Sonoco Products Company (NYSE: SON) — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports fourth-quarter results; this is an annual report, not a standalone quarterly filing. Sonoco manufactures consumer, industrial and protective packaging and provides packaging services through 312 locations in 36 countries.
Financial performance and position
| Metric | 2018 | 2017 |
|---|---|---|
| Net sales | $5.391 billion | $5.037 billion |
| Gross profit margin | 19.3% | 19.0% |
| Operating profit | $437.6 million | $412.4 million |
| Operating profit margin | 8.1% | 8.2% |
| Net income attributable to Sonoco | $313.6 million; $3.10 diluted EPS | $175.3 million; $1.74 diluted EPS |
| Base net income, non-GAAP | $340.6 million; $3.37 diluted EPS | $281.8 million; $2.79 diluted EPS |
| Cash from operations | $589.9 million | $348.3 million |
| Capital spending | $192.6 million | $188.9 million |
| Total debt at year-end | $1.385 billion | $1.447 billion |
| Cash and cash equivalents | $120.4 million | $254.9 million |
| Current ratio | 1.4 | 1.6 |
Revenue rose 7.0%, with $241 million of the increase from acquisitions, $63 million from pricing and $55 million from volume/mix. Operating profit increased 6.1%; base operating profit margin edged down to 9.1% from 9.2%. Net interest expense was $58.2 million, up from $52.7 million, primarily due to higher interest rates. Cash dividends were $161.4 million, or $1.62 per share.
Operating cash flow increased substantially, supported by higher earnings, lower pension contributions and improved working-capital performance. Investing used $444.1 million, including $277.2 million for acquisitions. Financing used $273.7 million. Debt-to-total-capital declined to 43.9% from 45.6%.
Material changes and business drivers
- Consumer Packaging sales increased 11.1% to $2.360 billion, but segment operating profit fell 12.2% to $224.5 million. Lower plastics volumes, product mix and manufacturing inefficiencies weighed on results.
- Paper and Industrial Converted Products sales increased 2.4% to $1.911 billion; segment operating profit rose 30.7% to $211.1 million, supported by favorable price/cost and paper-market conditions.
- Display and Packaging sales rose 16.5% to $592.3 million and segment operating profit improved to $13.3 million from $2.6 million. Sonoco exited a single-customer Atlanta-area contract after concluding acceptable margins were unattainable.
- Protective Solutions sales declined 2.1% to $527.7 million; segment operating profit was nearly flat at $42.9 million.
- Three 2018 acquisitions cost $278.8 million net of cash acquired, including Highland Packaging Solutions and the remaining 70% of Conitex Sonoco, bringing that joint venture under Sonoco’s control. Acquisitions contributed to reported sales growth; management said acquired businesses’ performance fell short of expectations in 2018.
Outlook, risks and unusual items
For 2019, management forecast nearly 5% growth in reported sales, approximately 1% organic volume growth, positive overall price/cost, modest improvement in gross and base operating margins, and about $600 million of operating cash flow. Planned capital spending was approximately $205 million. The base effective tax rate was expected at 25.5%–26.5%. Management did not provide projected GAAP earnings because certain gains, restructuring and acquisition costs, and tax effects could not be reliably forecast. Longer term, Sonoco aspired to annual sales of approximately $6 billion and OPBDA margins of 16% within two to three years.
- GAAP net income increased 78.8%, but the comparison was significantly affected by the prior year’s $51.3 million after-tax Tax Act charge and $20.2 million after-tax pension settlement charges, as well as a 2018 tax valuation-allowance release. Base earnings increased 20.9%.
- Restructuring and asset impairment charges were $40.1 million in 2018. The company announced multiple facility closures and eliminated approximately 120 positions; about $1.8 million of additional costs for announced actions was expected, mostly by the end of 2019.
- The IRS is challenging Sonoco’s tax treatment of a 2012–2013 intercompany-note distribution. The proposed incremental tax is approximately $89 million, excluding interest, and the IRS also proposed $18 million in penalties. Sonoco had not recorded an additional reserve and said the case was before the IRS Appeals Division; an adverse resolution could materially affect results and financial condition.
- Display and Packaging goodwill of approximately $203 million was identified as at risk if expected operating improvement fails or the outlook worsens. Fair value was approximately equal to carrying value; management estimated a roughly $25 million pretax impairment under specified sensitivity scenarios.
- Environmental liabilities accrued were $20.1 million. The company noted actual remediation costs could exceed reserves, while stating it did not believe resolution of the described matters was reasonably likely to materially adversely affect the financial statements.
- Defined-benefit plans had a net underfunded position of approximately $369 million; expected 2019 plan contributions were about $31 million. Sonoco cited market returns and actuarial assumptions as drivers of future funding needs.
- Sonoco adopted ASC 606 revenue recognition in 2018. Adoption increased opening retained earnings by $1.7 million and increased 2018 net income by $0.7 million versus the prior accounting method. The company expected lease-accounting adoption in 2019 to add $325–$350 million of right-of-use assets and liabilities.
Key risks include volatile recovered-paper, resin, metal, energy and transportation costs and the ability to pass increases through to customers; economic and currency fluctuations; competition and customer concentration; acquisition integration; operational and cyber disruptions; pension funding; and environmental, legal and tax contingencies. The five largest customers represented 64% of Display and Packaging segment sales; the largest customer represented 4.2% of consolidated revenue.
Important facts for investors to verify
- Review the GAAP-to-base earnings reconciliation and the extent to which tax items and recurring restructuring costs affect earnings comparability.
- Track Consumer Packaging’s volume, product mix and manufacturing efficiency, and whether the acquired businesses meet management’s expectations.
- Monitor Display and Packaging performance, major-customer retention and goodwill impairment headroom.
- Follow the IRS dispute, including potential tax, interest and penalty exposure, and updates to any reserve.
- Assess cash generation, acquisition spending, debt repayment, pension contributions and delivery against the 2019 outlook.