Business context and reporting period
Sonoco Products Company filed this unaudited Form 10-Q for the quarter ended July 1, 2018. The company provides consumer and industrial packaging, protective packaging, and packaging services, reporting through four segments. Comparisons are with the quarter ended July 2, 2017, and the six-month periods ended on those dates. Dollar amounts below are in millions unless otherwise stated.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $1,366.4 | $1,240.7 | $2,670.6 | $2,413.0 |
| Gross profit | $276.5 | $238.4 | $527.1 | $461.4 |
| Gross margin | 20.2% | 19.2% | 19.7% | 19.1% |
| Operating profit | $131.9 | $105.2 | $242.0 | $198.8 |
| Net income attributable to Sonoco | $89.4 | $43.1 | $163.5 | $96.9 |
| Diluted EPS | $0.88 | $0.43 | $1.62 | $0.96 |
| Operating cash flow | Not provided separately | Not provided separately | $251.2 | $103.2 |
Management’s non-GAAP “base” diluted EPS was $0.93 for Q2 and $1.67 for the first half, versus $0.71 and $1.31, respectively. These measures exclude specified restructuring, acquisition, pension, tax, and other items and are not GAAP results.
At July 1, 2018, cash was $197.7 (down from $254.9 at year-end); current assets were $1,575.0 and current liabilities $1,030.1. Total debt was approximately $1,452, compared with $1,447 at December 31, 2017. Six-month capital spending was $88.9; acquisitions used $141.3. Dividends paid in the half were $79.8, or $0.80 per share.
Material changes versus prior comparable periods
- Q2 sales rose 10.1%; management attributed the $125.7 increase to volume/mix ($35), pricing ($11), acquisitions ($62), and foreign exchange and other effects ($18). First-half sales rose 10.7%, with increases from volume/mix ($42), pricing ($34), acquisitions and divestitures ($122), and foreign exchange and other ($60).
- Q2 base earnings growth reflected improved price/cost, productivity, and stronger corrugating-medium conditions; management also cited lower restructuring and acquisition charges and a lower effective tax rate. First-half base diluted EPS increased 27.9%.
- Paper and Industrial Converted Products led operating improvement: Q2 segment operating profit rose 35.4% and first-half profit 40.2%, primarily on favorable price/cost. Display and Packaging was weaker: its Q2 segment operating result was a $0.6 loss versus $1.5 profit, and first-half profit fell 75.3%, due to startup inefficiencies and costs at its Atlanta pack center.
- Consumer Packaging sales grew, aided by acquisitions and pricing, but margins fell year over year amid business mix and cost pressures. Protective Solutions profit improved despite lower sales, with automotive-component weakness partly offset by temperature-assured packaging.
- Reported earnings comparisons are affected by unusually large 2017 pension settlement charges. The company also retrospectively changed pension-cost presentation under new accounting guidance; comparisons should be read with that presentation change in mind.
Outlook, commentary, risks, and unusual items
- The filing does not provide a clear full-year earnings or revenue guidance figure. Management estimated 2018 remaining capital spending of approximately $130 and pension/postretirement contributions of approximately $15, bringing expected full-year contributions to about $39.
- Management expected approximately $2.35 of additional charges for previously announced restructuring actions, mostly incurred and paid by year-end 2018; further restructuring actions remain possible.
- Sonoco completed its $148.8 Highland Packaging Solutions acquisition in April, financed partly with a new $100 term loan; $50 was repaid during Q2. A purchase-price working-capital adjustment remained pending. It also agreed to acquire the remaining 70% of Conitex Sonoco for about $133 and a Spanish rigid-paper facility for about $10, subject to regulatory review and expected to close in Q4 2018.
- A significant tax contingency remains: the IRS proposed an approximately $89 tax adjustment for 2013, excluding interest, and $18 in penalties. Sonoco disputes the position, has recorded no additional reserve, and says an adverse outcome could materially affect results and financial condition. The matter was referred to IRS Appeals after the company received the IRS rebuttal in July.
- Goodwill at Display and Packaging was identified as particularly sensitive to adverse changes in assumptions because estimated fair value was close to carrying value. A customer contract nonrenewal notice was subsequently resolved by retaining the business through 2021.
- Other exposures include raw-material, energy, freight, foreign-exchange, interest-rate, pension, customer-concentration, integration, and environmental risks. Environmental contingencies accrued were $19.6. Management reported debt covenants substantially above minimum requirements.
- Adoption of the revenue-recognition standard increased opening retained earnings by $1.7; the company reported that it reduced first-half 2018 revenue by $4.0 and Sonoco-attributable net income by $0.9 versus the amounts that would have been reported without adoption.
Important facts for investors to verify
- Whether price increases and productivity continue to offset raw-material, freight, wage, and other cost inflation, particularly in Paper and Industrial Converted Products.
- Progress and profitability at the Atlanta pack center, and whether Display and Packaging recovers from its startup losses.
- Final Highland purchase accounting and working-capital adjustment, and the funding and closing conditions for the planned Conitex Sonoco and Spain acquisitions.
- Developments in the IRS dispute, including potential tax, penalty, interest, and legal costs; no additional reserve was recorded.
- Cash conversion, debt levels, and planned capital spending and pension contributions; first-half operating cash flow included favorable tax timing and working-capital movements.
- Potential goodwill impairment sensitivity at Display and Packaging, and the effects of currency translation and the new revenue-recognition accounting on reported trends.
The independent accountant performed a review of the interim financial statements, not an audit, and reported no material modifications that should be made for GAAP conformity.