SILGAN HOLDINGS INC quarterly report, Q2 FY2011

Business context and reporting period

Silgan Holdings Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2011. The company supplies rigid packaging, including metal and plastic containers and closures. Results include the Vogel & Noot (VN) metal-container operations acquired March 1, 2011, and the DGS closure business acquired the same day.

Financial performance and liquidity

• Q2 sales rose 18.5%; six-month sales rose 12.3%. Q2 operating margin was 11.5% versus 9.7%, while gross margin declined to 14.2% from 15.7%. For six months, operating margin improved to 9.7% from 9.1%, but gross margin fell to 14.4% from 15.6%.
• Growth reflected acquisitions, higher selling prices that largely passed through higher raw-material costs, and favorable currency translation. Domestic metal-container volumes were lower over the first half, partly following customer buy-ahead at year-end 2010; plastic-container volumes were also lower.
• Cash used in operating activities was $52.5 million for the first half, compared with $172.5 million used in 2010. Receivables and inventory absorbed cash, consistent with seasonal working-capital needs; 2010 operating cash flow also included $92.3 million of pension contributions.
• First-half investing cash outflow was $345.4 million, including $264.4 million for acquisitions and $84.2 million of capital expenditures. Cash ended June at $127.5 million, versus $52.1 million a year earlier and $175.2 million at December 31, 2010.
• Total debt at June 30 was $1.492 billion, versus $848.8 million at June 30, 2010 and $904.7 million at year-end 2010. Current liabilities were $666.4 million and current assets $1.356 billion. Interest and other debt expense rose to $16.4 million for Q2 and $30.4 million for the first half.

Material changes, outlook and risks

• Earnings include a significant unusual gain: Graham Packaging terminated its merger agreement and paid Silgan a $39.5 million fee. After corporate-development costs, $27.0 million was included in Q2 operating income and $25.2 million in first-half operating income. Accordingly, reported operating-income growth substantially reflects this non-recurring item.
• VN contributed $75.4 million of Q2 sales and $100.4 million for the first half. Its post-acquisition results were described as not significant; purchase accounting included a $5.5 million pre-tax inventory write-up impact. Purchase-price allocation remained preliminary. DGS and IPEC also contributed to closure sales.
• Segment pressures included delayed pass-through of higher manufacturing or resin costs, less favorable product mix, lower volumes in certain businesses, and a $3.3 million past product-liability settlement charge. Rationalization charges were $2.4 million in Q2 and $4.1 million in the first half; $17.7 million of future cash spending was expected for outstanding plans in the current year and thereafter.
• On July 28, 2011, Silgan refinanced its prior facility with a new $1.9 billion secured credit agreement, including term loans and revolving facilities. The company reported compliance with its covenants and expected to remain compliant in 2011. It anticipated a roughly $1.0 million pre-tax debt-extinguishment charge in Q3. Management said operating cash and borrowing availability should cover foreseeable operating needs, capital spending, debt service, taxes, pensions, dividends, and share repurchases.
• Seasonality is material: harvest-related packaging demand typically makes unit sales and operating income disproportionately higher in Q3. Seasonal working-capital needs have peaked at approximately $300 million in recent years. On August 5, the board authorized repurchases of up to $300 million of shares, inclusive of prior authorizations, through December 31, 2014, and declared a $0.11 quarterly dividend.
• Risks and contingencies include harvest and weather variability, raw-material and energy prices, interest-rate and foreign-exchange exposure, acquisition integration, and an IRS examination of 2004–2007 tax returns. The company could not estimate the potential change in unrecognized tax benefits. The filing also states that VN’s internal controls were still being integrated; its controls would be included in the company’s 2012 annual assessment.

Important facts for investors to verify

1. How underlying earnings and margins trend after excluding the Graham Packaging termination proceeds, and whether cost pass-throughs catch up with raw-material inflation.
2. VN and other acquisitions’ ongoing sales, profitability, integration costs, and final purchase-price allocation.
3. Debt levels, borrowing availability, covenant headroom, seasonal working-capital requirements, and the terms and effect of the July refinancing.
4. Whether domestic metal-container and plastic-container volumes recover, and the impact of harvest conditions on the typically stronger third quarter.
5. Developments in the IRS audits, rationalization cash spending, and any remaining exposure related to the product-liability settlement.