SONOCO PRODUCTS CO quarterly report, Q2 FY2014

Sonoco Products Company — Q2 2014 Form 10-Q

Reporting period: Three and six months ended June 29, 2014. Sonoco makes consumer and industrial packaging, protective packaging, and related services. The interim financial statements are unaudited; the independent accountant performed a review, not an audit.

Financial performance

Metric	Q2 2014	Q2 2013	First half 2014	First half 2013
Net sales	$1,247.4m	$1,226.3m	$2,433.0m	$2,405.5m
Gross profit	$231.7m	$222.6m	$444.0m	$428.3m
Income before interest and taxes	$101.6m	$92.0m	$188.2m	$173.5m
Net income attributable to Sonoco	$61.5m	$55.0m	$113.8m	$103.1m
Diluted GAAP EPS	$0.59	$0.53	$1.10	$1.00

• Management’s non-GAAP “base” diluted EPS was $0.63 for Q2 versus $0.59, and $1.15 for the first half versus $1.09. Base results exclude restructuring and other specified items.
• Management reported a 50-basis-point increase in gross margin in both comparative periods, attributing improvement to favorable price/cost, productivity, and lower pension expense. Q2 sales rose 1.7%; first-half sales rose 1.1%, while overall volume was essentially flat.
• First-half operating cash flow was $105.5m, down from $244.5m. Capital spending was $85.9m; investing cash outflow was $93.1m. Financing cash outflow was $31.0m, and cash declined $17.8m to $199.8m.
• At June 29, cash was $199.8m; debt was approximately $1.0bn, including $51m of commercial paper. Current debt and notes payable were $90.1m and long-term debt was $947.1m. The $350m commercial-paper program is supported by a credit facility committed through October 2017; the company reported covenant headroom substantially above minimums.
• Quarterly dividends were $0.32 per share; first-half dividends paid totaled $64.4m. The company repurchased about 649,000 shares under its program in the first half at a cost of $27.1m.

Changes and segment performance

• Q2 operating income increased 10.4%; first-half operating income increased 8.5%. Lower restructuring charges and improved segment operating results contributed. Net interest expense declined, mainly following repayment of 6.5% debentures that matured in November 2013.
• Paper and Industrial Converted Products was the strongest contributor: Q2 segment operating profit rose 29.3%, and first-half profit rose 13.9%, supported by price/cost and productivity. Management cautioned that some Q2 price/cost benefit was temporary and expected it to dissipate as costs and prices reset in Q3.
• Display and Packaging operating profit increased 23.8% in Q2 and 34.4% in the first half, with domestic display and fulfillment activity helping. Consumer Packaging profit declined 9.6% in Q2 amid weaker North American composite-can demand, unfavorable mix, and higher costs. Protective Solutions profit fell 15.3% in Q2 and 29.3% for the first half, affected by price/cost pressure, startup costs at a Mexico facility, and winter weather.
• Effective January 1, 2014, Sonoco Alloyd was moved from Protective Solutions to Display and Packaging; comparative segment results were recast.

Outlook, risks, and unusual items

• The filing provides no specific full-year earnings or EPS guidance. Management expected approximately $100m of additional capital spending in the remainder of 2014, about $12m of additional pension and postretirement contributions, and repurchase of approximately 1.3m additional shares under the existing program.
• Approximately $1.3m of future charges were expected for announced restructuring actions, mostly to be incurred and paid by year-end 2014; a further approximately $0.7m was expected for older restructuring actions. The company continued to evaluate its cost structure and said further actions were possible.
• Cash generation was pressured by higher pension contributions, receivables growth, tax-payment timing, and a $14.7m payment in April toward a proposed Fox River settlement. Severe winter weather also disrupted production and raised costs, particularly in industrial businesses.
• Fox River environmental exposure remains contingent: the proposed settlement assigns U.S. Mills $14.7m but requires court approval and could be withdrawn. The company had a $34.0m reserve for OUs 2–5 liabilities plus a separate $3.2m Site-remediation accrual; it stated the timing and outcome remain uncertain. Total environmental accruals were $58.0m. The company believes its additional consolidated exposure beyond reserves is limited to U.S. Mills’ equity, approximately $97m, but that assessment depends on legal and allocation outcomes.
• A prior-period deferred-tax valuation-allowance error was corrected in the current period: long-term deferred tax assets were reduced $11.8m with a corresponding reduction to comprehensive income through accumulated other comprehensive loss. Management said the error was not material to prior or current financial statements.
• Goodwill impairment sensitivity was highlighted for Plastics–Blowmolding and Plastics–Thermoforming; management also noted customer concentration and future contract negotiations in Display and Packaging. Blowmolding performance improved in Q2 after short-term issues in Q1. Venezuela currency restrictions create potential translation and asset-impairment risk; alternative exchange rates could imply estimated translation losses of $2m or $4m.
• Disclosure controls and procedures were assessed as effective, with no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

• Whether the Q2 price/cost and productivity gains persist as management’s expected Q3 price and material-cost resets occur.
• Whether operating cash flow recovers from the first-half decline and supports planned capital spending, dividends, buybacks, and pension funding.
• The approval, final cost, and allocation of the Fox River settlement and whether environmental reserves remain adequate.
• Progress in Consumer Packaging and Protective Solutions, including resolution of the flexible-packaging production issue and Mexico facility startup costs.
• Updates on restructuring cash costs, goodwill impairment assumptions, and the Display and Packaging customer contract concentration.