the future five years or so, that we are in higher growth trajectory businesses, because we diversified our product portfolio, which in turn, diversified some of our end use segments that we sell to.

And just one last one on the macro Pete. I mean, people have been talking about a synchronized global expansion, and now they are no longer really talking about that because of what's happening in Europe and emerging markets. How would you characterize the global macro, just out of curiosity?

Yeah I mean. I think on a high level scale. I think it's positive. You certainly have some potential for some hot spots. You have the tariff situation by the U.S. government and what impact that may or may not have on trade globally. That could have impact on migration of manufacturing capabilities. You also have some political -- I wouldn't say turmoil, but noise in parts of Europe. So I think there is always going to be hotpots and trepidation at time, but I think overall, I think I would agree that it's fairly even, and in some regions, very strong, and I think we are performing very well in some of those regions. And again, I would tell you that, based in RIPS, based on our portfolio in steel, which is lower growth and our desire and goal to improve profitability in certain regions, we are behaving through margin management, that we may not grow, in accordance to global growth in certain regions. But our whole aim is to optimize profit and not worry about our volumes. Volume is only one piece of the profit curve, and there is other elements. And so we are trying to balance all those components to drive the most profit for our business.

Thanks so much Pete.

Yes. Thank you, Adam.

[Operator Instructions]. Your next question comes from Ketan Mamtora with BMO Capital Markets. Your line is open.

Thanks Pete, Larry.

Hi Ketan. How are you doing?

Good. Thanks. So first question, just can you talk a little bit about your M&A pipeline? You talked about your leverage being at the low end of your target range. Just give us a sense of kind of what you are seeing out there, in terms of opportunities, valuations, and kind of areas and regions that you would be most interested in?

Ketan, let me answer the first part and then turn it over to Larry. We have an active strategic acquisition pipeline. It's centered on the priorities that we outlined in Investor Day, and we will continue to do that. We will be disciplined, and get involved in those types of growth projects that return the appropriate and desired financial returns to our business, and we will just keep you updated on the progress as we move forward, and I will turn it over to Larry to talk about some of the debt levels.

I mean Ketan, clearly, we end up showing our best ratios at the end of our fourth quarter. And with our EBITDA levels increasing and our debt not increasing, we will be at that point, where we'd be below the 2 to 2.5 times. So from a financial flexibility standpoint, we feel very-very good about our capacity for any potential opportunity that would arise, and again, if we don't find things that we can act upon and we don't identify future uses of capital for growth oriented projects to utilize that capital, then we would be looking to the opportunity to share it back with our shareholders. But we have been encouraging and challenging our teams to bring to us high growth opportunity projects, that's what led to us in increasing our capital spend for this year. And we will continue to look for those opportunities. But the process that we have, which you have gone through with us previously, is very stringent. And so we feel very confident about the projects that we have been approving, and the bottom line that they will deliver. So we will continue to look for those as well.

That's very helpful. And my follow-on question would be, kind of just price costs in the RIPS in the U.S. and I recognize it's a little difficult to kind if pinpoint a specific number, but maybe even at the end of the second quarter, in your view, where do you think you all were with kind of recouping those higher costs? Would you say you are halfway through, more than halfway through, less than halfway through?

Yeah Ketan, I gave some numbers in the first quarter, that showed on our per unit, per steel drum basis, we were -- while we were not caught up, relative to where we wanted to be on a margin basis, we were actually ahead on the cost per unit, relative -- or the sales price per unit, relative to the cost per unit. However the, again rapid increase that occurred between the first quarter and our second quarter was like, steel prices for example in the U.S., the costs went up 10%, just from 1Q to 2Q. Our PAMs aren't going to catch us up in that scenario, and as a matter of fact, for the quarter-over-quarter, per unit steel drum, sales price was up $1.22 and the material costs were up $1.63. So we actually fell further behind, because of the continuing rapid increase. So I wouldn't -- it'd be hard for me to say, are we 50% there, are we 40% there, we are not there yet. But the price adjustments continue to kick in, and it's just going to take that price cost curve to start to level out for the catch-up. The one thing that would be a negative for us, would be a rapid decrease; because then you have got your costs build in and if the price decreases the timing of your PAMs, that's not a good scenario for us. I don't expect that to happen, given the current environment, but that's one that has us watching our inventory levels very closely.

Got it. That's very helpful. I will jump back in the queue. Good luck in the back half of the year.

Thank you.

Your next question comes from George Staphos with Bank of America Merrill Lynch. Please go ahead. Your line is open.

