Sonoco Products Company — Form 10-Q, 2012 Q3
Business context and period: Sonoco provides consumer, industrial and protective packaging and packaging services. This filing covers the three and nine months ended September 30, 2012; comparative periods ended October 2, 2011. Interim statements are unaudited and were reviewed, not audited, by the independent accounting firm.
Financial performance and position
Amounts are in millions of dollars except per-share data. “Base” results are management’s non-GAAP measures, adjusted for specified restructuring and other items.
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $1,195.5 | $1,124.2 | $3,610.3 | $3,369.4 |
| Income before interest and taxes | $96.3 | $84.8 | $263.8 | $256.6 |
| Net income attributable to Sonoco | $58.8 | $77.2 | $153.2 | $188.0 |
| Diluted EPS | $0.57 | $0.76 | $1.49 | $1.84 |
| Base diluted EPS | $0.55 | $0.66 | $1.65 | $1.82 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $296.5 | $131.9 |
- Sales and margins: Q3 sales increased 6.3%; nine-month sales rose 7.1%. Management reported base operating margin of 7.8% in Q3 versus 8.8%, and 7.9% year to date versus 8.4%.
- Cash flow and investment: Nine-month capital expenditures were $158.2 million, versus $124.5 million. Operating cash flow less capital expenditures was approximately $138.3 million, compared with $7.4 million in the prior period. Management attributed much of the cash-flow improvement to lower pension contributions and improved receivables-related cash use.
- Debt and liquidity: Cash was $201.1 million at September 30, up from $175.5 million at year-end 2011. Total debt, including current maturities, was approximately $1,236.5 million, down about $50.2 million from year-end. The company reported $10 million of commercial paper outstanding and entered into a new $350 million, five-year bank credit agreement on October 12, 2012. Debt covenants were reported substantially above required minimums.
- Other metrics: Q3 and nine-month effective tax rates were 31.2% and 33.5%, respectively, compared with 3.1% and 22.2% in 2011. Quarterly dividends were $0.30 per share; the board declared another $0.30 dividend payable in December.
Material changes versus prior periods
- Most sales growth reflected Tegrant, acquired in November 2011: acquisition-related sales added about $120 million in Q3 and $358 million year to date. Excluding acquisitions, management said operating profits were down more than 15% for Q3 and approximately 6% year to date.
- Q3 sales gains also included $10 million from volume/mix, offset by $32 million from lower selling prices and $27 million from foreign currency translation and other items. Year-to-date changes included negative volume/mix of $15 million, lower prices of $22 million, and negative currency/other effects of $80 million.
- Consumer Packaging and Paper and Industrial Converted Products posted lower Q3 segment operating profit, down 16.3% and 12.8%, respectively. Packaging Services profit rose 6.1%. Protective Packaging profit increased substantially, primarily because of Tegrant. Year to date, Packaging Services profit fell 30.2%, while Protective Packaging rose 192.3%, mostly due to the acquisition.
- Net income attributable to Sonoco fell despite higher reported sales and operating income. Comparisons were affected by the prior-year $18.8 million tax benefit from deferred-tax valuation allowance adjustments, and by higher 2012 interest expense following Tegrant’s acquisition. Base earnings also declined.
Outlook, commentary, risks and unusual items
- Management forecast approximately $60 million of capital spending for the remainder of 2012 and approximately $8.2 million of additional pension and postretirement plan contributions. It expected about $7.5 million of additional charges for previously announced restructuring actions, mostly incurred and paid by year-end; approximately $0.7 million of future charges was also expected for earlier actions. No full-year revenue or earnings guidance is stated in the provided filing text.
- Management said paperboard mill operating problems identified in the quarter had been resolved and were not expected to weigh on future operating profit. It cited higher pension, labor, maintenance and other costs, unfavorable product mix, currency effects, pricing and demand as factors affecting results. Tegrant’s retail packaging business had lower-than-expected sales and profit amid customer churn and weaker demand.
- Q3 2012 results included a net after-tax benefit of $2.6 million from facility-sale gains and insurance recoveries, partly offset by non-base charges. Nine-month results included $16.5 million of after-tax restructuring and other non-base charges. The prior-year tax benefit materially affects comparisons.
- Environmental contingency: Environmental reserves totaled $76.9 million at September 30. The Fox River reserve for potential liabilities associated with Operating Units 2–5 was $52.3 million, in addition to $3.2 million accrued for the separate Site cleanup. Sonoco stated that estimates and allocation of responsibility remain uncertain; it believes additional consolidated exposure is limited to U.S. Mills’ equity position, approximately $90 million, but outcomes are not assured.
- Goodwill: No impairment was identified in the 2012 annual test. Management identified Plastics—Blowmolding and Rigid Paper—Europe as comparatively more exposed if projected results fail to materialize. Packaging Services also has customer concentration and a major customer contract due for renegotiation in coming years.
- Other risks identified include raw-material availability and prices, demand and pricing pressure, pension obligations, foreign exchange and interest-rate movements, restructuring execution, acquisition integration, tax contingencies and environmental remediation. Management reported disclosure controls effective and no material quarterly change in internal control over financial reporting; Tegrant was excluded from the control assessment while its environment was being evaluated.
Important facts for investors to verify
- How much of Tegrant’s contribution is being sustained, and how legacy business volumes, mix and segment margins are trending.
- Whether higher pension, labor, maintenance and other costs are offset by productivity and price/cost improvements.
- Cash conversion, capital spending, debt reduction, interest costs and compliance with credit covenants.
- The timing and final cost of restructuring, and whether forecast 2012 charges and payments were realized.
- Developments in Fox River litigation and remediation, other environmental liabilities, and the assumptions behind the recorded reserves.
- Goodwill headroom and the customer-renewal risk in Packaging Services, alongside performance at the identified higher-risk reporting units.
- The effects of tax-rate variability, foreign-cash repatriation taxes and currency and commodity hedges on future results.