Sonoco Products Company — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 28, 2014; comparisons are with the periods ended September 29, 2013. Financial statements are unaudited and were subject to an interim review, not an audit. Unless stated otherwise, amounts below are in millions of dollars.
Business context and key financial metrics
Sonoco supplies consumer and industrial packaging, protective packaging, and packaging-related services through four reportable segments. It operated approximately 335 locations in 33 countries.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $1,263.6 | $1,227.7 | $3,696.6 | $3,633.2 |
| Gross profit | $227.7 | $224.0 | $671.7 | $652.3 |
| Income before interest and taxes | $111.2 | $100.3 | $299.4 | $273.7 |
| Net income attributable to Sonoco | $70.9 | $61.2 | $184.7 | $164.4 |
| Diluted EPS | $0.69 | $0.59 | $1.79 | $1.59 |
| Company-reported base diluted EPS (non-GAAP) | $0.72 | $0.63 | $1.87 | $1.72 |
Q3 gross margin was approximately 18.0%, down about 20 basis points year over year; nine-month gross margin was approximately 18.2%, up about 20 basis points. Operating margin was approximately 8.8% in Q3 versus 8.2%, and 8.1% for the nine months versus 7.5%. The company’s “base” measures exclude selected restructuring, impairment, acquisition, tax, and other items; they are non-GAAP measures.
- Cash flow: Nine-month operating cash flow was $267.4, down from $421.3. Capital spending was $135.3; investing cash outflow was $144.3. Financing cash outflow was $104.6. Cash increased $14.0 to $231.6.
- Liquidity and debt: Current assets were $1,470.8 and current liabilities $928.7. Debt totaled approximately $1,017.6, including $71.7 current and $945.9 long-term; cash was $231.6. Commercial paper outstanding was $36.0. Management said covenant measures were substantially above required minimums.
- Shareholder returns: Dividends were $0.32 per share in Q3. The company repurchased approximately 1.09 million shares under its buyback authorization during the first nine months, at a cost of $45.0.
Changes versus the prior comparable period
- Q3 sales rose 2.9%; nine-month sales increased 1.7%. Nine-month sales growth reflected volume/mix (+$24), pricing (+$28) and acquisitions (+$31), partly offset by foreign currency and other factors (-$20).
- Q3 income before interest and taxes increased 10.9%; nine-month operating income increased 9.4%. Net income attributable to Sonoco rose 15.8% in Q3 and 12.4% year to date.
- Paper and Industrial Converted Products was the main operating-profit growth driver: segment operating profit rose 29.9% in Q3 and 19.6% for the nine months. Protective Solutions operating profit fell 6.8% in Q3 and 21.6% year to date. Display and Packaging’s Q3 operating profit declined 6.9%, despite higher sales.
- Operating cash flow fell by $153.9 year over year, reflecting, among other factors, higher pension contributions, a larger receivables cash use, income-tax payment timing, and a $14.7 Fox River settlement funding payment. Debt reduction was smaller than in the prior-year period.
Outlook, management commentary, risks and unusual items
- Management cited favorable price/cost, productivity and lower pension expense, partly offset by higher labor, maintenance and other costs. Q3 results also reflected lower-margin product mix. Severe winter weather disrupted production and increased costs early in 2014; management said those effects had passed, although some industrial demand remained soft.
- No specific full-year earnings guidance is provided in the supplied filing text. Management expected approximately $50 of additional capital spending in the remainder of 2014, about $7 of additional pension and postretirement contributions, and approximately 0.9 million additional share repurchases during the balance of the year.
- Sonoco agreed to acquire Weidenhammer Packaging Group for approximately €286 million (about $383 million), subject to working-capital adjustment, and expected to close in Q4 2014. A new $600 million credit facility included a $250 million term loan intended to help fund the acquisition, contingent on closing; the remainder was expected to come from cash and short-term borrowings. The company also acquired Dalton Paper Products for a net cash cost of about $11.3 million in May.
- Q3 included an approximately $5 million pretax benefit from a technology-related legal settlement, net of related costs. Nine-month restructuring and asset-impairment charges were $11.6; Q3 included a $2.7 impairment of a customer list after the company lost the associated customer business. Management expected about $1.2 of additional charges for announced restructuring actions, mostly incurred and paid by year-end.
- An $11.8 deferred-tax valuation allowance adjustment was recorded in Q2 for foreign-subsidiary pension-related deferred tax assets. Management said it corrected prior-period error and was not material to previously issued or current-year financial statements.
- Fox River environmental claims remain uncertain. The company reported $57.9 in total environmental accruals, including $37.1 related to U.S. Mills; Fox River reserves included $3.2 for the Site and $33.9 for other potential liabilities. A proposed $14.7 settlement remained subject to court approval and appeals. The company stated that additional exposure beyond reserves was limited to U.S. Mills’ equity position, approximately $99, while noting uncertainties and possible contribution claims.
- The Village of Rockton filed 81 actions related to a closed plant undergoing remediation; Sonoco removed the cases to federal court and said it would defend them. Other risks include customer concentration and potential goodwill impairment in Display and Packaging, foreign-exchange exposure (including Venezuela), commodity and input costs, and pension obligations. The company estimated new mortality tables could increase domestic benefit obligations by about $75 at year-end 2014 and 2015 benefit costs by about $9.
- The company recorded a $46.9 foreign-currency translation loss in other comprehensive income for the first nine months. Goodwill impairment testing found no impairment, but management identified certain reporting units as more exposed if growth or margin assumptions are not achieved.
Most important facts for investors to verify
- Whether the Weidenhammer acquisition closed as expected, its final purchase price and financing, and subsequent leverage and integration results.
- Whether operating cash flow recovers from the year-over-year decline, particularly as receivables, pension funding and environmental payments affect cash generation.
- Developments in the Fox River settlement and litigation, Rockton actions, and whether environmental reserves remain adequate.
- Performance and goodwill headroom in Display and Packaging, Blowmolding, and Brazil tubes and paper, including customer retention and the expected productivity and margin improvements.
- The effect of updated pension mortality assumptions, foreign-exchange movements, and input-cost changes on earnings, liquidity and reported equity.