Hi everyone. Good morning. Thanks for taking my questions. The first thing I wanted to do, is talk about returns on capital and the outlook for the next several years, given where we have been. So if I look at our numbers, and obviously these are our figures, your return on invested capital actually has done reasonably well, based on our data of going back to 2011, 2012, through even the first half of this year, and certainly fiscal 2017. Despite what has been, and as you have termed numerous times, a choppier volume environment, and it shows the benefits of going for value over volume. In a world where you are investing now for growth, and with inflation certainly percolating more than it was several years ago, Larry, could you tell me why you think returns on capital can continue to move higher, when we have been in a world where that has been kind of the reverse of that? Yes, you expect volume will pick up -- to Adam's question earlier, but you are also investing and you also have more inflation. So what are the two or three things that make you confident about that return on capital continuing to trend higher? And then I had a follow-on.

I think George, I'd have two pieces to my answer to that. One is, just operational execution and discipline against our business system. We have room to continue to improve in our operational metrics in our plants. And so, on our invested capital base, we do believe that there is room for improvement in our returns on operating capital, even though, that's a very low growth business. We are also going to hold true to the discipline in our capital structure that we have gone through with you before, which is, that first column of our spreadsheet is our existing plants. If they can't show us that they can at least return our cost to capital, they have to have a plan develop immediately, to show us how they are going to get there, or we are going to rationalize the footprint. We are not going to sit and idly watch that deflate. And so, we feel very confident in that. The second half of it is, each one of these capital projects that we have approved, the -- and I won't go into what the returns on every one of them are, and I won't go into what the returns on every one of them are, but they are way in excess on a plan basis, our cost of capital. And you will always want to see that, because stuff happens. Like, blow molders getting delayed. So you try to factor in a risk mitigation element into the capital that you approve. But like Pete said, it's slightly over $100 million on that page, and you are going to end up returning $34 million, $35 million of operating profit, when these things get to maturity. And the ones that we just approved this year, they won't start to really play in until 2021 or so, but those are the light green ones -- the highlighted ones on that page, and those are going to produce $12 million in paper and $6 million RIP. So we feel very confident that we can continue to deliver nice returns on the capital we deploy.

And George, I have one comment, if you look at where we are investing in the regions and the products that serve certain markets, they have been our more successful businesses and business units with higher growth potential. So it's a targeted approach, and as I mentioned, trying to diversify our portfolio toward those higher growth segments of the economy.

Okay. Appreciate the thoughts there. My second question -- well first, maybe as a quick follow-on, would China materially -- whatever your resolution there, materially improved return, just yes or no? And then the second question would be, looking back over the last five quarters and in RIPS again, and recognizing, it is a diverse business. You can't control the weather. There have been things that are clearly beyond our control, including all the trade discussion, and I am putting that politely. Do you sense at all, that the business has become less predictable? Not because of your own actions, but just because of the world around you, and/or because of where we are in the cycle. And so recognizing, you think you want to, and you should grow, in the next couple of years, that maybe, your ability to forecast that going forward isn't quite what it would be, earlier in the cycle, because of what has been happening? Thank you guys.

Yeah George, so your first question about China; any decision we obviously make to that business will improve it. That would be the intent. And you make a good comment on past five quarters, and what has happened. So on the areas that we control, which is either pricing decisions and how we optimize our footprint in certain regions, and where we are trying to grow. I think we have good visibility and can forecast that well. What we don't know on a global portfolio or things out of our control, weather, macroeconomic issues, political changes that impact market. So it just depends on the amount of external non-controllable issues. But I feel we are very confident in what we can control and what we are trying to accomplish in certain regions and businesses. We feel that we can forecast fairly decently, those types of things.

Thank you. I will turn it over.

[Operator Instructions]. Your next question comes from Justin Bergner with Gabelli and Company. Your line is open.

Good morning.

Hey Justin.

Hey, could you just remind us your breakdown across the different substrates in Rigid Packaging now? That's the first part of the question. The second part of the question is, what gives you the confidence to, sort of choosing value over volume? Is the right decision in Europe, or parts of Europe? I understand that in Asia-Pacific, but in Europe, might you just sort of be -- be sort of shrinking your business, as opposed to trying to get it to a more strategically competitive position?

