Packaging Corporation of America — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. PCA makes corrugated packaging and containerboard and, following its October 2013 acquisition of Boise Inc., also produces white papers. Comparisons with 2013 are significantly affected by Boise’s inclusion in 2014 results.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $1,518.9 million | $845.4 million | $4,418.7 million | $2,400.9 million |
| Gross profit | $320.3 million | $227.6 million | $932.5 million | $608.1 million |
| Income from operations | $188.4 million | $142.8 million | $529.5 million | $359.0 million |
| Net income | $104.4 million | $84.7 million | $294.1 million | $213.2 million |
| Diluted EPS | $1.06 | $0.87 | $2.99 | $2.19 |
- Q3 sales rose 79.7%; nine-month sales rose 84.0%. Management attributed most of the increase to Boise, while PCA’s pre-acquisition operations also grew.
- Gross margin was 21.1% in Q3 and for the nine-month period, versus 26.9% and 25.3%, respectively, a year earlier. Management cited the addition of the lower-margin white paper business and DeRidder restructuring charges.
- Q3 operating income included $29.0 million of special items; nine-month operating income included $77.4 million. Excluding special items, net income was $123.9 million ($1.26 per diluted share) in Q3 and $344.2 million ($3.50 per diluted share) for nine months. These are non-GAAP measures.
- Q3 segment operating income was $164.7 million for Packaging and $43.0 million for Paper; Corporate and Other reported a $19.3 million loss.
- Nine-month operating cash flow was $556.7 million, compared with $420.2 million. Capital expenditures were $254.9 million; cash used in investing activities was $283.6 million. Cash declined $36.6 million to $154.3 million.
- At September 30, 2014, total debt was approximately $2.357 billion, including $6.5 million current maturities; the revolving facility was undrawn, with $325.0 million of available capacity net of letters of credit. Debt was reduced by $191.7 million net during the first nine months.
- The company issued $400 million of 3.65% senior notes due 2024 and used the proceeds, along with operating cash, to repay debt. Approximately 70% of debt was fixed-rate; management estimated a 1% rate rise on variable-rate debt would increase annual interest expense by $7.1 million.
Material changes and unusual items
- Boise’s results are included for all of 2014, but not for the comparable 2013 periods. Management said the acquisition contributed meaningfully to earnings before special items, including through integration synergies and white paper operating improvements.
- PCA completed the DeRidder No. 3 newsprint-machine conversion to containerboard on October 17, 2014, after exiting the newsprint business. Related restructuring charges were $47.8 million for nine months, mainly accelerated depreciation.
- Nine-month special items also included a $17.6 million settlement of the Kleen Products antitrust class action and $12.0 million of integration-related and other costs. The settlement received final court approval in September and was paid into escrow in June.
- Effective January 1, 2014, PCA changed certain inventory costing from LIFO to average cost, applied retrospectively. The filing states reported 2014 nine-month net income was $1.5 million lower than it would have been under the former method; September inventory was $69.3 million higher under the new method.
- Dividends declared were $0.40 per share in Q3, unchanged from Q3 2013; $118.0 million of dividends were paid during the first nine months.
Outlook, risks and contingencies
- Management expected Q4 2014 earnings excluding special items to be below Q3’s level, citing three fewer shipping days, seasonal demand softness, lower white paper shipments, higher annual outage-cost amortization, and seasonal fuel and transportation costs. DeRidder’s conversion was expected to raise containerboard production and reduce outside purchases.
- Management estimated 2014 capital investments of about $410 million, including acquisition synergies, Boiler MACT work, and the DeRidder project; estimated Boiler MACT spending was up to $25 million.
- Risks identified include economic and industry conditions, product demand and pricing, wood and recycled fiber and energy costs, operating interruptions, Boise integration, and environmental or tax regulation. About 22% of employees were covered by collective bargaining agreements expiring within 12 months.
- Office Depot, including OfficeMax, represented 9% of company sales and 44% of Paper segment sales in both reported periods. PCA disclosed that this customer concentration creates business and credit exposure.
- The company reported no material liabilities known from guarantees or indemnifications, and said other ordinary-course legal actions were not reasonably likely to have a material adverse effect. The filing reports no material changes to the previously disclosed risk factors.
Most important facts for investors to verify
- How much of reported growth and margin performance reflects Boise’s addition versus comparable organic performance, and whether projected integration benefits are being realized.
- The sustainability of operating cash flow and the funding of the approximately $410 million 2014 capital program, dividends, and ongoing debt service.
- Progress and costs associated with the DeRidder conversion, including whether added containerboard capacity delivers expected production, grade-mix, and freight benefits.
- Exposure to Office Depot/OfficeMax, paper-market structural decline, input-cost volatility, labor negotiations, and environmental compliance spending.
- Reported results against management’s Q4 expectation of lower earnings excluding special items; review the company’s non-GAAP reconciliations alongside GAAP results.