Business context and reporting period
Packaging Corporation of America (PCA) filed this Form 10-K for the fiscal year ended December 31, 2010. PCA operates four containerboard mills and 67 U.S. corrugated-product manufacturing facilities as an integrated packaging producer. About 80% of mill output is used internally. The filing also provides fourth-quarter 2010 results. Mark Kowlzan became CEO in July 2010, succeeding Paul Stecko, who became Executive Chairman.
Financial performance and position
| Metric | 2010 | 2009 |
|---|---|---|
| Net sales | $2,435.6 million | $2,147.6 million |
| Gross profit / margin | $532.2 million / 21.9% | $426.6 million / 19.9% |
| Income from operations | $185.4 million | $352.5 million |
| Net income | $205.4 million | $265.9 million |
| Diluted EPS | $2.00 | $2.60 |
| Operating cash flow | $349.9 million | $306.1 million |
| Capital expenditures | $320.2 million | $114.2 million |
- Sales rose 13.4%, driven by higher volume ($176.7 million) and pricing ($111.3 million). Corrugated shipments increased 7.2% to 31.0 billion square feet; external containerboard sales volume rose 17.6% to 507,000 tons.
- Despite lower reported GAAP net income, management’s non-GAAP net income excluding special items was $166.3 million ($1.62 diluted EPS), versus $95.9 million ($0.94) in 2009. The filing attributes the gap between GAAP and adjusted results largely to unusual energy-tax-credit accounting and related charges.
- Cash used in investing was $321.3 million, largely reflecting the energy optimization projects. Operating cash flow less capital expenditures was approximately $29.7 million. Cash declined $64.2 million to $196.6 million.
- At year-end, total debt obligations including capital leases were $680.6 million; debt and capital lease obligations on the balance sheet were approximately $681.4 million. Cash and unused borrowing capacity under credit facilities were $196.6 million and $172.2 million, respectively. The $109 million receivables facility was due March 1, 2011; PCA said it planned to renew it. PCA reported covenant compliance.
- Total assets were $2.224 billion and stockholders’ equity was $1.009 billion. Current assets were $798.0 million and current liabilities $405.6 million.
Fourth-quarter 2010
Net sales were $626.7 million, gross profit $147.3 million, operating income $96.4 million and net income $54.9 million ($0.54 diluted EPS). Excluding special items, net income was $53.0 million ($0.52 diluted EPS). Fourth-quarter 2009 net income was $58.7 million; it included substantial alternative-fuel tax-credit benefits.
Changes versus prior periods
Industry demand recovered in 2010 after the 2008–09 downturn. Industry corrugated shipments increased 3.5%; PCA’s shipments rose 7.2%, and its containerboard production increased 8.2% to 2.443 million tons, nearly matching its prior annual record. Higher pricing and volume improved underlying 2010 operating performance, but higher fiber, transportation, labor and maintenance costs partly offset the gains. Published recycled-fiber prices averaged 122% above 2009; wood-fiber costs rose 7%.
Reported operating income fell 47.4% and net income fell 22.7% year over year, but these comparisons are distorted by energy tax credits: 2009 included $171.3 million of net income from credits, compared with $47.7 million in 2010. Excluding special items, operating income increased to $285.4 million from $186.0 million. Capital expenditures rose sharply as the mill energy projects advanced.
Outlook, risks and unusual items
- Management expected first-quarter 2011 earnings before special items to be below fourth-quarter 2010 adjusted earnings of $53 million. Planned mill maintenance outages, higher fiber and energy costs, and higher taxes and benefit costs were cited.
- Management forecast 2011 capital expenditures of $255 million, including approximately $115 million for the Counce and Valdosta energy projects and $40 million for strategic box-plant projects. The projects were expected to be completed in the fourth quarter of 2011; total project spending was estimated at about $295 million over two years.
- PCA claimed alternative-energy tax credits relating to 2009 black-liquor production. It recorded a $102.0 million reserve for uncertain tax positions, principally because IRS guidance did not specifically address the proprietary process at its Filer City mill. The IRS was expected to review the credits; management said the reserve could change significantly. The filing reports up to $206.1 million of credits available to offset future cash taxes, subject to eligibility, utilization and expiration terms.
- Five consolidated class-action lawsuits allege that PCA and other producers conspired to restrict containerboard supply and raise prices from August 2005 onward. PCA denied the allegations; the filing says the outcome and reasonably possible loss range could not be estimated.
- Environmental reserve was $9.7 million. PCA reported material compliance with environmental requirements but identified possible future cost exposure from changing rules, including potential greenhouse-gas regulation.
- Key business risks include economic cyclicality, industry competition and pricing, volatile fiber and energy costs, manufacturing disruptions, labor negotiations and environmental obligations. The receivables credit facility’s near-term renewal and debt covenants are also relevant to liquidity.
Most important facts for investors to verify
- Review the tax-credit claims, the $102.0 million uncertain-tax-position reserve, the IRS review status and the amount and expiry of usable credits.
- Compare adjusted results with GAAP results and assess the sustainability of operating improvement as fiber, energy and other input costs change.
- Check renewal and terms of the $150 million receivables facility, borrowing availability, debt maturities and covenant headroom.
- Track actual spending, timing, completion and expected savings from the Counce and Valdosta energy projects, alongside other 2011 capital needs.
- Monitor the containerboard antitrust litigation, environmental exposures and first-quarter outlook against subsequent reported results.
Ernst & Young issued an unqualified opinion on the financial statements and internal control over financial reporting. The filing notes that previously reported 2009 and 2008 comprehensive income was restated to correct an omission related to employee-benefit obligations; the correction did not affect reported balance sheets, income statements or total equity.