Packaging Corporation of America — Q2 2019 Form 10-Q
Business context and reporting period. PCA manufactures corrugated packaging, containerboard and communication papers, operating primarily in the United States. This unaudited report covers the quarter and six months ended June 30, 2019; comparisons are with the same periods in 2018. Dollar amounts are in millions unless noted.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $1,759.9 | $1,767.5 | $3,493.6 | $3,458.1 |
| Gross profit | $427.9 | $420.6 | $849.3 | $776.7 |
| Income from operations | $280.4 | $269.6 | $555.8 | $482.5 |
| Net income | $193.6 | $186.6 | $380.4 | $326.7 |
| Diluted EPS | $2.04 | $1.97 | $4.02 | $3.46 |
| Gross margin | 24.3% | 23.8% | 24.3% | 22.5% |
| Operating margin | 15.9% | 15.3% | 15.9% | 14.0% |
| Net margin | 11.0% | 10.6% | 10.9% | 9.4% |
Q2 sales declined 0.4% year over year, while net income rose 3.8%. However, excluding special items, Q2 net income was $193.6 versus $197.0 in 2018 and diluted EPS was $2.04 versus $2.08. For the first half, sales grew 1.0%, net income increased 16.4%, and adjusted diluted EPS increased to $4.02 from $3.64. Prior-year Wallula restructuring charges benefited the GAAP comparison.
- Segments: Q2 Packaging sales were $1,504.6 and operating income $263.9, versus $1,496.2 and $273.2. Paper sales fell to $237.8 from $250.8, while operating income rose to $38.8 from $16.2. For the first half, Packaging operating income increased to $513.4 from $497.9; Paper operating income increased to $84.4 from $23.5.
- Drivers: Q2 Packaging results faced lower export containerboard prices and higher operating/converting costs, partly offset by improved domestic pricing and corrugated mix. Paper results benefited from better prices and mix and lower costs, but volumes were weaker, in part after the Wallula paper-business exit. First-half results also benefited from lower recycled-fiber costs and reduced Wallula conversion-related costs.
- Cash flow: First-half operating cash flow was $538.4, versus $533.5. Capital expenditures were $170.9, versus $273.9, yielding operating cash flow less capital expenditures of approximately $367.5, versus $259.6. Cash increased $207.9 to $569.4.
- Liquidity and debt: At June 30, cash was $569.4 and unused revolving-credit capacity was $328, net of letters of credit. Current assets were $2,402.7 and current liabilities $729.6. Long-term debt was $2,485.4; PCA reported $2,496.7 of fixed-rate senior notes outstanding, with all outstanding debt at fixed rates. The filing says liquidity is expected to meet foreseeable needs.
- Capital returns: First-half dividends paid were $149.3. The quarterly dividend was $0.79 per share. No shares were repurchased under the authorization in the period; $193.0 remained available.
Changes, outlook and risks
- PCA expects 2019 capital investments of $390–$410, excluding acquisitions; estimated environmental-compliance capital spending is about $10.
- For Q3 2019, management expects seasonally higher Packaging and Paper volumes, but lower packaging prices, lower Paper prices and mix, and slightly higher converting and other costs. Operating and scheduled maintenance costs are expected to be lower. Overall, management expects Q3 earnings below Q2.
- Industry data cited by PCA showed Q2 corrugated shipments per workday flat year over year, containerboard production down 5.8%, inventories up 4.4%, and export shipments down 16.4%. Published domestic containerboard prices declined during May and June.
- Operating risks include economic and industry conditions, product demand and pricing, fiber and energy costs, unplanned facility outages, and environmental or tax regulation. Office Depot represented about 7% of company sales and 51% of Paper segment sales in the first half; receivables due from it were $83.7 at quarter-end.
- Litigation relating to the 2017 DeRidder mill explosion, which caused three contractor fatalities and other injuries, remains ongoing. PCA is defending multiple lawsuits and cannot estimate a reasonable possible loss; the EPA investigation is also ongoing. The company states that it is not aware of material liabilities from other guarantees and indemnifications.
- PCA adopted lease accounting standard ASC 842 on January 1, 2019, recording $228 of operating lease liabilities and corresponding right-of-use assets at adoption. The filing says the adoption had an immaterial effect on earnings, liquidity and debt covenants.
Most important facts for investors to verify
- Whether Q3’s expected lower prices and earnings materialized, particularly for containerboard exports and domestic pricing.
- Whether Packaging cost pressures, Paper volume declines and the Wallula transition continued to affect segment results.
- Progress against the $390–$410 capital-spending outlook and the resulting effect on cash generation and liquidity.
- Developments in the DeRidder lawsuits and EPA investigation, including any change in the company’s ability to estimate potential losses.
- Office Depot’s ongoing importance to the Paper segment and any change in customer sales or receivable concentration.