Sonoco Products Company — 2015 Q3 Form 10-Q
Reporting period: Quarter and nine months ended September 27, 2015. Amounts below are in U.S. dollars; financial results are unaudited. The 2014 comparative results were restated.
Business context and financial performance
Sonoco provides consumer and industrial packaging, protective packaging, and packaging supply-chain services through four reportable segments. It operates approximately 334 locations in 34 countries.
| Metric | Q3 2015 | Q3 2014 restated | Nine months 2015 | Nine months 2014 restated |
|---|---|---|---|---|
| Net sales | $1,242.6m | $1,262.5m | $3,697.2m | $3,700.2m |
| Gross profit | $229.4m | $222.4m | $690.1m | $661.2m |
| Gross margin | 18.5% | 17.6% | 18.7% | 17.9% |
| Income before interest and taxes | $79.5m | $106.0m | $302.5m | $288.9m |
| Net income attributable to Sonoco | $43.9m | $67.1m | $194.1m | $176.9m |
| Diluted EPS attributable to Sonoco | $0.43 | $0.65 | $1.90 | $1.71 |
Management’s non-GAAP “base” diluted EPS was $0.65 for Q3 2015 versus $0.69 a year earlier, and $1.87 for the first nine months versus $1.80. Base measures exclude specified restructuring, impairment, acquisition, tax, and other items; they are not GAAP results.
Cash flow, debt and liquidity
- Operating cash flow for the first nine months was $318.1m, up from $267.4m. Investing used $129.8m and financing used $156.3m; cash increased $32.3m to $193.4m.
- Capital expenditures were $140.9m for the period; management expected approximately $60m of additional spending during the remainder of 2015.
- Balance-sheet debt, including current maturities, was approximately $1.20bn at September 27, versus approximately $1.25bn at December 31, 2014. The filing separately reports outstanding debt of $1.20bn at quarter-end versus $1.02bn a year earlier. Long-term debt carrying value, excluding current maturities, was $1.07bn.
- The $350m commercial-paper program had no commercial paper outstanding; it is supported by a $350m revolving credit facility committed through October 2019. The company reported covenant measures substantially above required minimums.
- Current assets were $1.40bn and current liabilities $974.7m. Cash held outside the United States was $77.9m; the company said it had no current plan to repatriate offshore cash.
Material changes and management commentary
- Q3 sales declined 1.6%; foreign currency translation and lower selling prices were largely offset by acquisition sales and modest volume growth. For nine months, sales were essentially flat: acquisitions and volume gains were offset by currency translation and lower prices tied to lower input costs.
- Management cited favorable price/cost relationships and productivity as drivers of higher gross margins. Q3 base EPS nevertheless fell 5.8%, with lower Paper and Industrial Converted Products results, higher pension, labor, maintenance and other costs, and currency effects weighing on performance.
- Segment operating profit for Q3 increased in Consumer Packaging, Display and Packaging, and Protective Solutions, but fell 34.1% in Paper and Industrial Converted Products. For nine months, segment operating profit rose in Consumer Packaging and Protective Solutions and declined in the other two segments.
- For the nine-month period, reported GAAP earnings included substantial non-base items, including a $32.5m pretax Fox River reserve reversal and gains associated with the sale of two metal-ends facilities. Restructuring, Venezuelan impairment, investigation costs, and acquisition costs partly offset those gains.
- Sonoco acquired a 67% controlling interest in Brazilian flexible-packaging company Graffo in April 2015 and acquired a high-density wood-plug business in September. The company also announced an intention to offer its Schweighouse-sur-Moder, France paper mill for sale after quarter-end.
Outlook, risks and unusual items
- The filing provides no specific full-year earnings or sales guidance. Management expected about $6.5m of additional charges for announced restructuring actions, mostly by year-end 2015, with most related costs expected to be paid by mid-2016. It also anticipated approximately $6m of additional pension and postretirement contributions in 2015.
- In Q3 Sonoco began translating Venezuelan operations at the SIMADI rate of 198 bolivars per U.S. dollar instead of the prior official rate of 6.3. Remeasurement and asset impairment charges totaled $12.1m, with no tax benefit recorded; the company reported remaining Venezuela exposure of approximately $2.5m.
- Restatement: an investigation found unsupported journal entries and other actions at the Irapuato, Mexico contract-packaging center, misstating financial-statement items from 2011 through Q1 2015. The company estimated cumulative net-income overstatement of approximately $23.3m through Q1 2015. Cash and previously reported operating cash flows were not affected. Prior-period financial statements were restated.
- Internal-control warning: management concluded disclosure controls and procedures were not effective at September 27, 2015 because of material weaknesses in internal control over financial reporting. Remediation had begun during Q3 and was ongoing.
- Fox River: a remaining Appvion CERCLA claim seeks approximately $200m from eight defendants. Sonoco had $4.4m reserved for its subsidiary’s remaining claim at quarter-end; the company said potential costs could exceed the reserve and that it could not estimate additional exposure. Trial was scheduled for June 2016.
- Other risks include foreign-exchange movements, raw-material and energy costs, pension obligations, restructuring execution, environmental matters, and possible goodwill impairment. No goodwill impairment was identified in the 2015 annual test, but management identified certain reporting units as more exposed if performance falls short of assumptions.
Important facts for investors to verify
- Whether internal-control remediation has been completed and whether subsequent filings report effective controls.
- Whether the Irapuato restatement, investigation costs, and corrective actions are fully reflected in reported periods.
- Developments in the Appvion Fox River litigation, including any change to the $4.4m reserve or estimated exposure.
- Whether the Q3 improvement in gross margin and base earnings is sustained, particularly in Paper and Industrial Converted Products.
- Execution and cash costs of restructuring, planned capital spending, debt maturities, and pension contributions.
- Effects of currency translation, especially Venezuela, and assumptions underlying goodwill valuations.