Packaging Corporation of America — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. PCA manufactures corrugated packaging and paper products, primarily in the United States, and reports Packaging, Paper, and Corporate and Other segments. Figures are in millions of dollars unless noted.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $1,767.5 | $1,584.0 | $3,458.1 | $3,120.5 |
| Gross profit | $420.6 | $364.3 | $776.7 | $702.5 |
| Income from operations | $269.6 | $234.1 | $482.5 | $437.5 |
| Net income | $186.6 | $143.2 | $326.7 | $260.6 |
| Diluted EPS | $1.97 | $1.52 | $3.46 | $2.76 |
| Operating cash flow | Not stated for quarter | $533.5 | $385.6 |
- Q2 sales rose 11.6%; net income rose 30.3%. Six-month sales rose 10.8%; net income rose 25.4%.
- Q2 gross margin was approximately 23.8%, versus 23.0%; operating margin was approximately 15.3%, versus 14.8%. Six-month gross and operating margins were approximately 22.5% and 14.0%, respectively, broadly in line with 2017.
- Management’s non-GAAP net income excluding special items was $197.0 million, or $2.08 diluted EPS, in Q2, and $343.9 million, or $3.64 diluted EPS, for the half year. These measures exclude items management considers non-recurring and are not substitutes for GAAP results.
- Packaging drove growth: Q2 segment sales increased 14.1% and operating income rose to $273.2 million from $226.2 million. Paper operating income declined to $16.2 million from $27.2 million. For the half year, Packaging operating income was $497.9 million versus $418.6 million, while Paper was $23.5 million versus $55.1 million.
Cash, debt, and liquidity
- At June 30, cash was $199.6 million; current assets were $1,956.6 million and current liabilities $715.8 million. Working capital was $1,240.8 million.
- Long-term debt, net of issuance costs, was $2,482.1 million; fixed-rate senior notes totaled $2,496.0 million before issuance costs. PCA repaid $150 million of 6.50% notes due March 2018. All outstanding debt was fixed-rate; weighted average rate reported was 3.64%.
- Unused revolving credit capacity, net of letters of credit, was $327 million. Management said cash, operating cash flow, borrowing capacity, and capital-market access should meet foreseeable liquidity and capital needs.
- Six-month capital expenditures were $273.9 million, compared with $139.4 million. PCA expected full-year 2018 capital investments of $530–$550 million. Cash declined $17.3 million to $199.6 million, after operating cash flow of $533.5 million, investing outflows of $273.5 million, and financing outflows of $277.3 million.
Material changes and unusual items
- Higher Packaging prices, product mix, and volumes, plus lower wood and recycled-fiber costs, supported results. Higher operating and converting costs, freight, maintenance outages, depreciation, and other expenses partly offset those gains. Tax reform reduced the effective tax rate to 23.9% in Q2 from 31.4%, and to 24.3% for the half year from 32.8%.
- PCA discontinued uncoated free-sheet and coated one-side production at its Wallula mill and converted the No. 3 machine to virgin kraft linerboard. The first phase was completed in Q2; the second phase was expected in Q4 2018. Wallula restructuring charges were $13.6 million pretax in Q2 and $22.4 million for the half year; additional charges were expected.
- Depreciation included $13.5 million of incremental expense in the first half from shortened useful lives of certain Wallula and corporate-facility assets. PCA acquired Sacramento Container in October 2017 for approximately $274 million, funded with cash; purchase-price allocation remained subject to finalization.
- Quarterly dividend was raised from $0.63 to $0.79 per share; the declared Q2 dividend was paid in July. No shares were repurchased under the board’s repurchase authorization in the period.
Outlook, risks, and contingencies
- Management expected Q3 2018 earnings excluding special items to exceed Q2. It anticipated continued strong Packaging demand, implementation of most remaining Packaging price increases, and completion of Paper price increases. Offsets included one fewer shipping day, lower seasonal Paper volumes around a mill outage, inflation, higher freight and logistics costs, higher maintenance expense, and a slightly higher tax rate.
- Key disclosed risks include economic and industry conditions, competition and pricing, wood and recycled-fiber and energy costs, facility outages, regulatory or environmental changes, and integration of acquired businesses.
- Office Depot represented approximately 7% of total company sales and 45% of Paper segment sales for the first half of 2018. Receivables from Office Depot rose to $68.8 million from $33.3 million, following extended credit terms; a reduction in purchases or payment ability could adversely affect PCA.
- Multiple lawsuits followed the February 2017 DeRidder mill explosion, which caused three contractor fatalities and other injuries. PCA was defending the claims and could not estimate a reasonable loss range. It received $17 million in property-damage and business-interruption insurance proceeds in Q1 2018; the EPA investigation remained ongoing. PCA reported no known material liabilities from its other guarantees or indemnifications.
- PCA expected to adopt lease accounting requirements effective January 1, 2019 and anticipated recognizing assets and liabilities for in-scope operating leases; the financial effect was still being assessed.
Important facts for investors to verify
- Whether the Wallula conversion reaches its expected Q4 completion and what remaining costs, downtime, and capacity benefits result.
- Whether strong Packaging demand, pricing, and shipment levels continue, and whether cost inflation and freight pressure erode margins.
- Whether Paper segment profitability stabilizes amid secular communication-paper demand declines and significant Office Depot customer concentration.
- How capital spending within the $530–$550 million forecast affects cash generation, and whether PCA maintains its stated liquidity and dividend capacity.
- Developments in the DeRidder litigation and EPA investigation, and completion of the Tax Act accounting and Sacramento Container purchase-price allocation.