Yeah. So Justin, our RIPS portfolio, steel is about 65%. IBC and plastics is about 20%, and the balance of that has to do with closures, fiber in the U.S. and our filling services business in the U.S. And that switch is changing, it will change over the next few years and have higher waiting in IBC and plastics. In regard to your question of value over volume, our whole intent goal is to optimize profit and find the right volume, and that's just one vehicle of that, and we expect to grow our operating profit, which is a combination of pricing, volume and operational efficiencies, and we pattern our behavior, based on those values, and in your reference to Europe, we do see in the chemical industry, shifts of migration production from Western Europe to the U.S., because of the energy cost advantage in the U.S., and that is one reason why we are optimizing our footprint in Central Europe and Western Europe, because we are -- it's a smaller pie in steel drum usage, and we got a major market share, and we are trying to optimize profit, and you are seeing that in some of our behavior. So again, I wouldn't focus as much on size, as we do on what the volume opportunities and the profit pools and the right markets, and how we match our operational footprint to take advantage of that.

And I would just add Justin, I mean, on all of these decisions, we are very disciplined in looking at it from a financial lens of what is the return that we have got coming out of a business? And like I said earlier, if a plant can justify that it can return at least our weighted cost to capital, there is no reason to continue to deploy that capital there, and we certainly wouldn't want to go spend a ton of capital to maintain and even upgrade that type of facility, when we have the opportunity to deploy that capital in a much higher return place. All of those things just factor into the decision of what do we do? Are you going to just continue to chase volume that maybe drives a 2% or 3% gross margin, doesn't seem to make any sense to us.

Thank you. That's very helpful. I mean, I am not so much concerned about chasing volume as the implications of sort of not growing volume on the operating leverage in the business, and maybe are you walking away from the bit -- too much volume, when you look at it on a multi-stage, multi-year point of view, maybe the calculus is a little bit different.

Yeah, we have looked at that. That goes into our analysis.

And Justin, just as a reminder, our growth platform in RIPS really is plastics and IBC. And our IBC business grew 8.1% last quarter, and we expect that growth to be high single digit, low double digit moving forward. So again, we are participating in the markets and investing where there is higher growth opportunity, and I think over time, when we diversify our Rigid portfolio, we expect to see better growth potential on an ongoing basis. But we just had a heavily weighted portfolio on steel, which is low single digit growth at the time.

Okay, thank you for that detailed explanation.

Yes. Thank you.

Your next question comes from Dan Jacome with Sidoti. Your line is open.

Hi, good morning.

Hi Dan.

Just one quick question; was excited to see the new triple walls up and running. It sounds like and you mentioned the ag market was something that you'd be looking to target. Are there any other markets that you are excited about? I was just going over the Analyst Day notes from last year, and I think you had talked about the automotive parts. So just wondering, any color there, maybe some other markets in the last year, since that comment, you have come across? And that's it.

Dan, thanks for the question. So the key markets or the ag market really watermelons and melons. But on the Southeast all the way up to the Midwest and up the East Coast, as the season progresses, that's a big market. But we are also growing our industrial market. Part of the industrial market, is the automotive parts business, where it's used for bulk packaging. The food business is part of that corrugated triple wall market. So as we get more capacity, our goal is to drive higher industrial growth, which is more balanced over throughout the year, and less reliant on seasonal ag business.

Okay. Terrific. And not a question, but more of a comment actually. I think your return on invested capital ratios can actually improve nicely in the next couple of years, if you are able to execute on that mix shift in RIPS, and then you have containerboard, kind of just steady as she goes. So just kind of my thought there. But we will see what happens.

We agree.

Okay, great. Thank you.

Thank you, Dan.

Your next question comes from George Staphos with Bank of America Merrill Lynch. Your line is open.

Hi guys. Next two questions, thanks for taking the follow-up. When we look at RIPS and the promoter scores and the CSI index, certainly it has done a lot better, but it was off a little bit year-on-year. Are there any implications in that, in terms of the performance in the quarter, year-over-year, or totally unrelated? And then, I just wanted to get into Larry, the tax commentary you had? On one hand, the incremental reserves that you took, and then, what that means for the back half of the year, given the guidance? Is there any way you can give us any kind of guidance on tax rate, effective tax rate for fiscal second half on an operating basis?

Yeah George, I will answer the first question, very insightful, and I will tell you, when you look at paper packaging and flexibles, scores in our customer satisfaction index and our net promoter score. There is no -- it's not a surprise, that those two businesses are growing in excess of the market, and that's the big part of our strategy. And when you look at RIPS, I will tell you, that about 11% of our operations are underperforming in regard to net promoter score and customer satisfaction, and it is aligned to growth trajectory and performance in the business. So I think, on a high level, your analysis is accurate, and I will trust you, we are working very diligently with that 11% to improve the performance. We have got good people in place. We have good plans, and I think you will see a correlation, once we get that business to higher levels, that you will see a more consistent volume trajectory across the whole portfolio.

