Business context and reporting period
Sonoco Products Company filed this unaudited Form 10-Q for the quarter and six months ended July 2, 2017. The company operates in consumer packaging, display and packaging, paper and industrial converted products, and protective solutions. Comparisons are with the quarter ended July 3, 2016, and the corresponding six-month period.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net sales | $1,240.7 million | $1,205.7 million | $2,413.0 million | $2,432.0 million |
| Gross margin | 19.0% | 20.1% | 18.9% | 20.0% |
| Income before interest and taxes | $70.8 million | $92.1 million | $160.7 million | $194.0 million |
| Net income attributable to Sonoco | $43.1 million | $56.3 million | $96.9 million | $116.2 million |
| Diluted EPS | $0.43 | $0.55 | $0.96 | $1.14 |
| Adjusted (“base”) diluted EPS | $0.71 | $0.73 | $1.31 | $1.38 |
First-half operating cash flow was $104.3 million, down from $186.0 million. Capital expenditures were $98.8 million; acquisition spending was $217.5 million, and investing activities used $314.1 million. Cash declined to $207.6 million from $257.2 million at year-end 2016. Debt outstanding rose to $1,307.7 million from $1,052.7 million. Total assets were $4,292.7 million and total equity was $1,681.8 million at July 2.
Material changes versus prior period
- Q2 sales increased 2.9%, reflecting higher prices and acquisitions, partly offset by lower volume and unfavorable currency translation. First-half sales declined 0.8%, with volume, divestitures and lost contract-packaging business outweighing price increases.
- Q2 GAAP net income attributable to Sonoco fell 23.3%; first-half income fell 16.6%. Adjusted base earnings declined 3.8% in Q2 and 6.7% year to date.
- Management attributed weaker underlying earnings mainly to volume and product-mix declines and the lag in recovering higher raw-material costs. Gross margin declined 110 basis points in both comparisons.
- Q2 Paper and Industrial Converted Products operating profit rose 16.1%, benefiting from price resets and productivity. Display and Packaging profit fell 71.3% in Q2 and 44.3% for the first half, reflecting lower volume/mix and productivity issues. Protective Solutions profit declined 23.0% in Q2.
Outlook, management commentary, risks and unusual items
- The filing provides no clear numerical full-year earnings or sales guidance. Management expected more complete recovery of higher raw-material costs after contract resets, but warned that further increases in old corrugated container (OCC) prices could impede recovery.
- Sonoco reported a $31.1 million pretax, noncash pension settlement charge in Q2. The company also incurred restructuring and impairment charges of $7.9 million in Q2 and $12.0 million year to date. Management expects approximately $1.6 million of additional charges for previously announced restructuring and says further actions are possible.
- The March acquisition of Packaging Holdings cost $217.5 million and added the Peninsula thermoformed-packaging business. After quarter-end, Sonoco acquired Clear Lam for approximately $170 million; it expects annual sales of about $140 million in Consumer Packaging.
- On July 20, 2017, Sonoco entered a new $750 million credit facility, including a $500 million revolving facility and $250 million term loan. The filing says covenant measures were substantially above required minimums at July 2.
- A significant tax contingency remains: the IRS proposed an approximately $84 million incremental tax adjustment for 2013, plus proposed penalties of $18 million, excluding interest. Sonoco disputes the position, has not recorded an additional reserve, and warns an adverse resolution could materially affect results and financial condition.
- Management identified Display and Packaging as having increased goodwill-impairment risk: recent results and outlook weakened, and the 2017 annual test could show a notably lower fair value relative to carrying value. The company said its interim assessment found no impairment likely as of July 2.
- The corrugating-medium operation continued to underperform amid excess North American supply. Management is considering options including modified schedules, cost reductions, partnerships, or potential closure. Other risks include commodity and currency movements, customer concentration, pensions, and environmental exposures.
- The interim financial statements received a review, not an audit, from the independent accountant. Management reported disclosure controls were effective as of July 2.
Important facts for investors to verify
- Whether pricing and productivity gains offset OCC, energy, labor and freight cost pressures, and whether any further OCC increases occur.
- Underlying segment trends, particularly Display and Packaging, Protective Solutions, and the corrugating-medium operation.
- The outcome and potential financial exposure of the IRS tax dispute, including penalties and interest.
- Integration, valuation and financing of Packaging Holdings and Clear Lam, including the effect of increased debt and acquisition-related costs.
- Results of the third-quarter 2017 goodwill impairment test and any additional restructuring charges.
- Cash conversion, pension funding needs, and continued compliance with debt covenants.