Sonoco Reports Strong Second Quarter 2018 Results
Staff Report From South Carolina CEO
Monday, July 23rd, 2018
Sonoco, one of the largest diversified global packaging companies, reported financial results for its second quarter, ending July 1, 2018.
Second Quarter Highlights
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Second-quarter 2018 GAAP earnings per diluted share were $0.88, compared with $0.43 in 2017.
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Second-quarter 2018 GAAP earnings included after-tax charges of $4.4 million related to restructuring and acquisition-related expenses. In the second quarter of 2017, GAAP results included $28.7 million, after tax, in charges for lump-sum pension settlement distributions, restructuring-related activities and acquisition expenses.
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Base net income attributable to Sonoco (base earnings) for second quarter 2018 was $0.93 per diluted share, compared with $0.71 in 2017. (See base earnings definition, explanation and reconciliation to GAAP earnings later in this release.) Sonoco previously provided second-quarter 2018 base earnings guidance of $0.83 to $0.89 per diluted share.
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Second-quarter 2018 net sales were $1.37 billion, up 10.1 percent from $1.24 billion in 2017.
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Cash flow from operations was $251.2 million in the first half of 2018, compared with $103.2 million in 2017. Year-to-date free cash flow was $88.8 million, compared with $(69.3) million in 2017. (See free cash flow definition and reconciliation to cash flow from operations later in this release.)
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On May 29, 2018, Sonoco signed a definitive agreement with Texpack, Inc. to acquire its 70 percent interest in the Conitex Sonoco joint venture and Texpack's composite can operation in Spain for approximately $143 million in cash. Conitex Sonoco is a vertically integrated global leader in the manufacturing of paper-based cones and tubes used in the textile industry. The transaction is subject to normal international regulatory reviews and is expected to close early in the fourth quarter of 2018. Conitex Sonoco will be included in our Paper and Industrial Converted Products Segment and the Spanish composite can operation in our Consumer Segment.
Third Quarter and Full-Year Guidance Update
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Base earnings for the third quarter of 2018 are estimated to be in the range of $0.82 to $0.88 per diluted share, compared to $0.76 per diluted share in the third quarter of 2017.
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Full-year 2018 base earnings guidance has been raised to $3.27 to $3.37 per diluted share, from the previous guidance of $3.22 to $3.32 per diluted share, to reflect the Company's strong second quarter results and expected solid second half results despite additional expenses anticipated from recently enacted tariffs on steel, aluminum and other products along with higher than previously expected freight and other non-material inflation. This new guidance does not include possible benefit from the expected completion of the Conitex Sonoco acquisition.
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Full-year 2018 operating cash flow and free cash flow guidance has been raised to a range of $570 million to $590 million and $190 million and $210 million, respectively.
Note: Third-quarter and full-year 2018 GAAP guidance are not provided in this release due to the likely occurrence of one or more of the following, the timing and magnitude of which we are unable to reliably forecast: possible gains or losses on the sale of businesses or other assets, restructuring costs and restructuring-related impairment charges, acquisition-related costs, and the income tax effects of these items and/or other income tax-related events. These items could have a significant impact on the Company's future GAAP financial results.
CEO Comments
Commenting on the Company’s second-quarter GAAP and base results, President and Chief Executive Officer Rob Tiede said, "Sonoco produced an outstanding quarter as our growing diversified mix of global packaging businesses improved both the top-line and bottom-line by double-digits over prior-year consolidated results. Net sales grew by 10.1 percent, while operating profit improved 25.4 percent and net income attributable to Sonoco gained 107.3 percent compared to last year. Base operating profit and base net income attributable to Sonoco improved 16.9 percent and 30.6 percent, respectively. Second-quarter GAAP and base operating profit benefitted from a positive price/cost relationship and improvements to productivity, which were partially offset by operating cost inflation and higher management incentives. Overall volume/mix was modestly higher compared to the prior-year quarter, with each business segment showing improvement. The year-over-year improvement also reflects a lower effective tax rate due to the 2017 Tax Cuts and Jobs Act. GAAP operating profit was further aided by lower restructuring and impairment charges compared to 2017. In addition, cash flow from operations and free cash flow were extremely strong during the first six months of 2018, with cash flow from operations improving approximately $148.1 million over the prior year.
“Net sales in our Consumer Packaging segment grew 18.2 percent over the prior year, while operating profit improved by approximately 5.5 percent. A positive price/cost relationship, solid productivity gains, the benefit of acquisitions and a slight improvement in volume/mix drove the second quarter operating profit increase and more than offset higher operating inflation.
“Our Paper and Industrial Converted Products segment achieved a record second-quarter operating profit, improving 35.4 percent from last year, while net sales grew 1.1 percent. The gain in segment operating profit was primarily driven by a positive price/cost relationship and better volume/mix, which more than offset higher operating costs.
