Tredegar Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Tredegar manufactures polyethylene films, flexible packaging films and aluminum extrusions.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Sales | $263.8m | $247.3m | $522.5m | $468.4m |
| Income before taxes | $19.3m | $47.0m | $42.7m | $53.2m |
| Net income | $14.7m | $44.2m | $32.9m | $47.9m |
| Diluted EPS | $0.44 | $1.34 | $1.00 | $1.45 |
| Gross margin | 16.9% | 17.8% | 17.5% | 16.5% |
- Q2 sales rose 6.6%; first-half sales rose 11.6%. Growth included higher aluminum extrusion prices and sales volumes, stronger flexible-film demand, and the Futura acquisition’s contribution.
- Q2 net income fell sharply year over year, largely because Q2 2017 included larger gains on kaléo, a $11.9m pretax Terphane escrow-settlement gain, and an $8.1m income-tax benefit from a worthless-stock deduction. Q2 2018 included a $5.8m pretax unrealized kaléo gain. First-half kaléo gains were $14.0m in 2018 versus $24.8m in 2017.
- Segment ongoing operating profit in Q2: PE Films $8.7m (down 18.8%); Flexible Packaging Films $1.3m versus a $0.3m loss; Aluminum Extrusions $13.2m (up 11.8%).
- Operating cash flow was $71.8m in the first half, versus $22.0m a year earlier. The increase reflected tax refunds versus prior-year tax payments as well as improved operating cash generation. Investing cash outflow was $9.2m, including $14.5m of capital expenditures; financing cash outflow was $35.4m, primarily $29m of net debt repayment and $7.3m of dividends.
- At June 30, cash was $62.3m and debt was $123.0m, for net debt of $60.7m. Approximately $277m was available under the $400m revolver. Leverage was 1.17x against a 4.00x maximum covenant; interest coverage was 10.53x against a 2.50x minimum. The company reported covenant compliance and expects cash, borrowing availability and operating cash flow to cover needs for the next 12 months.
- The six-month effective tax rate was 23.0%, compared with 9.9% in 2017. The 2018 rate reflects the new 21% U.S. federal corporate rate and other tax items; the company was still assessing certain Tax Cuts and Jobs Act effects, including GILTI accounting.
Material changes and management outlook
- PE Films: Q2 sales declined 8.0%, primarily on lower personal-care topsheet demand and timing of elastic-material sales. Management expects a significant customer product transition to begin in Q4 2018; when fully implemented, it estimates annual sales could be reduced by $70m and profits materially affected. The transition could lead to impairment of personal-care long-lived assets or goodwill, which was $47m at June 30. A $25m North American elastics capacity expansion is expected to begin production in mid-2019. Management projects 2018 PE Films capital expenditures of $32m.
- PE Films also plans to close its Shanghai facility, with production expected to cease by year-end 2018. Estimated exit costs are $7.1m cash plus $0.9m of noncash write-offs and accelerated depreciation; expected net annual cash savings are $1.7m. Execution, including property disposals, is expected to take 12–18 months. For surface-protection films, management estimates customer transitions to alternative processes or materials could be fully implemented by Q4 2019 and reduce annual ongoing operating profit by about $10m.
- Flexible Packaging Films: Q2 volume and sales increased, and the business returned to ongoing operating profit. Results benefited from lower depreciation and amortization after a $101m noncash asset impairment in Q4 2017. The segment was at full capacity in Q2; a previously idled line restarted in mid-June. Management cautions that results remain volatile amid Latin American overcapacity and competitive pricing.
- Aluminum Extrusions: Q2 net sales increased 17.3%, driven by volume and aluminum-price pass-through. Bookings and backlog remained strong, but Niles plant inefficiencies reduced Q2 operating profit by an estimated $1m. U.S. tariffs and sanctions contributed to higher aluminum input costs; management expects to pass through most increases, but warns sustained high prices could reduce demand or prompt substitutions. Management projects 2018 capital expenditures of $14m.
- Management estimates 2018 Flexible Packaging Films capital expenditures of $5m. Higher interest rates increased first-half interest expense to $3.2m from $2.8m.
- Other risks include raw-material and energy costs, customer concentration and product transitions, foreign-exchange exposure, pension obligations, international operations and the uncertain Level 3 valuation of kaléo. Tredegar’s approximately 20% kaléo interest was valued at $68m; actual value could differ materially and depends on projections, regulatory and market assumptions, and a future liquidity event.
- A court sustained the Commerce Department’s ruling that Terphane’s Brazilian films fall outside the antidumping-duty order; plaintiffs could appeal by August 19, 2018. The filing also notes possible claims associated with the 2017 Terphane escrow settlement, estimated by the company at approximately $3.5m.
Key investor checks
- Track the timing, customer implementation schedule and replacement business for the PE Films personal-care transition, and assess related impairment risk.
- Compare Shanghai closure costs and projected $1.7m annual savings with actual execution and disposal proceeds.
- Test the $68m kaléo fair-value estimate against its Level 3 assumptions and potential changes in commercial, regulatory or financing circumstances.
- Monitor aluminum tariffs, sanctions, input-cost pass-through, demand effects and Niles operating efficiency.
- Separate recurring operating cash generation from tax-refund timing; monitor capital spending, debt repayment and revolver availability.
- Follow Terphane’s competitive conditions, restarted-line contribution, and any appeal or resulting exposure in the antidumping matter.