Packaging Corporation of America — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; filed February 28, 2018. Amounts are in U.S. dollars unless otherwise noted.
Business context
PCA manufactures corrugated packaging, containerboard and uncoated freesheet (UFS) paper, primarily in the United States. It operates Packaging, Paper, and Corporate and Other segments. In October 2017, PCA acquired Sacramento Container for approximately $274 million, including a working-capital adjustment, to expand its corrugated packaging footprint.
Financial performance and liquidity
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Net sales | $6,444.9 million | $5,779.0 million | +11.5% |
| Gross profit / margin | $1,472.2 million / 22.8% | $1,275.7 million / 22.1% | Margin +0.7 percentage points |
| Operating income / margin | $931.2 million / 14.4% | $780.3 million / 13.5% | +19.3% |
| Net income | $668.6 million | $449.6 million | +48.7% |
| Diluted EPS | $7.07 | $4.75 | +48.8% |
| Operating cash flow | $856.1 million | $806.9 million | +$49.2 million |
| Capital expenditures | $343.0 million | $274.3 million | +$68.7 million |
- Net income included an estimated $122.1 million tax benefit from the 2017 Tax Cuts and Jobs Act. Excluding disclosed special items, net income was $569.1 million, or $6.02 per diluted share, versus $462.0 million, or $4.88, in 2016.
- Packaging sales rose 15.9% to $5.31 billion, supported by higher prices and mix and increased volumes. Corrugated shipments grew 8.6%; containerboard outside shipments grew 7.9%.
- Paper sales declined 3.8% to $1.05 billion. Paper segment operating income fell to $61.5 million from $138.1 million, reflecting lower volumes and prices, higher energy costs and outage expenses.
- Cash and cash equivalents were $216.9 million. PCA reported $326.9 million of unused revolving credit capacity after letters of credit. Current assets were $1.92 billion and current liabilities $832.7 million.
- Total debt obligations were approximately $2.65 billion; all outstanding debt was fixed-rate at year-end. PCA issued $1.0 billion of fixed-rate notes and used the proceeds to repay approximately $1.0 billion of variable-rate term loans. A $150 million note matured in March 2018.
- Dividends paid were $237.6 million. Net cash used for investing activities was $609.1 million, including $273.8 million for acquisitions. Cash declined $22.4 million during the year.
Material changes versus FY2016
- Packaging benefited from price increases and strong demand; higher fiber, energy, labor, freight and depreciation costs partly offset gains.
- Paper profitability weakened amid declining UFS demand and the December 2016 shutdown of market-pulp production at Wallula.
- PCA announced conversion of Wallula’s No. 3 paper machine to a 400,000-ton-per-year virgin kraft linerboard machine. The conversion was expected to cost about $150 million; approximately $33.4 million of related charges were recorded in 2017.
- Capital expenditures increased to $343 million. The company expected 2018 capital investments of $440–$460 million, including $134 million for the Wallula conversion.
- The effective tax rate fell to 19.3% from 34.7%, largely reflecting the tax-law change and its deferred-tax remeasurement benefit.
Outlook, risks and unusual items
- For the first quarter of 2018, management expected strong Packaging demand, but lower containerboard production and sales than in Q4 2017 due to scheduled mill outages. Paper volume was expected to be slightly lower. Management forecast Q1 earnings excluding special items to be slightly below Q4 2017.
- Management anticipated broad cost inflation, including freight, labor and benefits, energy, chemicals, repairs and materials; it expected recycled-fiber inflation to be fairly flat. It also expected a lower tax rate under the new tax law. The company estimated a 2018 combined federal and state effective tax rate of 24%–26%.
- A February 2017 explosion at the DeRidder mill caused three contractor fatalities and other injuries. PCA faces multiple lawsuits and additional claims; it stated that it could not estimate a reasonable range of possible losses. The company recorded a $17 million insurance recovery, net of the policy deductible; payment was received in January 2018.
- Office Depot accounted for 43% of Paper segment sales and 7% of consolidated sales in 2017. The supply agreement covered at least 50% of Office Depot’s commodity-office-paper requirements through December 2018, subject to potential termination circumstances.
- Other key risks include cyclical product pricing, declining communication-paper demand, volatile fiber and energy costs, transportation availability and expense, mill disruptions, labor negotiations, environmental regulation, and acquisition integration. PCA held a $31.5 million environmental reserve.
- The auditor issued an unqualified opinion on the financial statements and internal control over financial reporting. Sacramento Container was excluded from the 2017 internal-control assessment while integration proceeded.
Investor verification priorities
- Separate recurring operating improvement from the $122.1 million tax benefit and other special items; compare GAAP and adjusted earnings.
- Track Packaging pricing, volumes and input-cost pass-through, and assess whether the Paper segment’s decline is continuing.
- Verify Wallula conversion spending, timing, capacity ramp-up, and remaining restructuring charges.
- Review the DeRidder litigation, insurance coverage and any subsequent loss estimates or developments.
- Monitor Office Depot contract renewal and customer concentration, along with liquidity for the March 2018 note maturity and planned capital spending.