“Our Protective Solutions segment produced a solid turnaround, with operating profit improving 23.7 percent from last year as a positive price/cost relationship and productivity improvements helped offset higher operating inflation. Finally, our Display and Packaging segment operating profit declined as volume growth, a positive price/cost relationship and productivity improvements were more than offset by a negative mix of business and higher operating costs driven by the continued ramp up of operations at our new pack center in Atlanta.”
Second Quarter Review
Net sales for the second quarter were $1.37 billion, an increase of $125.7 million, or 10.1 percent, from last year’s quarter. The improvement reflects an increase in sales added by acquisitions, volume growth, the positive impact of foreign exchange and higher selling prices implemented to recover rising freight and other operating inflation.
GAAP net income attributable to Sonoco in the second quarter was $89.4 million, or $0.88 per diluted share, an increase of $46.3 million, compared with $43.1 million, or $0.43 per diluted share, in 2017. Second-quarter GAAP earnings included after-tax charges of $4.4 million related to restructuring and acquisition-related expenses. In the second quarter of 2017, GAAP earnings included $28.7 million after tax, related to lump-sum pension settlement distributions, restructuring costs from previously announced plant closures and acquisition-related expenses. Adjusted for these items, base earnings in the second quarter were $93.8 million, or $0.93 per diluted share, an increase of $22.0 million compared with $71.8 million, or $0.71 per diluted share, in 2017. Base earnings and base earnings per diluted share are non-GAAP financial measures adjusted to remove restructuring-related items, asset impairment charges, acquisition expenses and certain income tax-related events and other items, if any, the exclusion of which the Company believes improves comparability and analysis of the ongoing operating performance of the business. (See base earnings definition, explanation and reconciliation to GAAP earnings later in this release.)
Gross profits were a record $276.5 million in the second quarter, an increase of $38.1 million or 16.0 percent, compared with $238.4 million in the same period in 2017. Gross profit as a percentage of sales increased to 20.2 percent, compared with 19.2 percent in the same period in 2017. The 100 basis point gross profit percentage increase was primarily due to manufacturing and procurement productivity, partially offset by higher operating costs.
Second-quarter selling, general and administrative expenses increased $15.7 million from the prior year to $141.0 million. This increase was driven by expenses related to acquired businesses, wage inflation and higher management incentive accruals.
Segment Review
Sonoco reports its financial results in four operating segments: Consumer Packaging, Display and Packaging, Paper and Industrial Converted Products, and Protective Solutions. Segment operating results do not include restructuring and asset impairment charges, acquisition expenses, interest income and expense, income taxes or certain other items, if any, the exclusion of which the Company believes improves comparability and analysis.
Consumer Packaging
Sonoco’s Consumer Packaging segment includes the following products and services: round and shaped rigid containers and trays (both composite and thermoformed plastic); extruded and injection-molded plastic products; printed flexible packaging; global brand artwork management; and metal and peelable membrane ends and closures.
Second-quarter 2018 sales for the segment were $616 million, compared with $521 million in 2017. Segment operating profit was $63.7 million in the second quarter, compared with $60.4 million in the same quarter of 2017.
Segment sales increased 18.2 percent compared to the prior-year quarter due to sales added from acquisitions, the positive impact from changes in foreign exchange rates, and higher selling prices. Sales volume also increased as higher sales volume in flexible packaging and European and Asian composite cans exceeded a decline in plastic container sales volume. Segment operating profit grew 5.5 percent compared to the prior-year quarter due to a positive price/cost relationship, solid productivity gains, and the benefit of acquisitions which more than offset higher operating expenses due to inflation and higher management incentives. Segment operating margin declined to 10.3 percent in the quarter from 11.6 percent in 2017 due to changes in the mix of business, including changes from acquisitions, and higher operating costs.
Display and Packaging
The Display and Packaging segment includes the following products and services: designing, manufacturing,
assembling, packing and distributing temporary, semi-permanent and permanent point-of-purchase displays; supply chain management services, including contract packing, fulfillment and scalable service centers; retail packaging, including printed backer cards, thermoformed blisters and heat sealing equipment; and paper amenities, such as coasters and glass covers.
Second-quarter 2018 sales for this segment were $143 million, compared with $116 million in 2017. The segment reported an operating loss of $(0.6) million in the current quarter, compared with an operating profit of $1.5 million in the prior-year quarter.
Sales increased 23.9 percent compared to last year’s quarter due primarily to volume growth from a new pack center near Atlanta and the positive impact of foreign exchange. Segment operating profit declined $2.0 million largely due to inefficiencies and higher operating costs associated with the start up of new production lines at the Atlanta pack center. The Company is continuing to work to resolve these and other operational issues to achieve efficiency and cost levels in line with expectations.
Paper and Industrial Converted Products
The Paper and Industrial Converted Products segment includes the following products: paperboard tubes and cores; fiber-based construction tubes; wooden, metal and composite wire and cable reels and spools; and recycled paperboard, linerboard, corrugating medium, recovered paper and material recycling services.
Second-quarter 2018 sales for the segment were $474 million, up from $469 million in 2017. Segment operating profit was $61.5 million in the quarter, compared with $45.4 million in 2017.
