Sonoco Products Company — Q2 2015 Form 10-Q
Business context and period. Packaging and related products company with four reportable segments. This unaudited report covers the quarter and six months ended June 28, 2015; comparative 2014 results are restated. Dollar amounts below are in millions unless noted.
Financial results and liquidity
| Metric | Q2 2015 | Q2 2014 restated | Six months 2015 | Six months 2014 restated |
|---|---|---|---|---|
| Net sales | $1,248.6 | $1,247.6 | $2,454.6 | $2,437.6 |
| Gross profit | $240.3 | $229.0 | $460.7 | $438.7 |
| Income before interest and taxes | $99.0 | $98.8 | $223.1 | $182.8 |
| Net income attributable to Sonoco | $64.4 | $59.4 | $150.2 | $109.8 |
| Diluted EPS | $0.63 | $0.57 | $1.47 | $1.06 |
| Operating cash flow | Not reported quarterly | Not reported quarterly | $173.1 | $105.5 |
- Q2 sales were essentially flat (+0.1%); first-half sales rose 0.7%. Gross margin was 19.2% in Q2 and improved about 90 basis points year over year; first-half margin improved about 77 basis points.
- Management’s non-GAAP “base” diluted EPS was $0.68 for Q2 versus $0.61, and $1.22 for the first half versus $1.11. First-half GAAP earnings included net after-tax gains of $25.7 million, largely from the Fox River reserve reversal and metal-plant sale; base results exclude specified items.
- Six-month investing cash use was $74.2 million, including $86.7 million of capital spending; financing cash use was $54.8 million. Cash increased to $217.8 million from $161.2 million at year-end.
- Debt was approximately $1.27 billion at June 28, 2015. The $350 million commercial-paper program had no outstanding balance; a matching committed revolver runs through October 2019. The company reported covenant measures substantially above minimum requirements.
- Cash flow statement operating cash flow implies a $67.5 million year-over-year increase, while MD&A describes the increase as $64.7 million; verify this difference.
Material changes and segment performance
- Consumer Packaging sales rose 12.1% in Q2 and operating profit rose 34.3%, supported by acquisitions, productivity and price/cost improvements.
- Display and Packaging sales fell 13.0% and operating profit fell 78.1%, reflecting currency translation, weaker mix and loss of higher-margin U.S. business. Paper and Industrial Converted Products sales and operating profit declined 8.4% and 16.3%, respectively. Protective Solutions sales rose 4.8% and operating profit rose 41.1%.
- Acquisitions, particularly Weidenhammer and Brazil’s Graffo, supported growth. Graffo was acquired on April 1, 2015, for approximately $18.3 million total consideration, including assumed debt.
- First-half foreign-currency translation reduced sales, and the stronger U.S. dollar drove a $59.2 million translation loss in other comprehensive income.
Outlook, risks and unusual items
- The filing provides no clear consolidated earnings guidance. Management expected approximately $138 million of additional capital spending and $11 million of additional pension and postretirement contributions during the rest of 2015. Approximately $3.05 million of future restructuring charges were expected, mostly incurred and paid by year-end.
- In July 2015, Sonoco found unsupported journal entries and other irregularities at its Irapuato, Mexico, contract-packaging center. The investigation found misstatements intended to conceal operating-profit shortfalls. Results from 2012 through Q1 2015 were affected; cumulative net income had been overstated by about $23.3 million, or $0.23 per diluted share. The company restated prior periods and said cash and previously reported operating cash flows were unaffected. The 2014 and 2013 annual statements, 2012 annual statements, specified 2014 interim periods and Q1 2015 statements should no longer be relied upon.
- Management concluded disclosure controls were ineffective at June 28, 2015, due to material weaknesses in internal control over financial reporting. Remediation initiatives were implemented or planned. The independent accountant performed an interim review, not an audit.
- Fox River environmental settlement finalization led to a $32.5 million reserve reversal; $4.5 million remained reserved for Appvion’s CERCLA claim, which seeks approximately $200 million from eight defendants. Sonoco says its maximum additional consolidated exposure is limited to U.S. Mills’ equity, approximately $123 million, but it cannot estimate potential loss beyond the reserve. Trial was scheduled for June 2016.
- Environmental contingency accruals totaled $25.8 million. The Display and Packaging reporting unit had approximately $205 million of goodwill and an estimated fair-value cushion of about 19%; customer concentration, contract renewal, price pressure and execution of anticipated synergies create impairment risk.
- Other disclosed risks include restructuring and integration execution, raw-material and energy prices, currency exposure (including Venezuela), pension costs, and legal and environmental contingencies.
Important facts for investors to verify
- Review the amended 2014 Form 10-K and subsequent amended Q1 filing, and confirm all restated comparative figures and remediation disclosures.
- Track remediation of the Irapuato-related control weaknesses and whether the company reports effective controls in future filings.
- Assess the quality and recurrence of earnings excluding Fox River, asset-sale, tax and restructuring items; reconcile the cash-flow increase discrepancy.
- Monitor Display and Packaging customer renewal, margins and goodwill assumptions, as well as the Appvion claim and other environmental exposures.
- Verify delivery of stated 2015 capital-spending, pension-contribution and restructuring expectations alongside debt and cash trends.