Packaging Corporation of America — Q2 2016 Form 10-Q
Business context and period. PCA manufactures corrugated packaging and paper products, operating primarily in the United States through Packaging, Paper, and Corporate and Other segments. This unaudited report covers the quarter and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods. Amounts below are in millions of dollars except per-share data.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $1,417.4 | $1,454.3 | $2,818.4 | $2,880.0 |
| Gross profit | $320.1 | $317.7 | $619.1 | $594.7 |
| Income from operations | $200.2 | $197.6 | $381.0 | $354.7 |
| Net income | $115.9 | $114.0 | $219.6 | $204.8 |
| Diluted EPS | $1.23 | $1.16 | $2.32 | $2.08 |
| Gross margin | 22.6% | 21.9% | 22.0% | 20.6% |
| Operating margin | 14.1% | 13.6% | 13.5% | 12.3% |
| Net margin | 8.2% | 7.8% | 7.8% | 7.1% |
Q2 sales fell 2.5%, while net income rose 1.7%. For the first half, sales fell 2.1% and net income rose 7.2%. Management cited higher corrugated-product volumes and lower energy, fiber, freight, and maintenance costs as earnings supports; lower selling prices and mix, lower containerboard and pulp volumes, and lower white-paper prices offset those benefits. Share repurchases also reduced the share count and supported EPS.
- Segments: Q2 Packaging operating income was $192.4 versus $194.6; Paper was $24.4 versus $23.4. First-half Packaging income increased to $353.9 from $335.7; Paper increased to $60.5 from $59.0.
- Cash flow: First-half operating cash flow was $371.1 versus $304.5. Capital spending was $121.8 versus $141.9; operating cash flow less capital spending was $249.3 versus $162.6. Cash increased to $213.6 from $184.2.
- Liquidity and debt: At June 30, cash was $213.6 and unused revolver capacity was $326, net of letters of credit. Debt was $2,294.6, including $6.5 current maturities; cash less debt was approximately negative $2,081.0, excluding capital leases. About 70% of debt was fixed-rate. A 1 percentage-point increase in variable rates was estimated to raise annual interest expense by about $7.
- Capital returns: First-half dividends paid were $104.9; PCA repurchased 1.99 million shares for $100.3 and authorized an additional $200.0 million in buybacks. The declared quarterly dividend was $0.55 per share.
Changes, outlook, and risks
- Q2 domestic and export containerboard prices fell 4.9% and 8.6%, respectively, year over year; corrugated-product shipments rose 2.2%, while containerboard outside shipments fell 8.0%. First-half corrugated shipments rose 2.8%, while containerboard outside shipments fell 4.7%.
- Management expected higher Q3 containerboard, corrugated-product, and white-paper shipments, higher paper prices as announced increases took effect, and lower annual outage costs. It also expected less favorable corrugated mix and higher recycled-fiber, electricity, and fuel costs. Despite those cost and mix headwinds, management projected Q3 earnings excluding special items above Q2. No full-year earnings guidance was provided.
- First-half 2016 special-item pretax expense was $5.7, versus $16.5 in 2015. 2016 items included facility closures, TimBar acquisition-related costs, and a multiemployer pension-plan withdrawal; 2015 items included DeRidder restructuring and Boise integration costs. Reported results should be considered alongside, not replaced by, management’s non-GAAP adjusted measures.
- On July 1, 2016, PCA agreed to acquire substantially all TimBar Corporation assets for $386 cash, expected to be funded with a new term loan. Closing was expected in Q3, subject to customary conditions. TimBar reported 2015 net sales of $324. On July 29, PCA repaid the $25 outstanding on a term loan due in 2018.
- Office Depot accounted for approximately 8% of total first-half sales and 41% of Paper segment sales; PCA disclosed risk if this business declines or the customer’s financial condition weakens. Paper demand also faces competition from electronic alternatives. Other cited uncertainties include product prices and demand, fiber and energy costs, facility disruptions, acquisitions, and environmental or tax regulation.
- PCA froze its Salaried Retiree Medical Plan effective December 31, 2016, reducing the related obligation by $5.1. It expected at least $27.0 of qualified pension contributions in 2016. Management said it was not aware of material guarantee liabilities and did not expect pending ordinary-course litigation to have a material adverse effect. Disclosure controls were assessed as effective; no material changes to internal controls or risk factors were reported.
Important facts for investors to verify
- Whether TimBar closed as expected, its financing terms, integration costs, and realized contribution to sales and earnings.
- Whether Q3 shipment, pricing, outage-cost, and earnings expectations were achieved, especially against higher fiber and energy costs and weaker mix.
- Whether the improvement in operating cash flow is sustainable, given working-capital timing and taxes payable, and how planned capital spending of $250–$285 in 2016 develops.
- Trends in containerboard and corrugated pricing and volume, paper demand and margins, and exposure to Office Depot.
- Debt, liquidity, and capital-return decisions after the TimBar transaction, including the remaining buyback authorization and dividend funding.