Business context and reporting period
Tredegar Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2017. The company manufactures polyethylene films (PE Films), polyester films (Flexible Packaging Films/Terphane) and aluminum extrusions. Results include Futura Industries from its February 15, 2017 acquisition.
Financial and operating performance
| Metric | Third quarter 2017 | Nine months 2017 |
|---|---|---|
| Sales | $247.1 million, up 19.0% | $715.5 million, up 14.7% |
| Net income | $8.3 million, versus $12.0 million | $56.2 million, versus $22.7 million |
| Diluted EPS | $0.25, versus $0.37 | $1.70, versus $0.69 |
| Gross margin | 17.0%, versus 16.3% | 16.1%, versus 16.5% |
| Operating cash flow | $53.5 million for the nine months, versus $34.5 million | |
| Capital expenditures | $37.2 million for the nine months, versus $30.9 million |
Third-quarter net income fell despite higher sales, while year-to-date income rose sharply. Nine-month results included a $24.8 million unrealized gain on Tredegar’s kaléo investment and $11.9 million of income from settling the Terphane acquisition escrow. A $8.1 million tax benefit from a worthless-stock deduction also benefited 2017; the effective tax rate was 14.7%, versus 7.6% in 2016. These items make reported earnings less directly indicative of recurring operating performance.
By segment, third-quarter ongoing operating profit was $11.3 million for PE Films, a $1.1 million loss for Flexible Packaging Films and $12.6 million for Aluminum Extrusions. For the first nine months, the respective results were $31.0 million, a $3.4 million loss and $34.2 million. Futura contributed $6.2 million of Aluminum Extrusions ongoing operating profit since acquisition.
Balance sheet, debt and liquidity
At September 30, 2017, cash was $31.9 million and long-term debt was $177.0 million, or $145.2 million net of cash. The company had approximately $214 million of borrowing availability under its $400 million secured revolving credit facility. Leverage was 1.82x against a 4.00x maximum covenant; interest coverage was 10.77x against a 2.50x minimum. Tredegar reported compliance with all financial covenants and expects available cash, borrowing capacity and operating cash flow to meet working-capital, capital spending and dividend needs for the next 12 months. Nine-month dividends were $10.9 million, or $0.33 per share.
Operating cash flow improved year over year, while investing cash outflow rose to $124.2 million, primarily reflecting the $87.1 million Futura cash acquisition and capital expenditures. Debt increased from $95.0 million at year-end 2016, largely to fund the acquisition.
Material changes, outlook and risks
- Futura acquisition: Acquired for approximately $92 million, with about $87 million funded at closing. A $5 million escrow is expected to be returned in early 2018 because Futura is not expected to meet specified 2017 performance requirements. Futura generated $21.2 million of third-quarter sales and $2.4 million of ongoing operating profit.
- PE Films: Third-quarter ongoing profit improved on stronger surface protection and personal-care volumes and mix. Management estimates a potential annual sales reduction of $70 million from a personal-care product transition sometime in 2019–2021. Possible surface-protection product transitions could reduce annual ongoing operating profit by up to $5–$10 million; timing and impact remain uncertain. Storm-related supply and distribution disruption could reduce fourth-quarter profit by up to $1 million.
- Flexible Packaging Films: Third-quarter and year-to-date results weakened due to power outages and production inefficiencies in Brazil, raw-material cost pressure, inflation, currency effects and competitive overcapacity. Management expects continued volatility; new regional capacity could contribute to pricing pressure and may trigger impairment testing of Terphane assets.
- Aluminum Extrusions: Growth reflected Futura, higher aluminum-linked selling prices and organic volume gains. The Niles line startup disrupted production. The Newnan cast house resumed production in the third quarter after a 2016 explosion; management expected remaining insurance claims to settle in the fourth quarter, potentially producing a gain.
- Spending outlook: 2017 capital expenditure estimates were $18 million for PE Films, $4 million for Terphane and $23 million net of expected insurance recoveries for Aluminum Extrusions. Management also expected approximately $6 million of pension contributions in 2017.
- Other risks and contingencies: A possible U.S. tariff on imported aluminum billet could raise costs and affect demand; pass-through to customers is not assured. A customs and trade-court review concerning Terphane’s Brazilian film exports remained pending. The $45 million kaléo investment valuation relies on high-risk Level 3 projections discounted at 45%; the eventual value could differ materially.
Most important facts for investors to verify
- How much of nine-month earnings growth reflects the kaléo gain, Terphane escrow income and tax benefits rather than recurring segment performance.
- Whether PE Films can offset the disclosed product-transition risks through new products, customers and capacity investments.
- Whether Terphane can restore production and margins amid outages, inflation, currency exposure and increased regional capacity.
- Futura’s performance against its earnout terms and the expected $5 million escrow return.
- Actual insurance settlements, capital spending and debt levels, and any developments on aluminum tariffs or the Terphane trade case.