Sonoco Products Company — Q1 2018 Form 10-Q
Reporting period: Three months ended April 1, 2018; comparisons are with the three months ended April 2, 2017 unless noted. Financial statement figures below are in millions, except per-share data. Interim statements are unaudited and were reviewed, not audited.
Business context and results
Sonoco supplies consumer packaging, industrial products, protective packaging, and packaging services through four reportable segments. Net sales rose 11.2% to $1,304.2, reflecting acquisitions (+$61 million), foreign currency and other (+$42 million), selling prices (+$22 million), and volume/mix (+$7 million). Price increases largely passed through higher raw-material costs.
- Net income attributable to Sonoco increased 37.8% to $74.1; diluted GAAP EPS was $0.73 versus $0.53. Base, or adjusted, diluted EPS was $0.74 versus $0.59.
- Operating profit was $110.1, up 17.6%. Gross margin increased to 19.2% from 19.0%; SG&A rose 9.8% to $137.4.
- Net interest expense increased to $13.4 from $12.1, primarily due to higher average acquisition-related borrowings. The effective GAAP tax rate fell to 24.1% from 32.8%; the base rate was 25.9% versus 30.9%.
Segments
- Consumer Packaging: Sales rose 18.2% to $569.9; segment operating profit increased 2.7% to $61.1. Margin declined to 10.7% from 12.3%, reflecting operating-cost and resin inflation, mix, and acquisitions.
- Display and Packaging: Sales increased 24.4% to $142.7, while operating profit fell 46.2% to $1.7. Management cited ramp-up inefficiencies and higher costs at a new Atlanta-area pack center; results improved sequentially.
- Paper and Industrial Converted Products: Sales rose 4.1% to $460.7; operating profit increased 48.2% to $39.8 and margin improved 250 basis points to 8.6%, mainly from favorable price/cost relationships.
- Protective Solutions: Sales declined 1.5% to $131.0 and operating profit fell 2.3% to $10.7, primarily due to lower automotive-component volume.
Cash flow, debt, and liquidity
- Operating cash flow was $119.8 versus $67.4. Investing used $35.9 versus $270.3, with the prior-year period including $221.4 of acquisition spending. Financing used $36.6 versus providing $154.0.
- Capital expenditures were $41.4; management expected approximately $180 million for the remainder of 2018. Cash and equivalents were $305.3 at quarter-end, including approximately $281.7 held by foreign subsidiaries.
- Total debt was $1,464.6 at April 1, compared with $1,447.3 at year-end. Current and long-term debt on the balance sheet totaled $1,464.6. The company reported covenant measures substantially above minimum requirements and had a $350 million commercial paper program supported by a $500 million revolving facility.
- Quarterly dividends were $0.39 per share; on April 18, the board declared $0.41 per share, payable June 8, 2018. No shares were repurchased under the public authorization during the quarter.
Changes, outlook, risks, and unusual items
- Operating earnings benefited from favorable price/cost timing, manufacturing productivity, lower restructuring and acquisition costs, and the lower tax rate. Wage and operating-cost inflation and higher management incentives partly offset these benefits. A weaker U.S. dollar increased reported cost of goods sold by approximately $37 million.
- On April 12, after quarter-end, Sonoco acquired Highland Packaging Solutions for $150 million ($142.5 million paid at closing and $7.5 million contingent), subject to a working-capital adjustment. Highland is expected to contribute about $100 million in annual Consumer Packaging sales. Funding included a newly drawn $100 million, 364-day term loan and existing credit facilities.
- After quarter-end, a Display and Packaging customer notified Sonoco that its contract would not renew after December 31, 2018. Annual sales were approximately $12 million, or 2.4% of that reporting unit’s sales. Given the unit’s narrow excess of estimated fair value over carrying value, management said an impairment was probable and estimated a charge below $20 million, subject to completion of its analysis.
- Restructuring and asset impairment charges were $3.1 million. Management expected approximately $1.8 million of further charges for previously announced actions, mostly incurred and paid by year-end; additional actions remain possible. Restructuring accruals are expected to be funded from operating cash flow.
- A significant tax contingency remains: the IRS proposes an approximately $89 million incremental tax liability, excluding interest, plus $18 million in penalties related to a 2012 intercompany-note distribution and its 2013 repayment. Sonoco filed a protest, disputes the IRS position, and has not recorded an additional reserve; an adverse outcome could materially affect results and financial condition.
- Environmental contingency accruals totaled $19.7 million. Sonoco stated it could not estimate potential Spartanburg-site exposure beyond the amount accrued, but did not believe resolution had a reasonable possibility of materially adversely affecting its financial statements.
- Topic 606 revenue accounting was adopted January 1, 2018, increasing opening retained earnings by $1.7 million. It increased reported Q1 net income by $0.3 million versus the presentation without adoption; 2017 comparative figures were not recast. The filing also notes that lease accounting adoption is expected to materially increase balance-sheet assets and liabilities.
- No full-year earnings or EPS guidance is stated in the supplied filing text. Management cautioned that quarterly results are not necessarily indicative of full-year results. Key risks include raw-material, energy, freight and labor costs; customer retention; acquisition integration; foreign exchange; pension funding; and tax and goodwill estimates.
Most important facts for investors to verify
- Whether the Display and Packaging customer loss results in the estimated goodwill impairment below $20 million, and whether other assumptions change.
- The outcome, timing, interest, and potential penalties associated with the IRS dispute and proposed tax adjustment.
- Highland’s final working-capital adjustment, integration, financing costs, and actual contribution to sales and earnings.
- Whether favorable price/cost relationships and segment productivity persist as raw-material, freight, wage, and other costs change.
- Progress on the pack-center ramp-up, restructuring cash costs, and the forecast $180 million of remaining 2018 capital spending.
- Cash deployment and borrowing needs, including the use of offshore cash and compliance with debt covenants.