And then George, on the tax component. You have tax exams and true-ups and revisits to tax positions you have had, and particularly as we are doing a deep dive into all of the tax law changes, you visit your reserves, and when you end up making adjustments, it can impact a particular quarter. As well, we have had this same scenario that we have talked about in the past with the standard Fin 18, that requires that you cannot book the benefit of loss carry forwards for operations that have turned around. In the year, when it starts to turn around, you can't do it until the end of the year. So you have some fluctuations that occurs from quarter-to-quarter, and those factors combined to drive that effective tax rate for the quarter, up to that 34.2% on adjusted basis, and our expectation right now, is that we gave the range of 28% to 32% for that, for the year. Where we would calculate it now, is right -- maxed in the middle of that. But there are things that could shift it one way or the other. But our expectation, what we know about things that we are doing, we anticipate it being in the center of that range for the year.

Your next question comes from Kurt Yinger with D.A. Davidson. Your line is open.

Good morning Pete and Larry.

Good morning Kurt.

Two quick questions. First, a couple of quarters ago, you had outlined hopes, for I believe, 8% gross profit improvement in RIPS this year. Just given where volumes and price costs have trended, is there sort of a new goal for the year, and where does that fit?

Kurt, clearly the rapid increase in the cost of steel, and as well as some of the other raw materials, have pushed back that opportunity. That said, we generally are always looking for us to deliver a 20% plus gross margin on a RIPS basis, on a global basis. That's what we are always looking for. Obviously, as the cost and price goes up, percentage goes down, if your dollar margin remains the same. So in an inflating cost environment, you have also got that impact occurring. So we did not anticipate this environment, at the time we were talking in those terms. So we remain committed to trying to drive to that 20%, being our annual gross margin in our RIPS business.

Okay. I mean, is it fair to say that, in the third quarter, you still might be a bit below that and sort of trend higher into the fourth quarter, to going into 2019, you would be at that goal?

That would be consistent with the way that our models are showing right now, Kurt, and obviously depending on what happens in the environment relative to steel costs, which is the big driver for us. So if it goes to the level that I communicated earlier, where basically flat, even a slight trending down in the rest of the world, and if the U.S. starts to mitigate in the latter part of this quarter, then yeah, that should play out exactly as you stated.

Great. Thank you. And then, last question, are there informal volume commitments with customers for any of the RIPS expansion project?

Yes.

Okay. Great. Thank you.

Your next question comes from Chris Manuel with Wells Fargo Securities. Your line is open.

[indiscernible] towards the end gentlemen, I will try and make them quick. One is a housekeeping. Larry, I remember a $10 million to $30 million use for working capital in prior free cash guidance. Does that still hold true, with inflation and everything else that's going on?

Yes.

Okay. And then to piggyback off the last question, not to put the cart before the horse, but seems like, we'd assume that you guys had some anchor customers with those investments. Is it logical that you might get in excess of $34 million to $35 million of OP, as you grow with other customers beyond anchor, or does that incorporate that already?

I mean Gabe, that's always obviously objective. What we tried to and still discipline, is what we want to have in our capital cases, is what we believe is most likely, given everything that we know at the beginning, we don't try to build optimistic business cases, which actually did occur in the past. And so we are not pessimistic, we are not optimistic, but then obviously, once we get things in place, we will try to beat it.

Thank you.

Your last question comes from George Staphos with Bank of America Merrill Lynch. Your line is open.

Hey guys, thanks. Just more for the record and housekeeping. Just to be clear, the pension funding, the $70 million, that's a onetime item in fiscal 3Q, that is not part of your free cash flow guidance, I just want to be clear on that. If you had in your materials, I missed it, I apologize. And then Larry, back to my question on tax, so you said you will be right in the middle of your tax rate guidance for the year, given what you know right now. Given that you had a 34% in fiscal 2Q, would that not suggest, haven't done the math yet, but that does not suggest that you were lower than your target range for the year, in the back half of the year, and if you had any kind of precision on that, that'd be great. Thanks and good luck in the quarter.

Sure, thanks George. The pension item, just to be clear, we already have put $10 million in the pension in December. We look at this $70 million as a onetime unusual item. So it is not included in that $200 million to $220 million free cash flow guidance. And on the tax rate, yes, your assumption is correct. Clearly for us to be at the midpoint of that range, which is where we think we will be, but you know, obviously, we give a range for a reason; is that, to get there, we'd obviously have to be on the lower end in the back half of the year.

Okay. Thank you very much guys.

Thank you, George.

And at this time, I will turn the call over to Mr. Eichmann.

Thanks a lot Sharon. That concludes today's second quarter conference call. We appreciate your interest in Greif and hope you have a great remainder to the week.

This concludes today's conference call. You may now disconnect.