Business context and reporting period
Sonoco Products Company’s unaudited Form 10-Q covers the quarter and nine months ended September 26, 2010, with comparisons to the periods ended September 27, 2009. Sonoco manufactures consumer and industrial packaging and provides packaging services, operating through Consumer Packaging, Tubes and Cores/Paper, Packaging Services, and All Other Sonoco. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Third quarter 2010 | Third quarter 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $1,051.7 | $930.6 | $2,997.0 | $2,595.4 |
| Gross profit | $199.6 | $173.1 | $567.9 | $472.2 |
| Gross margin | 19.0% | 18.6% | 18.9% | 18.2% |
| Income before interest and taxes | $84.9 | $74.8 | $250.9 | $176.8 |
| Net income attributable to Sonoco | $59.0 | $47.7 | $166.5 | $104.4 |
| Diluted earnings per share | $0.57 | $0.47 | $1.63 | $1.03 |
- Sales increased 13.0% in the quarter and 15.5% year to date. Quarterly growth reflected higher volume/mix, selling prices, acquisitions, and newly reported corrugating-medium sales, partly offset by unfavorable currency translation. Nine-month growth also benefited from favorable currency translation.
- Management’s non-GAAP “base” diluted EPS, excluding specified restructuring, impairment, and acquisition costs, was $0.65 for the quarter versus $0.50, and $1.75 for nine months versus $1.20. GAAP earnings included $6.9 million after-tax of specified charges in the quarter and $12.1 million year to date.
- Operating cash flow was $260.6 million for nine months, down from $357.8 million. Higher earnings were more than offset in cash flow by working-capital investment and tax-payment timing. Capital expenditures were $101.2 million and acquisition spending was $134.3 million; dividends paid were $83.4 million.
- Cash was $168.7 million at September 26, down from $185.2 million at December 31, 2009. Debt totaled approximately $626.0 million, including $112.4 million current and $513.6 million long term; debt increased $45.2 million during the nine months. Cash less reported debt was approximately $457.3 million.
- Current assets were $1,178.9 million and current liabilities $888.8 million at September 26. The company reported $43.0 million outstanding under its $500 million commercial-paper program. On October 18, it replaced the supporting bank facility with a $350 million five-year facility. A $100 million, 6.75% debenture was due in November 2010; management expected to meet it with cash, operating cash flow, and/or refinancing.
Material changes and management commentary
- Industrial-focused businesses rebounded from recession-affected results. Quarterly Tubes and Cores/Paper operating profit rose 76.5%; All Other Sonoco rose 129.9%. Consumer Packaging profit increased 5.0%, while Packaging Services profit fell 64.9% on lower pricing and unfavorable business mix.
- For the first nine months, segment operating profit increased in all four reported groups: Consumer Packaging 9.4%, Tubes and Cores/Paper 98.8%, Packaging Services 50.9%, and All Other Sonoco 67.7%.
- Management attributed margin improvement to stronger volumes, productivity, manufacturing efficiencies, and lower pension costs. These benefits more than offset higher material costs overall, though the rapid first-quarter rise in recovered-paper prices and higher resin costs created an unfavorable price/cost relationship.
- The June acquisition of Associated Packaging Technologies, a frozen-food container supplier, cost approximately $120 million and is expected to contribute about $150 million in annualized sales. Two smaller acquisitions were also completed. The company expected full-year 2010 capital spending of approximately $150 million, including approximately $50 million in the fourth quarter.
Outlook, risks, contingencies, and unusual items
- No specific earnings or revenue guidance is provided in the filing. Management expected operating cash flows to remain strong for the rest of 2010 and Packaging Services business to remain at current levels for the balance of the year.
- A major Flexible Packaging customer will not renew part of its contract; the business is expected to phase out over two years. The filing says the loss was not expected to affect 2010 sales or base earnings. Sonoco recorded a $12.6 million noncash impairment charge on affected assets and expects replacement business and productivity improvements, but notes goodwill impairment could result if growth or margin assumptions are not achieved.
- Packaging Services had transitioned approximately $45 million of annualized sales lost following a customer’s 2009 bidding process. A separate customer decision is expected to reduce annual sales by approximately $35 million by 2012; management expects new business to offset the losses, but timing and success are uncertain.
- Annual goodwill testing found no impairment. Management identified several reporting units with impairment risk if forecast growth or margin improvements fail to materialize, including Packaging Services, Flexible Packaging, Matrix Packaging, Tubes and Cores/Paper—Europe, and Rigid Paper Containers—Australia/New Zealand.
- Sonoco reported $58.9 million in accrued environmental contingencies at September 26, primarily associated with U.S. Paper Mills and Fox River contamination. The company estimated its share of remaining remediation costs at the specific site at $1.9 million to $4.9 million. Broader Fox River claims remain uncertain; Sonoco stated its maximum additional consolidated exposure was limited to U.S. Mills’ approximately $84 million equity position. Government litigation was filed October 14, 2010, and the subsidiary intends to defend itself. The filing does not provide a clear estimate of the ultimate loss for the broader claims.
- Other risks include raw-material and energy prices, foreign-exchange and interest-rate movements, pension assumptions and funding, customer demand and pricing, acquisition integration, restructuring execution, and legal and environmental claims. Commodity hedges were in an unfavorable fair-value position of $15.2 million at quarter-end; management stated hedges were highly effective and were not used for speculation.
- Previously announced restructuring actions were expected to require approximately $3.7 million of additional cash costs, mostly incurred and paid by year-end 2010. Further restructuring may occur. Management stated debt covenants were satisfied, with defined net worth approximately $507 million above the minimum requirement.
- Interim statements were reviewed, not audited, by the independent accounting firm. The filing states disclosure controls were effective and no material change in internal control over financial reporting occurred during the quarter.
Most important facts for investors to verify
- Whether volume growth and productivity can continue to offset input-cost inflation and the unfavorable price/cost relationship.
- Whether customer losses in Flexible Packaging and Packaging Services are replaced on schedule, and whether the associated goodwill assumptions remain supportable.
- Cash conversion and working-capital trends, particularly given operating cash flow’s year-over-year decline despite higher earnings.
- Funding and refinancing of the November 2010 debenture, along with debt levels and compliance with credit-facility covenants.
- Developments in Fox River litigation and remediation, including whether potential exposure exceeds recorded reserves or management’s stated subsidiary-equity limitation.
- Performance and integration of APT and other acquired businesses, and realization of expected sales and productivity benefits.