Sonoco Products Company — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 27, 2010. Financial statements are unaudited and were reviewed, not audited. Dollar amounts below are in millions unless noted.
Business context and results
Sonoco manufactures consumer and industrial packaging and provides packaging services through Consumer Packaging, Tubes and Cores/Paper, Packaging Services, and All Other Sonoco. Second-quarter sales increased 16.9% year over year; first-half sales rose 16.8%.
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $1,010.1 | $864.2 | $1,945.2 | $1,664.9 |
| Gross profit | $192.5 | $158.3 | $368.3 | $299.1 |
| Gross margin | 19.1% | 18.3% | 18.9% | 18.0% |
| Income before interest and taxes | $90.4 | $57.3 | $166.0 | $102.0 |
| Net income attributable to Sonoco | $59.0 | $33.6 | $107.5 | $56.7 |
| Diluted EPS | $0.58 | $0.33 | $1.05 | $0.56 |
| Non-GAAP base diluted EPS | $0.59 | $0.41 | $1.09 | $0.70 |
Management’s non-GAAP “base” results exclude restructuring and asset impairment charges. Q2 net income included $1.6 million of after-tax restructuring charges, compared with $7.3 million a year earlier; first-half charges were $4.1 million versus $13.4 million.
Cash flow, debt, and liquidity
- First-half operating cash flow was $115.4 million, down from $181.9 million. Higher working-capital needs and cash income-tax payments offset stronger earnings.
- Capital expenditures were $59.0 million; cash dividends were $55.2 million. Cash ended the period at $167.4 million, down from $185.2 million at year-end 2009.
- Total debt was approximately $581.9 million, down $3.6 million net during the first half. No commercial paper was outstanding under the $500 million program, supported by a bank facility committed through May 2011; Sonoco expected to renew it before year-end.
- Current assets were $1,097.9 million and current liabilities $834.8 million. The $100 million, 6.75% debentures mature in November 2010; management expected to meet them with cash, operating cash flow, and/or refinancing.
- Debt covenants include a minimum-net-worth requirement; reported defined net worth exceeded the covenant minimum by approximately $487 million.
Drivers and material changes
- Q2 sales growth reflected volume/mix (+$76 million), selling prices (+$43 million), foreign currency (+$12 million), and other factors (+$15 million). First-half increases were $147 million, $59 million, $49 million, and $25 million, respectively.
- Higher volume, productivity, cost containment, and lower pension expense improved margins. Higher recovered-paper and resin costs pressured results; first-half price/cost effects were unfavorable, although Tubes and Cores/Paper achieved a neutral relationship in Q2 after price resets.
- Tubes and Cores/Paper was the largest growth contributor: Q2 sales rose 28.5% and segment operating profit rose to $36.9 million from $20.2 million. Reported sales also include corrugating medium sold on the open market after a cost-plus arrangement ended; this change added $17 million of Q2 sales and $31 million in the first half.
- Q2 segment sales changes: Consumer Packaging +4.3%, Packaging Services +19.6%, and All Other Sonoco +26.9%. Segment operating profit increased across all four groupings.
Outlook, risks, and unusual items
- Management expected operating cash flows to remain strong in the second half of 2010, full-year capital spending of about $160 million, and total 2010 pension and postretirement contributions of about $24 million. No quantified earnings guidance was provided in the supplied filing text.
- After quarter-end, Sonoco acquired Associated Packaging Technologies for approximately $120 million cash, expected to add about $150 million of annualized sales in Consumer Packaging. The purchase price was funded with cash and available credit; acquisition-date fair values were not yet determined. In May, it acquired Madem Reels USA for $10.2 million, with expected annual sales of about $9 million.
- Previously announced restructuring actions were expected to require about $4 million of additional cash costs, mostly by year-end 2010. New 2010 actions included facility consolidation/closure and elimination of 87 positions.
- A major-customer bid involving Flexible Packaging could result in lost business or lower margins and possible goodwill impairment or restructuring charges; the unit had about $92 million of goodwill. Packaging Services expected to lose about $45 million of annualized sales by the second half of 2010 and another approximately $35 million by 2012, with management expecting new business to offset the long-term effect.
- Environmental exposure includes Fox River matters. Sonoco accrued $62.5 million for environmental contingencies, including $59.3 million related to U.S. Mills’ Fox River liabilities. Sonoco estimated its share of cleanup costs at one site at $1.9–$4.9 million; it stated that potential additional exposure on other legacy claims was limited to U.S. Mills’ equity of approximately $81 million. Outcomes and ultimate costs remain uncertain.
- Other risks include raw-material availability and pricing, economic and demand conditions, pension assumptions and investment returns, currency/interest/commodity movements, customer retention, acquisitions, litigation, and potential goodwill impairment. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether volume and productivity gains can continue to offset recovered-paper, resin, and other input-cost pressures.
- Cash conversion and working-capital trends, as first-half operating cash flow fell despite higher earnings.
- Funding and refinancing of the November 2010 debentures, renewal of the commercial-paper credit facility, and the liquidity effect of the APT acquisition and planned capital spending.
- Customer-bid outcomes, expected sales losses, and any resulting impairment or restructuring charges.
- Fox River litigation and remediation developments, and whether recorded environmental reserves remain adequate.
- Third-quarter goodwill impairment testing, particularly for the units identified as exposed to customer losses or weak performance.