Sonoco Products Company — Q2 2016 Form 10-Q
Reporting period: Three and six months ended July 3, 2016; comparisons are to the periods ended June 28, 2015. Sonoco provides consumer, industrial and protective packaging and related services across four reportable segments. Financial statements are unaudited and received a limited review, not an audit.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net sales | $1,205.7m | $1,248.6m | $2,432.0m | $2,454.6m |
| Gross profit | $242.0m | $240.3m | $487.3m | $460.7m |
| Gross margin | 20.1% | 19.2% | 20.0% | 18.8% |
| Income before interest and taxes | $92.1m | $99.0m | $194.0m | $223.1m |
| Net income attributable to Sonoco | $56.3m | $64.4m | $116.2m | $150.2m |
| Diluted EPS attributable to Sonoco | $0.55 | $0.63 | $1.14 | $1.47 |
Management’s non-GAAP “base” diluted EPS was $0.73 for Q2 versus $0.68, and $1.38 for the first half versus $1.22. Base results exclude restructuring and impairment charges and other specified items; they are not GAAP measures.
For the first half, operating cash flow was $186.0m (prior year $173.1m); capital spending was $98.8m (prior year $86.7m). Cash and equivalents were $107.7m at July 3, down from $182.4m at year-end 2015. Total debt was approximately $1.08bn, compared with $1.13bn at year-end; balance-sheet current and long-term debt totaled $1.082bn. The company had $14m of commercial paper outstanding and a $350m commercial paper program backed by a revolving facility committed through October 2019. It reported covenant ratios substantially above required minimums.
Cash dividends paid in the first half were $72.7m; the quarterly dividend was declared at $0.37 per share. Total assets were $3.965bn and shareholders’ equity including noncontrolling interests was $1.576bn at July 3.
Changes and segment performance
- Q2 sales declined 3.4%; first-half sales declined 0.9%. Lower selling prices, foreign-currency translation and the loss of Irapuato, Mexico contract-packaging business weighed on revenue; volume and mix were favorable overall.
- GAAP Sonoco-attributable income fell 12.6% in Q2 and 22.6% in the first half. Comparisons were affected by 2015 gains, including the Fox River reserve reversal and proceeds/gains from metal-ends plant sales, while 2016 included higher restructuring and asset-impairment costs.
- Q2 segment operating profit improved in Consumer Packaging, Display and Packaging, and Protective Solutions, but declined 3.8% in Paper and Industrial Converted Products. First-half segment operating profit increased in all four segments; total company GAAP operating income nevertheless declined because of higher restructuring charges and prior-year other gains.
- Management attributed stronger margins chiefly to favorable price-versus-cost trends, productivity and lower pension costs. Higher labor, maintenance and other operating expenses and adverse currency translation partly offset these benefits.
Outlook, risks and unusual items
- No specific earnings guidance is stated in the supplied filing text. Management expected approximately $100m of capital spending during the remainder of 2016, approximately $62m of additional 2016 share repurchases, and approximately $10.3m of additional pension and postretirement contributions. It expected most remaining restructuring costs to be paid by year-end; about $3.85m of future charges were expected for announced actions.
- Q2 restructuring and impairment charges were $23.3m; first-half charges were $32.5m. They included a $12.7m loss on the sale of a French paperboard mill and impairment related to the Puerto Rico retail-security packaging business, sold July 5, after quarter-end.
- Corrugating medium faced excess North American supply, lower prices and reduced volumes; management was considering operating-schedule changes, cost reductions and strategic partnerships. A major Consumer Packaging customer contract was under negotiation, with possible loss of business or lower margins. Display and Packaging goodwill also depends in part on retaining or replacing concentrated customer business.
- A Fox River CERCLA claim by Appvion asserts approximately $200m against eight defendants, including Sonoco subsidiary U.S. Mills. Sonoco had $3.3m reserved and said it could not estimate potential liability beyond that reserve; it stated the subsidiary’s equity of about $127.5m represented the maximum additional exposure to the consolidated financial position. Trial was scheduled for 2017.
- Environmental contingency accruals totaled $24.5m. Other key exposures include commodity, foreign-exchange and pension risks. Sonoco uses hedges, but actual costs and hedge outcomes may differ from estimates.
- Management stated the previously identified material weakness in internal control over financial reporting had been remediated as of July 3, 2016. Disclosure controls were deemed effective. The 2015 comparative results included a $32.5m Fox River reserve reversal and other material gains that complicate year-over-year comparisons.
Important facts for investors to verify
- Reconcile GAAP earnings with management’s base earnings and review the exclusions and tax effects underlying the non-GAAP comparisons.
- Track whether the customer contract under negotiation is retained, and monitor customer concentration and the effect of the Irapuato business loss.
- Assess progress and cash costs of restructuring, including the French mill disposition, Puerto Rico sale and remaining announced actions.
- Follow the Appvion Fox River litigation, its reserve adequacy, and any change in estimated exposure or trial timing.
- Review cash generation against planned capital spending, pension contributions, dividends and share repurchases, as well as debt and covenant headroom.
- Monitor corrugating medium performance, goodwill impairment assumptions for higher-risk reporting units, and whether the remediated internal control continues to operate effectively.