Packaging Corporation of America — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; compared with the corresponding 2018 periods. PCA manufactures corrugated packaging, containerboard and communication papers, primarily in the United States.
Financial results
| Metric | Q3 2019 | Q3 2018 | First nine months 2019 | First nine months 2018 |
|---|---|---|---|---|
| Net sales | $1,750.7 million | $1,809.9 million | $5,244.3 million | $5,268.1 million |
| Gross profit | $411.4 million | $443.2 million | $1,260.7 million | $1,219.9 million |
| Income from operations | $262.8 million | $298.5 million | $818.6 million | $781.0 million |
| Net income | $179.8 million | $206.7 million | $560.2 million | $533.4 million |
| Diluted EPS | $1.89 | $2.18 | $5.91 | $5.64 |
| Operating cash flow | Not separately stated | Not separately stated | $878.2 million | $834.5 million |
- Q3 revenue fell 3.3% and net income fell 13.0% year over year. Gross margin was approximately 23.5%, versus 24.5%; operating margin was 15.0%, versus 16.5%.
- For the first nine months, revenue declined 0.5%, while net income rose 5.0%. Gross margin improved to approximately 24.0% from 23.2%; operating margin rose to 15.6% from 14.8%.
- Q3 diluted EPS excluding special items was $1.92, versus $2.23. Nine-month adjusted diluted EPS was $5.94, versus $5.87. These are company-defined non-GAAP measures.
- Cash and equivalents were $738.3 million at September 30, up from $361.5 million at December 31, 2018. PCA also reported $329 million of unused revolving-credit capacity, net of letters of credit.
- Long-term debt was $2,486.3 million; the debt note reports $2,496.8 million of fixed-rate senior notes outstanding. All outstanding debt was fixed-rate. Cash exceeded reported long-term debt by roughly $1.75 billion, before considering other obligations.
- Nine-month capital expenditures were $263.8 million, down from $404.3 million. Operating cash flow less reported capital expenditures was approximately $614 million. Dividends paid were $223.9 million, and declared dividends were $0.79 per share in Q3.
Material changes and segment performance
- Packaging: Q3 sales decreased 2.9% to $1,489.9 million, and operating income fell to $235.1 million from $284.4 million. Lower domestic and export containerboard prices, corrugated pricing and mix, volume, and higher operating and converting costs were key drags; lower outage and freight costs partly offset them. Nine-month operating income declined to $748.6 million from $782.3 million.
- Paper: Q3 sales decreased 4.5% to $242.8 million, mainly on lower volume, partly offset by improved pricing and mix. Operating income increased to $48.1 million from $32.3 million. Nine-month operating income rose to $132.5 million from $55.7 million, reflecting higher prices and mix, lower operating costs and depreciation, partly offset by reduced volume.
- The Wallula mill conversion from communication-paper production to virgin kraft linerboard affected Paper volumes and prior-period comparisons. PCA said it did not expect further related charges going forward.
- PCA adopted lease-accounting guidance in January 2019, recording $228 million of operating lease liabilities and corresponding right-of-use assets at adoption. The company said adoption had an immaterial effect on earnings, liquidity and debt covenants.
Outlook, risks and unusual items
- Management expected Q4 2019 earnings to be below Q3. It forecast slightly lower domestic containerboard pricing as earlier price decreases flowed through, lower export prices and containerboard sales volume, seasonally weaker corrugated mix and shipments, and lower Paper volumes and average prices. Higher energy, operating, converting and maintenance-outage costs were also expected; the Richland, Washington box plant startup would add costs.
- PCA expected 2019 capital investments of $385–$395 million, excluding acquisitions, including an estimated $10 million for environmental compliance.
- Q3 2019 included $3.0 million of pretax charges for DeRidder mill fixed-asset disposals. Nine-month special-item expense was $3.6 million pretax, compared with $28.8 million in 2018, primarily due to the Wallula restructuring.
- Office Depot represented approximately 7% of company sales and 50% of Paper segment sales in the first nine months of 2019; receivables from it were $78.5 million at quarter-end.
- Lawsuits related to the 2017 DeRidder mill explosion remain ongoing. PCA said it could not estimate a reasonable range of possible losses; it believes the claims are covered by liability insurance, subject to a $1.0 million aggregate deductible. An EPA notice alleged Clean Air Act violations at the Wallula mill; discussions were ongoing, and management did not expect a material adverse effect.
- Risks highlighted include economic conditions, demand and pricing, competition, wood and recycled-fiber and energy costs, unplanned facility outages, and environmental or tax regulation. Management stated disclosure controls were effective and reported no material change in risk factors.
Investor verification points
- Verify the drivers and sustainability of weaker Q3 Packaging pricing, mix and margins, and the extent to which Paper’s improvement can offset them.
- Track whether Q4 earnings, pricing, volumes, costs and maintenance-outage expectations match management’s outlook.
- Review cash generation against the remaining 2019 capital-spending plan, dividends and debt obligations, including lease liabilities.
- Monitor Office Depot concentration and receivables, the DeRidder litigation and insurance coverage, and the Wallula EPA matter for changes in exposure.
- Distinguish GAAP results from management’s adjusted EPS and EBITDA measures, which exclude specified special items.