Business context and reporting period
Packaging Corporation of America (PCA) filed this Form 10-K for the fiscal year ended December 31, 2016. PCA makes corrugated packaging and containerboard, as well as uncoated freesheet and specialty papers; it operates primarily in the United States through Packaging, Paper, and Corporate and Other segments.
During 2016, PCA acquired TimBar for approximately $386 million and Columbus Container for approximately $100 million, adding corrugated packaging capacity. TimBar was financed primarily with a new $385 million five-year term loan; Columbus Container was funded with cash.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Net sales | $5.779 billion | $5.742 billion |
| Gross profit / margin | $1.276 billion / 22.1% | $1.208 billion / 21.0% |
| Operating income / margin | $780.3 million / 13.5% | $750.0 million / 13.1% |
| Net income | $449.6 million | $436.8 million |
| Diluted EPS | $4.75 | $4.47 |
| Operating cash flow | $801.2 million | $762.6 million |
| Capital expenditures | $274.3 million | $314.5 million |
Management’s non-GAAP net income excluding special items was $462.0 million ($4.88 per diluted share), versus $442.6 million ($4.53) in 2015. EBITDA was $1.138 billion; EBITDA excluding special items was $1.155 billion. These measures are not substitutes for GAAP results.
Packaging sales rose 2.4% to $4.585 billion; segment operating income was $711.1 million versus $714.9 million. Paper sales fell 4.3% to $1.094 billion, while segment operating income increased to $138.1 million from $112.5 million. Consolidated gross and operating margins above are calculated from reported amounts.
For fourth-quarter 2016, net sales were $1.477 billion, operating income $192.9 million, net income $110.6 million, and diluted EPS $1.17. Fourth-quarter 2015 comparatives were $1.391 billion, $175.9 million, $104.3 million, and $1.07, respectively.
At year-end, cash and cash equivalents were $239.3 million. Debt was approximately $2.658 billion before debt issuance costs, including $1.011 billion of variable-rate term loans; capital lease obligations were $21.6 million. PCA had $324.9 million of unused revolver capacity, net of letters of credit, and reported compliance with debt covenants. Dividends declared were $2.36 per share for 2016; the quarterly dividend was raised to $0.63.
Material changes versus the prior comparable period
- Sales increased 0.6% and net income rose 2.9%. Higher volumes, improved operating costs, and fewer weighted-average shares supported earnings; lower Packaging prices and mix and lower Paper volumes partly offset those factors.
- Packaging corrugated shipments increased 5.0%; containerboard production rose to 3.736 million tons from 3.656 million. The acquisitions contributed $117 million of Packaging sales growth, according to management.
- Paper sales declined chiefly because PCA ceased Wallula softwood market pulp production in December; market pulp sales fell to $28.1 million from $53.5 million.
- Interest expense increased to $91.8 million from $85.5 million, reflecting higher rates on variable debt and the TimBar borrowing. Debt increased year over year.
- Operating cash flow reached a reported record, while investing cash outflow increased substantially, principally due to $485.4 million of acquisition spending net of cash acquired.
Outlook, risks, contingencies, and unusual items
For first-quarter 2017, management expected most previously announced Packaging price increases to take effect, higher corrugated shipments, and first-quarter EPS above fourth-quarter 2016. It also anticipated lower production due to scheduled mill maintenance, higher freight, labor and benefit costs, and inflation in recycled fiber, energy, and chemicals. PCA expected 2017 capital investments of $310 million to $325 million, excluding acquisitions.
- Key risks include industry cyclicality and pricing pressure, fiber and energy cost volatility, manufacturing interruptions, environmental regulation, labor negotiations, and integration and performance of acquisitions.
- Office Depot represented 42% of Paper segment sales and 8% of consolidated sales in 2016. The supply agreement required PCA to provide at least half of Office Depot’s commodity office-paper requirements through December 2017; renewal and possible termination provisions create customer-concentration risk.
- PCA carried $25.3 million in environmental-related reserves. The company said it believed additional future environmental expenditures above accrued amounts were not reasonably likely to have a material impact, but Boiler MACT rule changes and future regulation remain uncertain.
- On February 8, 2017, an explosion during repair work at the DeRidder mill caused three contractor fatalities. The D3 machine continued operating and the mill resumed full operation by February 19. PCA was still assessing the financial impact; property and business-interruption insurance is subject to a $5 million deductible.
- 2016 special items included $11.0 million of facility closure costs, $4.5 million of acquisition costs, $2.7 million of Wallula restructuring costs, and $0.9 million related to a multiemployer pension withdrawal. PCA reported no goodwill impairment. Its financial statement audit opinion was unqualified; management and the auditor excluded the two 2016 acquisitions from the year-end internal-control assessment.
Important facts for investors to verify
- Whether the TimBar and Columbus Container acquisitions deliver expected integration, growth, and margin benefits; purchase-price allocations remained preliminary.
- Progress and realized economics of Packaging price increases, including whether higher fiber, energy, labor, and freight costs offset them.
- Office Depot contract status, volumes, and any replacement demand or pricing if its purchases decline.
- The eventual financial, operational, and legal effects of the DeRidder explosion, including insurance recovery and any interruption-related costs.
- Debt repayment and interest-rate exposure, pension funding needs, and execution of the planned 2017 capital program.