PACKAGING CORP OF AMERICA quarterly report, Q3 FY2016

Business context and reporting period

Packaging Corporation of America (PCA) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. PCA manufactures corrugated packaging and paper products, primarily in the United States, and reports Packaging, Paper, and Corporate and Other segments.

On August 29, PCA acquired substantially all of TimBar Corporation’s assets, adding six corrugated-products facilities. TimBar’s results are included from the acquisition date.

Financial performance and position

• Q3 sales rose 0.9%, while net income declined 6.6%. Nine-month sales fell 1.1%, but net income increased 1.9%.
• Gross margin, calculated from reported sales and gross profit, was approximately 22.2% in Q3 2016 versus 22.3% in Q3 2015, and 22.1% for the first nine months versus 21.2%.
• Management’s non-GAAP results excluding special items were diluted EPS of $1.30 versus $1.26 in Q3, and $3.65 versus $3.45 for the nine-month periods. These measures are not GAAP results.
• Cash and cash equivalents were $279.8 million at September 30, up from $184.2 million at December 31, 2015. Current assets were $1,747.0 million and current liabilities $637.5 million.
• Debt totaled $2,664.6 million before deducting the current portion and unamortized issuance costs; the balance sheet reported $25.8 million current maturities and $2,625.8 million long-term debt. PCA had $325 million of unused revolver capacity, net of letters of credit. Approximately 62% of debt was fixed-rate.
• Capital expenditures were $188.1 million for the first nine months. Dividends paid were $156.7 million and share repurchases were $100.3 million.

Material changes versus prior periods

• Q3 Packaging segment operating income fell to $179.6 million from $198.2 million, primarily reflecting lower domestic and export containerboard and corrugated-product prices and mix, plus higher labor costs. Higher shipment volumes and lower freight, energy, and outage costs partly offset the declines.
• Q3 Paper segment operating income rose to $44.5 million from $39.5 million, helped by improved prices and mix, higher white-paper volume, and lower fiber costs. For the nine months, Paper sales declined 3.4%, while segment operating income rose to $105.0 million from $98.6 million.
• For the first nine months, Packaging operating income was essentially unchanged at $533.5 million. Higher volumes and lower freight, outage, energy, and fiber costs were offset by lower prices and mix and higher labor costs.
• Operating cash flow increased $46 million year over year. Investing cash use increased to $582.7 million, principally due to the $385.6 million TimBar acquisition; financing provided $90.1 million, including proceeds from the new term loan.
• Q3 reported operating income included $5 million of special-item expense in 2016, compared with $8 million of special-item income in 2015. Nine-month special-item expense was $11 million in 2016 versus $8 million in 2015.

Outlook, commentary, and risks

• Management expected Q4 2016 earnings to be below Q3, citing four fewer shipping days, seasonally lower volumes and less favorable product mix, higher seasonal wood and fuel costs, recycled-fiber inflation, and scheduled mill maintenance. Three months of TimBar activity were expected in Q4 versus one month in Q3.
• PCA communicated a $50-per-ton containerboard price increase effective October 1 and a corrugated-products price increase. The filing also notes industry-published containerboard prices rose $40 per ton in October.
• PCA expected 2016 capital investment of $250 million to $285 million, excluding acquisitions and other strategic activity. Management stated available cash, operating cash flow, revolver capacity, and capital-market access should be adequate for foreseeable liquidity needs.
• On October 11, 2016, PCA agreed to acquire substantially all Columbus Container assets for $100 million in cash; closing was expected in Q4, subject to customary conditions, and PCA expected to use cash on hand.
• In October, PCA announced it would cease softwood market-pulp operations and permanently shut down Wallula mill’s No. 1 machine, representing approximately 100,000 tons of capacity, effective December 1, 2016.
• Risk factors include cyclical demand and pricing, competition, fiber and energy costs, unplanned facility outages, acquisition integration, and environmental or tax regulation. Office Depot represented about 8% of total company sales and 41% of Paper segment sales for the first nine months of 2016. PCA said legal actions were not reasonably expected to have a material adverse effect; it could not predict the effect of revised Boiler MACT requirements.

Important facts for investors to verify

• TimBar’s integration, contribution to earnings and cash flow, and final purchase-price allocation, which remained preliminary.
• Whether announced price increases offset seasonal volume, mix, input-cost, and maintenance pressures in Q4.
• Funding and completion of the Columbus Container acquisition, and the financial effects of the Wallula pulp shutdown.
• Debt levels, variable-rate exposure, refinancing needs, and continuing shareholder returns, including the increased quarterly dividend of $0.63 per share.
• Office Depot customer concentration and potential changes in demand for communication papers.