Sonoco Products Company (NYSE: SON) — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual filing, not a standalone fourth-quarter report. The company manufactures consumer, industrial and protective packaging and provides packaging services through four reportable segments and approximately 320 locations in 36 countries.
Financial results and position
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net sales | $5.374 billion | $5.391 billion | Down 0.3% |
| Gross profit | $1.058 billion | $1.041 billion | Up 1.6% |
| Gross margin | 19.7% | 19.3% | Up 0.4 percentage points |
| Operating profit (GAAP) | $467.1 million | $437.6 million | Up 6.7% |
| Net income attributable to Sonoco | $291.8 million | $313.6 million | Down 6.9% |
| Diluted EPS | $2.88 | $3.10 | Down 7.1% |
| Base earnings and diluted EPS (non-GAAP) | $357.2 million; $3.53 | $340.6 million; $3.37 | Base earnings up 4.9% |
| Cash from operations | $425.9 million | $589.9 million | Down $164.0 million |
| Free cash flow (non-GAAP) | $74.3 million | $260.2 million | Down $185.9 million |
| Total debt at year-end | $1.681 billion | $1.385 billion | Up $296.2 million |
| Cash and cash equivalents | $145.3 million | $120.4 million | Up $24.9 million |
| Current ratio | 1.1 | 1.4 | Lower |
GAAP operating margin was 8.7% versus 8.1%; management’s base operating margin was 9.8% versus 9.1%. Net interest expense was $61.6 million, up from $58.2 million. The effective GAAP tax rate rose to 24.5% from 19.8%, primarily because 2018 included a $16.1 million tax benefit from a valuation-allowance release. The base tax rate was 23.9% versus 23.7%.
Operating cash flow included the impact of $231.2 million of pension and postretirement contributions, including voluntary U.S. pension contributions of $200 million. Management attributed the lower cash flow and free cash flow principally to those contributions, higher capital spending and dividends. Capital expenditures were $195.9 million; cash dividends were $170.3 million. The company paid annual dividends of $1.70 per share, up from $1.62.
Fourth-quarter snapshot
Q4 2019 net sales were $1.309 billion versus $1.356 billion in Q4 2018. Net income attributable to Sonoco was $44.9 million, or $0.44 diluted EPS, compared with $77.7 million, or $0.77, a year earlier. Q4 restructuring and asset impairment charges were $29.2 million versus $11.4 million.
Segments and material changes
- Consumer Packaging: Trade sales declined 1.1% to $2.333 billion; segment operating profit increased 1.7% to $228.4 million. Volume weakness and manufacturing inefficiencies were partly offset by productivity, pricing and acquisitions.
- Display and Packaging: Trade sales fell 6.4% to $554.1 million, largely reflecting the exit of a low-margin Atlanta customer contract; segment operating profit increased to $27.7 million from $13.3 million.
- Paper and Industrial Converted Products: Trade sales rose 3.3% to $1.975 billion and segment operating profit rose 3.8% to $219.1 million, helped by acquisitions and productivity but offset by volume declines and unfavorable price/cost conditions.
- Protective Solutions: Trade sales declined 3.0% to $512.0 million; segment operating profit increased 17.0% to $50.2 million, primarily on productivity.
Company-wide volume/mix declined approximately 2.5% and price/cost was flat. Acquisitions added approximately $251 million to comparable sales, while foreign exchange reduced sales by approximately $90 million. Higher operating profit and margins reflected acquisitions, procurement and fixed-cost productivity, and lower controllable expenses; manufacturing productivity weakened amid lower volume and operational issues.
Outlook, commentary and significant items
- For 2020, management targeted approximately 1% organic volume growth, about 3% reported sales growth, gross-margin improvement of approximately 0.3 percentage points and base operating-margin improvement of approximately 0.1 percentage points. Price/cost was expected to be negative; productivity was expected to offset much of labor and other cost inflation.
- Management forecast operating cash flow of approximately $635 million and free cash flow of approximately $260 million, with capital spending of approximately $195 million. These are forward-looking estimates, and free cash flow is a non-GAAP measure.
- Management expected a full year of Corenso and TEQ results in 2020. The 2019 acquisitions cost $297.9 million net of cash acquired: Corenso for $110.6 million and TEQ for $187.3 million. TEQ closed on December 31, 2019, so it contributed no 2019 operating results.
- The termination of the Inactive U.S. Pension Plan is expected to result in approximately $600 million of noncash settlement charges beginning in 2020 as benefits are settled. Sonoco anticipated an additional approximately $150 million contribution to fund the plan for termination in late 2020 or early 2021, plus approximately $25 million of contributions to other defined-benefit plans in 2020.
- Restructuring and asset impairment charges were $59.9 million in 2019 versus $40.1 million in 2018. The company eliminated approximately 223 positions and expected about $2.8 million of additional costs for previously announced actions, mostly paid by the end of 2020. Further restructuring may occur.
- Two 2019 impairments included a $10.1 million charge related to temperature-controlled shipping assets and a $4.1 million charge related to a U.S. plastic-can business line. A single flexible-packaging customer’s departure also led to a fixed-asset and intangible-asset impairment charge.
- A favorable $10.0 million revision to an environmental remediation estimate reduced 2019 SG&A. Environmental reserves were $8.7 million at year-end, down from $20.1 million.
- The IRS is challenging the company’s treatment of a 2012–2013 intercompany-note distribution. The proposed incremental tax liability is approximately $89 million, excluding interest and proposed $18 million penalties. Sonoco recorded no additional reserve and is contesting the matter; an adverse outcome could materially affect results and financial condition.
- Management reported that the early-2020 coronavirus outbreak had somewhat negatively affected demand and supply chains at Sonoco’s eight China manufacturing locations. China sales were approximately $130 million in 2019. Brexit-related uncertainty was also identified, though management then assessed the likelihood of a material impact as low.
- CEO Robert Tiede resigned effective February 1, 2020; R. Howard Coker became CEO. The auditor issued unqualified opinions on the financial statements and internal controls. Corenso and TEQ were excluded from the year-end internal-control assessment because they were acquired during 2019.
Other notable exposures include raw-material, energy and freight costs; tariffs and trade uncertainty; competitive pricing and customer concentration; foreign exchange; pension funding and discount-rate sensitivity; goodwill impairment; operational and cybersecurity disruptions; and environmental, product-liability and other legal risks. Goodwill in the Display and Packaging reporting unit was identified as at risk if performance or outlook weakens, although estimated fair value exceeded carrying value by approximately 35% in the 2019 test.
Investor verification priorities
- Reconcile GAAP earnings with management’s “base” non-GAAP results and review the exclusions and tax effects; restructuring charges recur and can vary materially.
- Track cash conversion, capital spending, dividends and debt, including the $200 million term loan maturing in May 2020 and the company’s stated intention to seek an extension.
- Assess the timing, cash funding and accounting effects of the Inactive Plan termination, including the anticipated $600 million noncash charge and approximately $150 million contribution.
- Monitor progress against 2020 volume, margin, sales and cash-flow targets, especially given projected negative price/cost and dependence on productivity gains.
- Review the IRS dispute, environmental contingencies, Display and Packaging goodwill sensitivity, and the evolving effects of coronavirus, tariffs and Brexit.
- Evaluate customer concentration: the five largest Display and Packaging customers represented approximately 58% of that segment’s sales; the largest customer accounted for about 4.6% of consolidated revenue and 8% of trade receivables.