Packaging Corporation of America — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Amounts are in U.S. dollars; financial statement figures are in millions except per-share data. The filing is unaudited.
Business context and results
PCA manufactures corrugated packaging and containerboard, as well as white paper. It reports Packaging, Paper, and Corporate and Other segments and operates primarily in the United States.
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $1,640.1 | $1,484.0 | $4,760.6 | $4,302.4 |
| Gross profit | $397.3 | $329.5 | $1,100.5 | $948.6 |
| Income from operations | $242.3 | $206.4 | $679.2 | $587.4 |
| Net income | $139.1 | $119.3 | $399.7 | $338.9 |
| Diluted EPS | $1.47 | $1.26 | $4.23 | $3.58 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $583.3 | $593.5 |
Calculated margins: Q3 gross margin was 24.2% versus 22.2%; operating margin 14.8% versus 13.9%; and net margin 8.5% versus 8.0%. For the nine months, gross margin was 23.1% versus 22.0%, operating margin 14.3% versus 13.7%, and net margin 8.4% versus 7.9%.
Material changes and segment performance
- Packaging: Q3 sales rose 15.4% to $1,346.6 and operating income rose to $261.5 from $179.6. Higher prices and mix contributed $88 million to the operating-income increase; higher sales and production volumes contributed $17 million. Higher recycled fiber, labor, and freight costs partly offset gains.
- Paper: Q3 sales declined 7.3% to $271.4; the segment recorded an operating loss of $0.7, including Wallula restructuring charges, versus operating income of $44.5 a year earlier. Excluding special items, Paper EBITDA was $39.4 versus $59.3. Lower prices, mix, and volumes, plus higher energy, outage, and freight costs, weighed on results.
- For the first nine months, Packaging operating income increased to $676.8 from $533.5, while Paper operating income fell to $58.1 from $105.0. Consolidated sales rose 10.6% and net income rose 17.9%.
- Management-reported diluted EPS excluding special items was $1.68 for Q3 versus $1.30, and $4.47 for nine months versus $3.65. These are non-GAAP measures; reported diluted EPS was $1.47 and $4.23, respectively, in 2017.
Cash flow, debt, and liquidity
- Nine-month operating cash flow was $583.3, down from $593.5. Capital expenditures were $226.2, making approximate operating cash flow less capital expenditures $357.1, versus $405.4 in 2016.
- Cash and cash equivalents were $370.5 at September 30, 2017, compared with $239.3 at December 31, 2016. Unused revolving-credit capacity was $327, net of letters of credit.
- Debt totaled $2,612.8, including $156.5 of current maturities and $2,456.3 of long-term debt, compared with $2,645.8 at year-end 2016. Cash less reported debt was approximately $2,242.3; this simple calculation excludes capital leases.
- Approximately 63% of debt was fixed-rate. Management estimated that a 1-percentage-point increase in rates on variable-rate debt would increase annual interest expense by about $10 million. Nine-month net interest expense was $74.6, up from $67.5.
- The company paid $178.2 in dividends during the first nine months and declared $0.63 per share for Q3. It made no open-market share repurchases during the period.
Outlook, unusual items, and risks
- Management expected Q4 2017 earnings excluding special items to be below Q3. It cited seasonally lower Packaging volumes, one fewer shipping day, a less favorable corrugated mix, seasonally lower Paper volumes and mix, higher wood, energy, chemical, and freight costs, and increased scheduled mill-outage expense. Recycled-fiber prices were expected to decline. Sacramento Container operations were expected to be included in Q4 results.
- PCA announced that it would discontinue uncoated free-sheet and coated one-side paper production at its Wallula, Washington mill in Q2 2018 and convert the No. 3 machine to a 400,000-ton-per-year virgin kraft linerboard machine. The conversion was expected to cost approximately $150 million. Q3 included $25.3 million of related charges; further charges were expected.
- On October 2, 2017, after the quarter-end, PCA completed the Sacramento Container, Northern Sheets, and Central California Sheets acquisition for $265 million, funded from cash on hand.
- A February 2017 explosion at the DeRidder mill caused three contractor fatalities and other injuries. Multiple lawsuits had been filed, and the company could not estimate a reasonable range of potential losses. Insurance recovery timing and amounts remained uncertain; the property-damage and business-interruption claim was subject to a $5 million deductible.
- Office Depot represented about 7% of company sales and 42% of Paper segment sales for the first nine months of 2017, creating customer concentration risk. Other identified risks include demand and pricing, fiber and energy costs, facility outages, acquired-business integration, and environmental or tax regulation.
- Management said liquidity sources were expected to meet foreseeable needs, including dividends. Q3 disclosure controls were considered effective; the filing reported no material change to previously disclosed risk factors.
Important facts for investors to verify
- Progress, remaining costs, timing, and expected capacity or earnings effects of the Wallula conversion.
- DeRidder litigation exposure and the timing and amount of insurance recoveries, which the company could not yet estimate fully.
- Q4 and subsequent performance against management’s stated expectations, including paper demand, pricing, input costs, outages, and Sacramento integration.
- Cash and debt after the $265 million post-quarter acquisition, and the impact of working capital and capital spending on free cash flow.
- Whether PCA can sustain packaging margin gains while managing recycled-fiber, labor, freight, energy, and interest costs, and the exposure associated with Office Depot.