PACKAGING CORP OF AMERICA annual report, FY2011

Business context and reporting period

Packaging Corporation of America (PCA) filed this Form 10-K for the fiscal year ended December 31, 2011. PCA is an integrated U.S. producer of containerboard and corrugated packaging, operating four mills and 71 corrugated manufacturing facilities. It produced 2.499 million tons of containerboard and shipped 32.5 billion square feet of corrugated products in 2011; approximately 80% of mill output was used internally.

Financial and operating performance

• Sales rose 7.6%, driven by higher corrugated and containerboard volumes and prices. Corrugated shipments increased 5.0%; external containerboard sales volume increased 1.2%.
• Operating income increased on a GAAP basis, but comparability is affected by alternative-energy tax-credit accounting in 2010. Excluding identified special items, operating income was $278.6 million versus $285.4 million, net income was $161.8 million versus $166.3 million, and diluted EPS was $1.61 versus $1.62.
• Higher transportation, chemical, labor, recycled-fiber, medical-benefit and energy costs offset price and volume benefits. Gross margin declined from 21.9% to 20.7%.
• Fourth-quarter 2011 sales were $654.3 million, net income was $39.5 million and diluted EPS was $0.40.
• Investing cash outflow was $350.2 million, including $57.3 million for acquisitions; capital expenditures were $280.2 million. Financing cash outflow was $35.6 million. Cash ended the year at $156.3 million, down from $196.6 million.
• Debt obligations including capital leases totaled approximately $830.3 million at year-end; stockholders’ equity was $928.9 million. Available capacity under credit facilities was $326.7 million, net of letters of credit. PCA reported compliance with debt covenants.

Changes, outlook and material items

• PCA completed major energy-optimization projects at its Counce and Valdosta mills in late 2011. Management expects lower purchased fuel and electricity use and a full-quarter earnings benefit in Q1 2012.
• Management expected Q1 2012 corrugated shipments to benefit from four additional workdays versus Q4 2011, with normal seasonal, maintenance, benefit-cost and tax-rate pressures. It expected Q1 earnings, excluding special items, to be approximately equal to Q4 reported diluted EPS of $0.40.
• A February 3, 2012 amendment to PCA’s 2009 tax return is expected to cause a non-cash, after-tax charge of $23 million in Q1 2012. The IRS review of the 2008 and 2009 returns, including the biofuel credits, was ongoing. PCA recorded a $102.0 million reserve related to uncertainty over the Filer City process; the company estimated the uncertain-tax-position reserve could change by $0 to $104.7 million. Tax-credit carryforwards were subject to use by December 31, 2015.
• PCA’s $400 million of 5.75% senior notes mature in 2013. The company had entered interest-rate protection arrangements in connection with anticipated refinancing; successful refinancing remains important.
• A 2010 antitrust class action alleges containerboard producers conspired to restrict supply and raise prices. PCA disputes the allegations but could not estimate the outcome or reasonably possible loss.
• Boiler MACT rules could require significant boiler modifications; timing and cost remain uncertain. PCA reported a $10.5 million environmental reserve and estimated 2012 environmental capital spending of $1.0 million.
• A fire at the Valdosta mill in April 2011 caused lost production and repair costs. PCA had received $9.4 million in insurance proceeds by year-end and expected additional proceeds as work was completed.
• PCA increased its quarterly dividend to $0.20 per share in 2011 and authorized an additional $150 million share-repurchase program in December 2011.

Investor facts to verify

• Reconcile GAAP earnings with management’s adjusted results, particularly the unusual 2010–2012 biofuel tax-credit effects and the expected $23 million Q1 2012 charge.
• Track the IRS audit, the $102 million tax reserve, potential reserve changes and the deadline for using remaining tax credits.
• Assess refinancing plans for the $400 million 2013 note maturity and monitor leverage, covenant headroom and borrowing availability.
• Evaluate whether energy-project savings offset higher operating costs and whether volume and pricing remain resilient.
• Monitor the antitrust litigation, Boiler MACT compliance costs, environmental obligations and final insurance recovery for the Valdosta fire.