Business context and reporting period
Packaging Corporation of America (PCA) reported unaudited results for the three months ended March 31, 2014. The quarter includes a full quarter of Boise, acquired October 25, 2013; first-quarter 2013 results do not. PCA operates Packaging and Paper segments, plus Corporate and Other. Comparative figures were retrospectively adjusted for a change in inventory costing method.
Key financial metrics
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $1.431 billion | $755.2 million |
| Gross profit; gross margin | $301.4 million; 21.1% | $185.2 million; 24.5% |
| Operating income | $160.9 million | $106.0 million |
| Net income; diluted EPS | $90.1 million; $0.92 | $62.3 million; $0.64 |
| Net income excluding special items; diluted EPS | $106.5 million; $1.08 | $62.3 million; $0.64 |
| EBITDA; EBITDA excluding special items | $244.3 million; $270.0 million | $148.7 million |
| Operating cash flow | $149.3 million | $95.8 million |
| Capital expenditures | $50.9 million | $27.3 million |
At March 31, cash was $185.7 million and unused revolver capacity was $328.5 million, net of letters of credit. Debt comprised approximately $2.48 billion of long- and short-term borrowings, plus $24.7 million of capital leases. PCA repaid $66.0 million of debt principal in the quarter. The filing states liquidity should be adequate for foreseeable needs, while noting future refinancing depends on economic and financial conditions.
Material changes versus the prior comparable period
- Sales rose 89.5%, principally because Boise contributed $610.8 million of sales. PCA’s historical operations added $65.3 million, reflecting higher price/mix and volume.
- Reported net income rose $27.8 million. Excluding $25.7 million of pretax special items, net income was $106.5 million, up from $62.3 million; management attributed the increase to Boise and improvement in PCA’s historical operations.
- Gross margin fell to 21.1% from 24.5%, mainly because the acquired white-paper business generally has lower margins than packaging. Higher labor, energy, repair, and freight costs also weighed on results.
- Interest expense increased to $20.8 million from $9.3 million, primarily due to acquisition-related borrowings. Operating cash flow increased, but working-capital requirements also rose.
- Q1 2014 special items were a $17.6 million accrual for the Kleen Products class-action settlement, $4.1 million of Boise integration costs, and $4.0 million of DeRidder restructuring charges. The settlement was preliminarily approved by the court in May 2014; final approval was scheduled for September 4, 2014.
For context, PCA provided pro forma Q1 2013 results as if Boise had been combined with PCA from January 1, 2013: sales of $1.355 billion, net income of $76.3 million, and diluted EPS of $0.78. These illustrative figures are not actual reported results and exclude potential synergies and integration costs.
Outlook, commentary, risks, and unusual items
- For Q2 2014, management expected higher corrugated volumes and paper prices and lower fuel consumption, offset by three planned mill maintenance outages, higher medical and workers’ compensation costs, seasonal electricity cost increases, remaining weather-related costs, and a higher tax rate. Management expected Q2 earnings excluding special items to be comparable to Q1’s $1.08 per diluted share.
- PCA planned to convert its DeRidder No. 3 newsprint machine to lightweight linerboard and corrugating medium, with expected annual capacity of 355,000 tons. Newsprint production was to continue through mid-September 2014, with conversion startup anticipated by November 1. Estimated project cost was $115 million, including $100 million expected in 2014; approximately $14 million was spent in Q1. Management also expected about $30 million of incremental depreciation in Q2 and Q3 related primarily to revised useful lives of newsprint assets.
- Management estimated 2014 capital investments of about $400 million, including the DeRidder project and up to $25 million for Boiler MACT compliance.
- Extreme Q1 weather affected shipments and costs by approximately $0.09 per share, according to management: $0.06 was reflected in Q1 earnings and $0.03 was capitalized in inventory, expected to reduce Q2 earnings.
- Office Depot, including OfficeMax, represented 9% of company sales and 42% of Paper segment sales; receivables were $55.2 million at quarter-end. PCA cited uncertainty about the effect of the OfficeMax–Office Depot merger. Other risks include secular decline in communication papers, labor negotiations, input-cost volatility, facility disruptions, acquisition integration, and environmental or tax regulation.
- PCA changed certain inventory costing from LIFO to average cost retrospectively. The change increased Q1 2013 net income by $1.7 million and opening retained earnings at January 1, 2013 by $38.8 million. Without the change, Q1 2014 net income would have been $1.4 million higher and inventory $69.5 million lower.
Important facts for investors to verify
- Track post-acquisition performance against pro forma comparisons, and distinguish Boise’s contribution from organic growth and integration costs.
- Monitor gross-margin trends, packaging and paper pricing, and the extent to which Q1 weather-related inventory costs affect Q2.
- Verify the timing, spending, startup, and expected returns of the DeRidder conversion, along with the forecast incremental depreciation.
- Review debt reduction, variable-rate exposure, capital spending, and dividend funding; a 1 percentage-point increase in variable rates was estimated to raise annual interest expense by $12.3 million.
- Follow final court approval and payment of the $17.6 million class-action settlement, and monitor Office Depot customer concentration and labor contract renewals.