Tredegar Corporation — Q3 2018 Form 10-Q
Business context and period. Tredegar manufactures polyethylene films (PE Films), polyester films (Flexible Packaging Films) and aluminum extrusions. This unaudited report covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Sales | $267.3m | $247.1m | $789.8m | $715.5m |
| Net income (loss) | $(34.2)m | $8.3m | $(1.3)m | $56.2m |
| Diluted EPS | $(1.03) | $0.25 | $(0.04) | $1.70 |
| Operating cash flow | Not reported by quarter | Not reported by quarter | $93.0m | $53.5m |
| Capital expenditures | Not reported by quarter | Not reported by quarter | $25.1m | $37.2m |
- Q3 net sales, excluding freight, rose 8.1% to $257.9m. Consolidated gross margin fell to 15.1% from 17.8%. The company reported a $30.0m operating loss, including a $46.8m goodwill impairment charge.
- Nine-month sales increased 10.4%, while net income turned to a loss. The 2018 period included a $46.8m goodwill impairment and $11.9m of unrealized gains on the kaléo investment; 2017 included $24.8m of kaléo gains and an $11.9m Terphane escrow-settlement gain. The effective tax rate was 172.1% in 2018 versus 14.7% in 2017.
- At September 30, cash was $36.8m; current assets were $268.6m and current liabilities $173.2m. Debt was $91.0m, down from $152.0m at year-end 2017; net debt was $54.2m. Approximately $309m was available to borrow under the credit facility. The company reported compliance with its covenants, a 0.92x leverage ratio and 10.71x interest coverage ratio.
- Cash from operations increased year over year, primarily due to income tax refunds relative to tax payments. Investing cash use was $19.7m; financing cash use was $70.9m, chiefly net debt repayments and dividends. Cash increased $0.3m over the nine-month period. Dividends were $0.11 per share quarterly, or $0.33 for the nine months.
Segment changes and material developments
- PE Films: Q3 net sales fell 14.8% to $76.5m and ongoing operating profit fell 63.2% to $4.1m, reflecting lower personal-care and surface-protection volumes, quality-claim reserves and related costs. Nine-month ongoing operating profit declined 13.3% to $26.9m.
- Flexible Packaging Films: Q3 net sales rose 26.7% to $33.7m and ongoing operating profit improved to $3.6m from a $1.1m loss. Higher demand and restarted Brazilian production capacity contributed; lower depreciation following a 2017 asset impairment also benefited results. Management cautioned that industry overcapacity and competitive pricing make results volatile.
- Aluminum Extrusions: Q3 net sales rose 20.9% to $147.7m, but ongoing operating profit fell 6.9% to $11.7m as higher operating costs and Niles, Michigan inefficiencies offset volume and mix gains. Higher aluminum costs were largely passed through to customers, but could weaken demand or encourage substitutions.
- Tredegar wrote off all $46.8m of goodwill for PE Films’ Personal Care component after a customer transition and revised forecasts. The charge was $38.2m after tax.
Outlook, risks and unusual items
- A Personal Care customer transition is expected to affect approximately $70m of annual sales. Management expects $30–$35m of sales in 2019, with the possibility of no sales thereafter; the 2019 operating-profit impact is unclear but expected to exceed $10m. Replacement products and cost actions may mitigate the loss.
- Surface Protection customer transitions are expected to be fully implemented by Q4 2019. Management estimates an approximately $11m annualized adverse operating-profit impact once implemented.
- The Shanghai PE Films plant was expected to cease production in Q4 2018. Estimated transition costs are $7.1m in cash costs plus $0.9m of non-cash write-offs and accelerated depreciation; expected annual cash savings are $1.7m. Execution is expected to take 12–18 months.
- Management projected 2018 capital expenditures of $46m across the segments: $26m for PE Films, $5m for Flexible Packaging Films and $15m for Aluminum Extrusions. These are estimates, not a full-year earnings forecast.
- The $65.9m kaléo investment is valued using Level 3 assumptions and is not publicly traded. Its ultimate realized value could differ materially; the filing also notes an ongoing Department of Justice investigation related to kaléo’s Evzio business.
- Disclosure controls were deemed ineffective, and management concluded that material weaknesses existed in financial-reporting controls relating to review of cash-flow forecasts used in valuations and controls over revenue accuracy and occurrence. Prior conclusions on control effectiveness were no longer to be relied upon. Remediation was underway, but completion and testing by year-end were not assured; management stated it knew of no resulting material misstatement.
Important facts for investors to verify
- Whether the expected Personal Care and Surface Protection customer transitions occur on schedule, and their realized revenue, profit and replacement-product effects.
- Whether PE Films completes the Shanghai closure within estimated costs and achieves projected savings.
- Whether Aluminum Extrusions sustains demand and passes through raw-material costs without material volume or substitution effects; monitor Niles operating inefficiencies.
- Changes in the estimated fair value of kaléo, including the effects of business, regulatory and legal developments.
- Progress and independent testing of internal-control remediation, and whether additional control deficiencies are identified.
- Tax-rate and cash-flow effects of the Tax Cuts and Jobs Act, including the company’s still-undecided GILTI accounting policy.