Business context and reporting period
Tredegar Corporation filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2017. Its businesses are PE Films, Flexible Packaging Films and Aluminum Extrusions. On February 15, 2017, its Bonnell Aluminum subsidiary acquired Futura Industries; Futura’s results are included from the acquisition date.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Sales | $247.3 million | $208.5 million | $468.4 million | $415.9 million |
| Net income | $44.2 million | $3.4 million | $47.9 million | $10.7 million |
| Diluted EPS | $1.34 | $0.10 | $1.45 | $0.33 |
| Gross margin | 17.0% | 15.2% | 15.6% | 16.6% |
- Q2 sales increased 18.6%; first-half sales increased 12.6%. Aluminum Extrusions’ growth included Futura and higher aluminum-related selling prices. Segment net sales in Q2 were PE Films $89.6 million, Flexible Packaging Films $26.6 million and Aluminum Extrusions $123.2 million.
- Operating profit from ongoing operations in the first half was $19.7 million for PE Films, a $2.3 million loss for Flexible Packaging Films and $21.6 million for Aluminum Extrusions. Futura contributed $30.8 million in sales and $3.8 million in ongoing operating profit from acquisition through June 30.
- Operating cash flow was $22.0 million in the first half, versus $18.3 million a year earlier. Investing used $113.7 million, including $87.1 million for Futura and $26.7 million of capital expenditures. Financing provided $85.7 million, principally from net borrowings.
- At June 30, cash was $24.0 million, long-term debt was $187.3 million and debt net of cash was $163.2 million. The $400 million revolving facility had approximately $193 million available under the most restrictive covenants. The company reported covenant compliance; leverage was 1.99x against a 4.00x maximum and interest coverage was 12.37x against a 2.50x minimum.
- Current assets were $258.4 million and current liabilities were $134.0 million. Total shareholders’ equity was $359.4 million. The quarterly dividend was $0.11 per share.
- The first-half effective tax rate was 9.9%, compared with 29.8% in 2016.
Material changes and unusual items
- Reported earnings included substantial non-operating and tax benefits. Q2 included a $21.5 million pretax unrealized gain on Tredegar’s kaléo investment, an $11.9 million pretax gain from settling an escrow arrangement related to the 2011 Terphane acquisition, and an $8.1 million income-tax benefit from a worthless-stock deduction. The first-half kaléo unrealized gain was $24.8 million pretax.
- kaléo’s estimated fair value rose to $45.0 million from $20.2 million at year-end. The privately held investment is valued using high-risk Level 3 projections discounted at 45%; the filing cautions that ultimate realization may differ materially. A 500-basis-point change in the discount rate would change estimated value by approximately $8–9 million.
- Futura was acquired for an approximately $92 million initial purchase price; approximately $87 million was funded in cash. Up to $5 million may be returned if specified performance conditions are not met. The filing reports actual diluted EPS accretion of $0.04 in Q2 and $0.05 in the first half.
- Flexible Packaging Films moved from $1.1 million first-half ongoing operating profit in 2016 to a $2.3 million loss in 2017, reflecting competitive pricing, raw-material cost pass-through timing, Brazilian inflation and currency effects. Management expects volatility to continue; additional Latin American PET capacity was expected online in Q3 2017.
Outlook, management commentary and risks
- Management said existing borrowing availability, cash and operating cash flow should fund working capital, capital expenditures and dividends for the next 12 months.
- PE Films’ domestic facility consolidation was expected to finish in Q4 2017. Total pretax cash expenditures were estimated at approximately $17 million, with annual pretax cash savings of $5–6 million once complete. The company had spent $14.4 million by June 30.
- Management identified possible customer transitions in surface protection films that could reduce annual ongoing operating profit by up to $5–10 million, with timing and magnitude uncertain. A significant personal-care product transition after 2018 could also adversely affect profit; its impact was not yet clear.
- Management projected 2017 capital expenditures of $26 million for PE Films, $3 million for Flexible Packaging Films and $25 million for Aluminum Extrusions. The latter includes capacity expansion and cast-house repair work.
- Risks include raw-material and energy costs and the ability to pass them through, foreign exchange and Brazilian economic conditions, customer concentration and product transitions, acquisition integration, and manufacturing disruption. Possible U.S. tariffs on imported aluminum could raise Bonnell’s costs and, despite expected pass-through, could encourage product substitution.
- Following the Terphane escrow settlement, Tredegar assumed the risk of claims previously secured by that escrow. The ultimate claims are unknown; management estimated possible future claims of approximately $3.5 million. A trade-court remand also returned certain PET-film antidumping scope issues to the Department of Commerce for reconsideration.
Important facts for investors to verify
- How much of reported earnings reflects recurring segment operations versus the kaléo valuation gain, Terphane escrow settlement and tax benefit.
- Whether kaléo achieves projected performance and whether its estimated $45.0 million fair value can ultimately be realized.
- Futura’s performance against earnout conditions, integration progress and contribution to Aluminum Extrusions.
- Whether Flexible Packaging Films can restore profitability amid competitive capacity, Brazilian inflation and currency exposure.
- Progress on PE Films customer transitions and facility consolidation, including realized savings and any lost-business impact.
- Potential aluminum tariffs, Terphane claims and litigation, and the company’s capacity to fund planned investment while maintaining covenant headroom.