Packaging Corporation of America — Q2 2015 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and six months ended June 30, 2015. PCA manufactures corrugated packaging and paper products, primarily in the U.S., and reports Packaging, Paper, and Corporate and Other segments. It sold its Hexacomb operations in Europe and Mexico on April 1, 2015, for $23.0 million; the sale was not material to consolidated results.
Key financial results
| Metric | Q2 2015 | Q2 2014 | First half 2015 | First half 2014 |
|---|---|---|---|---|
| Net sales | $1,454.3 million | $1,468.4 million | $2,880.0 million | $2,899.7 million |
| Gross profit | $323.7 million | $310.8 million | $600.7 million | $612.2 million |
| Income from operations | $197.6 million | $180.2 million | $354.7 million | $341.2 million |
| Net income | $114.0 million | $99.6 million | $204.8 million | $189.6 million |
| Diluted EPS | $1.16 | $1.01 | $2.08 | $1.93 |
| Net cash from operating activities | Not provided for quarter | Not provided for quarter | $304.5 million | $334.1 million |
Q2 gross, operating, and net margins were approximately 22.3%, 13.6%, and 7.8%, respectively; the prior-year Q2 margins were approximately 21.2%, 12.3%, and 6.8%. First-half 2015 margins were approximately 20.9%, 12.3%, and 7.1%, versus 21.1%, 11.8%, and 6.5% in 2014. Q2 reported EBITDA was $284.4 million versus $281.8 million; first-half EBITDA was $534.9 million versus $526.2 million. These are non-GAAP measures.
Cash, debt, and liquidity at June 30, 2015: Cash was $163.7 million. Current assets were $1,657.4 million and current liabilities $606.2 million. Long-term debt was $2,345.8 million, with $6.5 million of current maturities; total debt was therefore $2,352.3 million. Debt comprised $1,647.0 million fixed-rate senior notes and $705.3 million variable-rate term loans. PCA had $326.5 million of unused revolving-credit capacity, net of letters of credit. The filing states liquidity sources are expected to be adequate for foreseeable needs, while noting future refinancing depends on market and other conditions.
First-half operating cash flow was down $29.6 million year over year, primarily reflecting greater cash use for working capital and higher cash tax payments. Investing used $123.9 million, including $141.9 million of capital expenditures and $23.0 million sale proceeds. Financing used $141.8 million, including $93.5 million in dividends and $43.3 million in share repurchases. Cash increased $38.8 million over the half-year.
Material changes versus comparable periods
- Q2 sales declined 1%, while net income rose 14% and diluted EPS increased from $1.01 to $1.16. Excluding special items, Q2 diluted EPS was $1.18 versus $1.16.
- Q2 Packaging operating income increased to $194.6 million from $166.4 million; segment EBITDA rose to $266.7 million from $253.8 million. Higher volumes, energy savings, and improved corrugated mix helped, partly offset by labor, outage, freight, wood, and export-pricing costs.
- Q2 Paper operating income fell to $23.4 million from $33.6 million, primarily due to lower white-paper prices and product mix. Paper EBITDA was $37.1 million versus $45.9 million.
- First-half reported net income rose to $204.8 million from $189.6 million, but net income excluding special items declined to $215.2 million from $220.3 million. First-half Packaging EBITDA decreased to $486.5 million from $494.0 million, with the extended DeRidder mill outage contributing to weaker first-half performance.
- First-half sales were down 1%. Paper sales declined $26.1 million, while Packaging sales were nearly flat. The DeRidder No. 3 machine conversion contributed 151,000 tons of first-half containerboard production and reduced outside containerboard purchases.
Outlook, commentary, and risks
- For Q3 2015, management expected higher containerboard, corrugated, and white-paper shipments than Q2, lower annual mill-outage and chemical costs, and lower white-paper prices. It expected earnings excluding special items to exceed Q2 adjusted earnings.
- The DeRidder No. 3 machine was scheduled for a 13-day September outage to install additional dryers, with approximately 13,000 tons of lost production; the project is intended to enable design capacity of 1,000 tons per day. Management expected 2015 capital investment of $275 million to $300 million.
- White-paper demand faces continuing substitution from electronic communication and storage. Office Depot, including OfficeMax, represented approximately 10% of company sales and 45% of Paper segment sales; its pending merger with Staples created uncertainty around PCA’s customer relationship and paper business.
- Other identified risks include economic conditions, product demand and pricing, fiber and energy costs, unplanned facility outages, Boise integration, and environmental or tax regulation. A 1% increase in variable interest rates would add approximately $7 million to annual interest expense. About 70% of debt was fixed-rate.
- Q2 2015 special items included $3.7 million of integration and other costs, partly offset by $1.0 million of DeRidder-related insurance proceeds. First-half special items totaled $16.5 million, including $9.3 million of DeRidder restructuring charges and $7.2 million of integration costs. First-half 2014 included $17.6 million for a class-action settlement.
- PCA said ordinary-course legal matters were not reasonably expected to have a material adverse effect; it reported no material guarantee liabilities or off-balance-sheet arrangements. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether Q3 shipment growth and adjusted-earnings expectations were achieved, and the production impact and benefits of the DeRidder dryer installation.
- Whether the improvement in reported earnings is sustainable given weaker first-half adjusted earnings, paper-price pressure, and elevated labor and outage costs.
- Cash conversion and working-capital trends, alongside the planned $275–$300 million of 2015 capital spending, dividend commitments, and announced additional share-repurchase authorization.
- Developments in the Staples–Office Depot transaction and any resulting changes to PCA’s concentrated Paper segment customer exposure.
- Debt, interest-rate, environmental-compliance, and facility-outage exposures, including the assumptions behind management’s liquidity assessment.