Sonoco Products Company (SON) — Q2 2019 Form 10-Q
Business context and period: Packaging and industrial-products company reporting the quarter and six months ended June 30, 2019. Comparatives are the three and six months ended July 1, 2018. Amounts below are in millions unless stated otherwise. Interim statements were reviewed, not audited.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $1,359.7 | $1,366.4 | $2,711.4 | $2,670.6 |
| Gross profit | $275.3 | $276.5 | $545.5 | $527.1 |
| Gross margin | 20.2% | 20.2% | 20.1% | 19.7% |
| Operating profit | $129.8 | $131.9 | $246.7 | $242.0 |
| Net income attributable to Sonoco | $81.2 | $89.4 | $154.8 | $163.5 |
| Diluted EPS | $0.80 | $0.88 | $1.53 | $1.62 |
| Adjusted “base” diluted EPS | $0.95 | $0.93 | $1.81 | $1.66 |
- Q2 sales declined 0.5%; six-month sales grew 1.5%. For the first half, acquisitions and higher prices added approximately $188 million, offset by volume/mix declines of $64 million and foreign currency/other headwinds of $83 million.
- Q2 GAAP earnings fell 9.2%; first-half GAAP earnings fell 5.3%. Management’s non-GAAP base earnings rose 3.0% in Q2 and 8.7% year to date. These measures exclude specified restructuring, pension, acquisition and other items.
- First-half segment operating profit increased 8.2% in Paper and Industrial Converted Products and 4.0% in Protective Solutions; Consumer Packaging was nearly flat, while Display and Packaging improved substantially from a prior-year loss. Sales declined in Display and Packaging and Protective Solutions.
Cash flow, debt and liquidity
- First-half operating cash flow was $40.1 million, versus $251.2 million a year earlier. The main driver was $199.0 million of pension and retiree-plan contributions, including a voluntary $190 million U.S. pension contribution.
- Capital spending was $102.3 million; investing cash outflow was $99.9 million. Financing provided $34.7 million. Cash declined $24.1 million to $96.3 million at June 30.
- Current notes and current maturities of debt were $357.2 million; long-term debt was $1,188.0 million. The company drew a $200 million, 364-day term loan in May, using $190 million for pension contributions. A $500 million revolving facility, committed through July 2022, supports a $350 million commercial-paper program. Management reported covenant measures substantially above required minimums.
- Adoption of lease accounting added a $304.7 million operating right-of-use asset and $313.8 million operating lease liabilities at June 30. Total lease liabilities, including finance leases, were $332.8 million.
Management commentary, outlook and risks
- Management attributed adjusted earnings growth to productivity, acquisition contributions, favorable price/cost performance and a lower base tax rate, partly offset by volume weakness and higher net interest expense. Demand softness and customer inventory management—amid tariffs and economic-slowdown concerns—affected several businesses.
- Management expected 2019 capital spending not to exceed $110 million in the second half; anticipated approximately $22 million of second-half cash tax benefits associated with pension contributions; and expected about $17.1 million of additional plan contributions in the rest of 2019. No full-year earnings guidance is stated in the provided filing text.
- Restructuring and asset-impairment charges were $24.0 million for the first half, versus $6.6 million. Approximately $6.6 million of additional charges were expected for previously announced actions, mostly incurred and paid by year-end; further restructuring actions remained possible.
- After quarter-end, the board approved termination of the inactive pension plan, subject to regulatory approvals. Sonoco expects to settle remaining obligations in 2020, contribute an estimated $75–$125 million then, and incur noncash settlement charges of $525–$575 million. Amounts depend on participant settlements and market conditions.
- A significant IRS dispute concerns the 2013 tax treatment of an intercompany-note distribution. The IRS proposed approximately $89 million of additional tax, excluding interest, and $18 million of penalties. The company contests the position, has recorded no additional reserve, and warns an adverse resolution could materially affect results and financial condition.
- Other exposures include raw-material, energy, freight and foreign-exchange costs; tariffs and demand; pension assumptions; goodwill impairment risk (management identified Display and Packaging goodwill of $203.4 million as at risk if performance or outlook worsens); and environmental matters. Environmental accruals totaled $19.9 million.
Most important facts to verify
- Whether weaker volumes persist and whether acquisition growth, pricing and productivity can sustain base earnings improvement.
- Cash generation after the unusually large pension contribution, and funding needs for the planned pension termination and 2020 settlement.
- Outcome and potential financial impact of the IRS tax dispute, including proposed tax, interest and penalties.
- Actual restructuring costs and savings, capital spending, and the status and economics of the proposed Corenso acquisition, expected to close by the end of Q3 2019.
- Whether Display and Packaging performance supports its goodwill valuation and whether customer concentration creates impairment risk.