PACKAGING CORP OF AMERICA quarterly report, Q3 FY2018

Packaging Corporation of America — Q3 2018 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. PCA manufactures corrugated packaging and paper products, primarily in the United States, and reports Packaging, Paper, and Corporate and Other segments. Figures are in millions of dollars except per-share data.

Financial results

Metric	Q3 2018	Q3 2017	Nine months 2018	Nine months 2017
Net sales	$1,809.9	$1,640.1	$5,268.1	$4,760.6
Gross profit	$443.2	$397.0	$1,219.9	$1,099.4
Income from operations	$298.5	$242.6	$781.0	$680.1
Net income	$206.7	$139.1	$533.4	$399.7
Diluted EPS	$2.18	$1.47	$5.64	$4.23

Q3 sales rose 10.4%, operating income 23.0%, and net income 48.6% year over year. Gross, operating, and net margins were approximately 24.5%, 16.5%, and 11.4%, respectively, versus 24.2%, 14.8%, and 8.5% in Q3 2017.
For the first nine months, sales increased 10.7%, operating income 14.8%, and net income 33.5%. Gross, operating, and net margins were approximately 23.2%, 14.8%, and 10.1%, compared with 23.1%, 14.3%, and 8.4%.
Management-reported adjusted diluted EPS was $2.23 in Q3 and $5.87 for nine months, excluding special items; reported GAAP diluted EPS was $2.18 and $5.64. Adjusted EPS is a non-GAAP measure.
Q3 Packaging revenue rose 14.0% to $1,535.1; Paper revenue fell 6.3% to $254.3. Segment operating income was $284.4 for Packaging and $32.3 for Paper, compared with $263.2 and a $2.6 loss, respectively, in Q3 2017. Nine-month Packaging operating income was $782.3; Paper was $55.7.
Nine-month operating cash flow was $834.5, investing cash outflow $405.3, and financing cash outflow $352.3. Capital expenditures were $404.3; operating cash flow less capital expenditures was approximately $430.2. Cash increased $76.9 to $293.8.
At September 30, cash was $293.8 and unused revolver capacity was $327, net of letters of credit. Long-term debt carrying value was $2,482.9; outstanding senior notes had a stated value of $2,496.2 and were fixed-rate, with a weighted average rate of 3.64%. PCA repaid $150.0 of 6.50% notes due March 2018.
Quarterly dividends declared were $0.79 per share, increased from $0.63 a year earlier. The company paid $193.4 in dividends during the first nine months.

Changes and drivers

Packaging benefited from higher prices and mix, stronger shipment volumes, and lower wood and recycled-fiber costs; higher operating/converting costs, freight, outages, and depreciation partly offset the gains. Q3 corrugated shipments increased 8.2% and containerboard outside shipments 11.4% year over year.
Paper’s Q3 improvement reflected better prices and mix and lower operating costs, despite lower volumes. Nine-month Paper adjusted EBITDA was $113.0 versus $120.6 in 2017, with lower volumes and higher freight and fiber costs weighing on results.
The effective tax rate declined to 24.6% in Q3 from 35.9%, and to 24.4% for nine months from 33.9%, primarily due to the Tax Act. Nine-month cash taxes paid, net of refunds, were $73.2 versus $208.3.
During Q2, PCA stopped producing certain white paper grades at its Wallula mill and converted the No. 3 machine to virgin kraft linerboard. The mill’s results were primarily reported in Packaging after conversion in May. Nine-month Wallula-related charges were $26.4; management said further charges were expected.
PCA acquired Sacramento Container in October 2017 for approximately $274 million, funded with cash. Its results are included in Packaging from acquisition.

Outlook, risks, and unusual items

For Q4 2018, management expected Packaging demand to remain strong, but anticipated two fewer shipping days and a seasonally less favorable product mix. Paper volumes were expected to be seasonally lower, with recently communicated price increases continuing and inventory tight.
Management expected higher seasonal fuel costs, continued inflation in most operating and converting costs, wage pressure, and an extended Wallula outage to complete the machine conversion. It expected Q4 earnings excluding special items to be below Q3 2018.
Management forecast 2018 capital expenditures of $530–$550 million, excluding acquisitions; estimated environmental compliance spending was about $8 million. It said operating cash generation, cash on hand, revolver capacity, and capital-market access should meet foreseeable liquidity needs.
Special items included Wallula restructuring, facility closures, acquisition/integration costs, and a weather-related property-damage insurance deductible. The filing’s reported results include these costs; management’s adjusted measures exclude specified items.
The DeRidder mill explosion in February 2017 caused three contractor fatalities and injuries. Related lawsuits allege negligence and seek compensatory and punitive damages; PCA is defending them and could not estimate a reasonable loss range. The EPA investigation remained ongoing. PCA received $17 million of insurance proceeds in Q1 2018 related to property damage and business interruption.
Office Depot represented about 7% of company sales and 46% of Paper segment sales for the first nine months of 2018. Receivables from Office Depot rose to $73.5, or 7% of company receivables; PCA cited extended credit terms. A reduction in this business or customer financial deterioration could adversely affect results.
Other risks cited include economic and industry conditions, product pricing and demand, fiber and energy costs, unplanned facility outages, acquired-business integration, and environmental or tax regulation. All debt was fixed-rate and PCA reported no derivative arrangements or off-balance-sheet arrangements at quarter-end.
PCA planned to adopt the new lease accounting standard on January 1, 2019 and expected to recognize assets and liabilities for in-scope operating leases; the ultimate financial-statement effect was still being assessed.

Important facts for investors to verify

Whether Packaging pricing, shipment growth, and margins can offset ongoing cost, freight, labor, and outage pressures.
The total remaining cost and timing of the Wallula conversion, including the Q4 outage and any additional restructuring charges.
Capital spending against the $530–$550 million forecast and the resulting cash flow after investment and dividends.
Office Depot’s continuing purchases, payment performance, and share of Paper segment sales and receivables.
Developments in the DeRidder lawsuits and EPA investigation, including whether PCA’s insurance coverage is sufficient.
The eventual balance-sheet impact of adopting lease accounting and any final Tax Act measurement-period adjustments.