Packaging Corporation of America — FY 2018 Form 10-K
Reporting period: Year ended December 31, 2018. The filing was signed February 28, 2019. PCA produces containerboard and corrugated packaging, as well as uncoated freesheet paper, primarily in the United States.
Financial performance
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net sales | $7,014.6 million | $6,444.9 million | +8.8% |
| Gross profit | $1,645.3 million | $1,470.8 million | +11.9% |
| Income from operations | $1,067.7 million | $932.5 million | +14.5% |
| Net income | $738.0 million | $668.6 million | +10.4% |
| Diluted EPS | $7.80 | $7.07 | +10.3% |
| Operating cash flow | $1,180.1 million | $856.1 million | +$324.0 million |
| Capital expenditures | $551.4 million | $343.0 million | +$208.4 million |
Calculated from reported figures, gross margin was approximately 23.5% (2017: 22.8%), operating margin 15.2% (14.5%), and net margin 10.5% (10.4%). Operating cash flow less property, plant and equipment additions was approximately $628.7 million; this is a simple calculation, not a company-reported non-GAAP measure.
- Segments: Packaging sales rose 11.8% to $5,938.5 million and operating income increased to $1,045.4 million from $950.3 million. Paper sales fell 4.7% to $1,002.0 million, while operating income increased to $97.7 million from $54.0 million.
- Packaging growth reflected higher prices and mix and stronger volumes; containerboard outside shipments rose 10.7%, while corrugated shipments increased 5.6% in total. Paper revenue declined primarily because Wallula production was converted away from paper.
- Reported net income included $22.4 million of net special-item expense in 2018, versus $99.5 million of net special-item income in 2017, largely due to the prior-year $122.1 million tax-reform benefit. Excluding special items, net income was $760.4 million versus $569.1 million, and diluted EPS was $8.03 versus $6.02. These are non-GAAP measures.
- Fourth-quarter 2018 sales were $1,746.6 million and net income was $204.6 million, compared with $1,684.3 million and $268.9 million, respectively, in fourth-quarter 2017. The year-over-year net-income comparison includes the substantial 2017 tax-reform benefit.
Cash, debt, and liquidity
- Year-end cash and cash equivalents were $361.5 million, up from $216.9 million. PCA also had $326.9 million of unused revolving-credit capacity, net of letters of credit.
- Total debt obligations were approximately $2.50 billion, down from $2.65 billion. The outstanding notes were fixed-rate, with a weighted-average rate of 3.64%; PCA reported compliance with debt covenants.
- Cash flow from operations increased by $324.0 million. Management attributed the improvement to stronger operating results, lower pension contributions, and working-capital and tax-payment timing; cash flow also benefited from receipt of $17.0 million in DeRidder insurance proceeds.
- Dividends paid were $268.1 million. The company declared $3.00 per share for 2018 and raised its quarterly dividend in May; the new annualized rate was $3.16 per share. No shares were repurchased under the board-authorized program during 2018.
Material changes, outlook, and risks
- In May 2018, PCA converted Wallula’s No. 3 machine from white paper to a 400,000-ton-per-year virgin kraft linerboard machine. The filing reports $30.0 million of related restructuring charges in 2018 and a $3.1 million impairment of associated fiber-farm assets.
- PCA acquired Englander dZignPak for $56.3 million in October 2018. The Sacramento Container acquisition completed in 2017 contributed to Packaging volume growth.
- For first-quarter 2019, management expected strong Packaging demand and continued strong Paper market conditions, but forecast earnings excluding special items below fourth-quarter 2018. Expected pressures included wage and benefit increases, some chemical and maintenance-cost inflation, seasonal energy and wood costs, and a slightly higher tax rate. Management expected freight and recycled-fiber costs to be fairly flat and no significant special items.
- Planned 2019 capital investment was $390–$410 million, including an estimated $10 million for environmental compliance. Year-end capital commitments were $112.8 million.
- Principal risks include cyclical product pricing and demand, competition, rising fiber, energy, chemical and transportation costs, facility disruptions, environmental regulation, labor negotiations, pension funding and cyber incidents. Communication-paper demand faces continued substitution by electronic alternatives.
- Office Depot represented 47% of Paper segment sales and 7% of consolidated sales in 2018. Its supply agreement required PCA to supply at least half of its commodity office-paper requirements through December 2019, subject to termination circumstances; the filing notes renewal provisions and possible phase-out obligations.
- Litigation arising from the February 2017 DeRidder mill explosion, which caused three contractor fatalities and other injuries, remained in early stages; PCA said it could not estimate a reasonable range of possible losses. The EPA investigation was ongoing. Environmental reserves totaled $27.3 million; management did not expect additional future environmental expenditures above the reserve to have a material impact.
- Adoption of the new lease standard in January 2019 was expected to add approximately $220–$240 million of lease liabilities and corresponding right-of-use assets, without a material effect on earnings, liquidity, or debt covenants.
Important facts for investors to verify
- Whether Packaging pricing, shipment growth, and margins remain resilient as industry inventories and capacity change.
- Execution, costs, and expected returns from the Wallula conversion and elevated Packaging capital spending.
- Office Depot contract renewal, purchasing levels, and customer-credit exposure as the agreement approaches renewal.
- Cash generation after capital investment, dividend payments, and upcoming debt maturities, including the $500 million note maturity in 2020.
- Developments in the DeRidder lawsuits and EPA investigation, environmental obligations, and any changes to the recorded reserves.
- Underlying performance versus reported results: 2017 included a large tax-reform benefit, and management’s adjusted earnings and EBITDA measures exclude selected special items.
The independent auditor gave an unqualified opinion on the consolidated financial statements and internal control over financial reporting as of December 31, 2018.