Sonoco Products Company — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; comparisons are to the three and six months ended July 1, 2012. Sonoco supplies consumer and industrial packaging, protective packaging, and packaging services. Unless noted, amounts below are in millions of dollars. Interim financial statements are unaudited and were reviewed, not audited, by the independent accountant.
Financial performance and liquidity
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Net sales | $1,226.3 | $1,202.4 | $2,405.5 | $2,414.7 |
| Gross profit | $222.6 | $216.5 | $428.3 | $433.4 |
| Gross margin | 18.1% | 18.0% | 17.8% | 17.9% |
| Income before interest and taxes | $92.0 | $88.6 | $173.5 | $167.4 |
| Net income attributable to Sonoco | $55.0 | $51.3 | $103.1 | $94.4 |
| Diluted GAAP EPS | $0.53 | $0.50 | $1.00 | $0.92 |
| Base diluted EPS (non-GAAP) | $0.59 | $0.58 | $1.09 | $1.11 |
- Sales and earnings: Q2 sales rose 2.0%, driven almost entirely by volume growth in Display and Packaging and Protective Solutions. First-half sales declined 0.4%; volume was essentially flat and lower selling prices, especially for recovered paper, weighed on revenue.
- Profitability: Q2 base EPS increased modestly, while first-half base EPS declined slightly. Management cited productivity and a modestly positive price/cost relationship as offsets to higher maintenance, labor, pension, and other costs. GAAP restructuring and asset-impairment charges were $8.7 million in Q2 and $13.0 million in the first half.
- Cash flow and investment: First-half operating cash flow was $244.5 million, versus $140.4 million; capital spending was $99.0 million. Cash flow from operations less capital spending was approximately $145.5 million. Investing activities used $94.5 million.
- Debt and liquidity: Debt outstanding was $1,091.5 million at June 30, down $281.4 million during the first half. Cash and equivalents were $179.4 million, compared with $373.1 million at year-end 2012; commercial paper outstanding was zero, versus $152 million at year-end. The company has a $350 million commercial-paper program backed by a $350 million bank facility committed through October 2017. Management said covenant measures were substantially above required minimums.
- Dividends: Sonoco paid $0.31 per share in Q2 and declared another $0.31 quarterly dividend, payable September 10, 2013.
Material changes and management commentary
- Q2 segment operating profit increased 10.8% in Consumer Packaging, 33.6% in Display and Packaging, and 3.5% in Protective Solutions; it declined 9.2% in Paper and Industrial Converted Products. For the first half, the two latter growth segments advanced 13.7% and 10.3%, while Consumer Packaging fell 3.4% and Paper and Industrial Converted Products fell 6.9%.
- Consumer Packaging faced lower first-half volume and selling prices, customer preference shifts, European softness, and production interruptions. Management said new opportunities in thermoformed and blow-molded plastics could improve volume and reduce goodwill impairment risk. Blow molding results were also affected by a quality issue and unplanned downtime.
- Paper and Industrial Converted Products faced lower sales prices tied to recovered-paper costs, the exit from European recycled-fiber trading, and higher operating costs. Display and Packaging benefited from contract-packaging and display volume growth; Protective Solutions benefited from foam packaging demand for auto components and strength in appliance-related business.
- The company repatriated approximately $260 million of foreign cash in the first half and used it to repay a $135 million term loan and commercial paper. It said it had no plans to repatriate other offshore cash; future repatriation could incur additional U.S. federal income taxes.
Outlook, risks, and unusual items
- No specific full-year earnings or EPS guidance is provided in the filing. Management expected approximately $110 million of capital spending during the remainder of 2013, including completion by year-end of a $75 million biomass boiler project. It anticipated about $17.25 million of additional pension and postretirement contributions in 2013.
- Approximately $8.25 million of additional charges were expected for announced restructuring actions, mostly to be incurred and paid by year-end; further restructuring remains possible. Current actions include facility closures, workforce reductions, and a small business sale.
- Environmental contingencies are significant. Environmental accruals totaled $73.7 million at June 30, including a $49.4 million reserve for potential Fox River liabilities and $3.2 million for a separate remediation project. The company states its maximum additional pretax exposure to consolidated financial position is limited to U.S. Mills’ approximately $92 million equity position; litigation and allocation of remediation costs remain uncertain.
- Goodwill impairment was not recorded in the period, but management identified plastics businesses and certain other reporting units as more exposed if expected improvements do not materialize. A major Display and Packaging customer’s business is concentrated and will be renegotiated over the next few years.
- Unusual items included a $1.9 million Canadian pension settlement charge and a $0.9 million loss related to the February 2013 Venezuelan bolivar devaluation. First-half foreign-currency translation reduced other comprehensive income by $40.7 million.
- Key risks identified include raw-material pricing and availability, demand and pricing pressure, productivity and restructuring execution, pension costs, foreign exchange and commodity exposures, tax contingencies, acquisition integration, and environmental liabilities. The company revised the 2012 comparative cash flow statement for a $4.0 million insurance-proceeds classification error; it said the adjustment was not material.
Investor verification priorities
- Confirm the drivers and sustainability of first-half operating cash flow growth, particularly working-capital movements and lower pension contributions.
- Track segment volumes, margins, and recovery in Consumer Packaging plastics and Paper and Industrial Converted Products; assess the assumptions underlying goodwill impairment tests.
- Monitor Fox River litigation, remediation estimates, and whether the stated U.S. Mills exposure limit remains supportable.
- Verify delivery, remaining capital costs, and expected incentives for the biomass boiler, alongside planned capital spending and pension contributions.
- Reconcile reported GAAP results with “base” non-GAAP results and review future restructuring charges and cash payments.