Segment sales grew 1.1 percent from the prior-year quarter as volume/mix growth and the positive impact of foreign exchange more than offset lower selling prices associated with lower recovered paper prices. Volume/mix gains in North American paper operations as well as wire and cable reels were partially offset by declines in North American and European tube and core volumes. Segment operating profit improved 35.4 percent over the prior year driven by a positive price/cost relationship across most of the segment, excluding recycling operations. Segment operating margin improved 330 basis points to 13.0 percent.
Protective Solutions
The Protective Solutions segment includes the following products: custom-engineered, paperboard-based and expanded foam protective packaging and components; and temperature-assured packaging.
Second-quarter 2018 sales were $133 million, down slightly from $135 million in 2017. Operating profit was $13.6 million, a 23.7 percent improvement from the second quarter of 2017.
This segment’s sales declined slightly year over year as the negative impact of declining foreign exchange rates offset higher selling prices. Volume/mix was essentially flat as continued declines in the segment’s automotive components business was offset by growth in temperature-assured packaging. Improvement in segment operating profit for the quarter was driven by a positive price/cost relationship and productivity improvements more than offsetting higher operating inflation. Segment operating margin was 10.3 percent, an improvement of 210 basis points.
Corporate/Tax
Net interest expense for the second quarter of 2018 increased to $15.1 million, compared with $12.8 million during the same period in 2017, primarily due to higher borrowings in the current-year quarter stemming from acquisitions. The 2018 second-quarter effective tax rates on GAAP and base earnings were 26.1 percent and 26.7 percent, respectively, compared with 29.6 percent and 32.0 percent, respectively, in the prior year’s quarter. The 2017 U.S. Tax Cuts and Jobs Act (Tax Act) lowered the year-over-year effective tax rate on both GAAP and base earnings. The prior year's GAAP tax rate benefitted from a favorable distribution of earnings between low and high tax jurisdictions, primarily from the previously discussed pension settlement expense occurring in the U.S. This lessened the year-over-year change in the GAAP effective tax rate.
Note: In regards to the effect of the Tax Act, Sonoco has not yet fully completed its accounting. For certain of the Tax Act's provisions, the Company has made reasonable estimates and has included any measurement period adjustments in its second quarter and first six months earnings accordingly. In other cases, the Company has not been able to make a reasonable estimate due either to complexity or uncertainty and, as such, continues to account for those items consistent with their pre-Tax Act accounting. The Company believes any adjustments remaining to be made upon the completion of its accounting will not have a material impact on the Company's financial position.
Year-to-date Results
For the first six months of 2018 net sales were $2.67 billion, up $257.6 million compared with $2.41 billion in the first six months of 2017. Sales grew 10.7 percent in the first half of the year due to acquisitions, the positive impact of foreign exchange, volume growth and higher selling prices implemented to recover higher freight and operating inflation and certain rising material costs.
GAAP net income attributable to Sonoco for the first half of 2018 was $163.5 million or $1.62 per diluted share, compared with $96.9 million or $0.96 per diluted share in the first half 2017. Earnings in the first half of 2018 included after-tax charges totaling $5.0 million largely related to restructuring charges, acquisition costs and the effect of income tax rate changes on deferred tax items. Earnings in the first half of 2017 included net after-tax charges of $34.9 million primarily related to lump-sum pension settlements, restructuring charges and acquisition-related expenses.
Base earnings for the first six months of 2018 were $168.5 million, or $1.67 per diluted share, compared with $131.7 million, or $1.31 per diluted share, in the same period in 2017, a 27.9 percent and 27.5 percent increase, respectively. (See base earnings definition, explanation and reconciliation to GAAP earnings later in this release.)
Current year-to-date gross profit was a record $527.1 million, compared with $461.4 million in 2017. Gross profit as a percentage of sales in 2018 was 19.7 percent, compared with 19.1 percent in 2017. Selling, general and administrative expenses increased $28.0 million, driven by acquisitions and increased management incentives. Non-Operating Pension costs decreased $37.9 million as the previously disclosed 2017 settlement charges did not recur in 2018. Base operating profit for the first six months of 2018 increased 15.0 percent to $251.5 million due primarily to a positive price/cost relationship and productivity improvements.
Cash Flow and Free Cash Flow
For the first half of 2018, cash generated from operations was $251.2 million, compared with $103.2 million in 2017, an increase of $148.1 million. This increase reflects the improvement in GAAP net income of $66.6 million and the following described year-over-year changes. In 2018, year-to-date net cash paid for taxes was $2.9 million less than reported tax expense while in 2017 it was $20.9 million more, a year-over-year benefit of $23.8 million. This difference is largely due to the timing of taxes paid on the 2016 sale of our blowmolding plastics business and normal changes in various deferred tax items. Pension and post-retirement plan contributions, net of non-cash expenses, had a negative year-over-year impact of $13.4 million. This change is composed of a $24.4 million year-over-year decrease in cash contributions that was more than offset by a $37.8 million decrease in non-cash expense which was largely driven by 2017 non-base pension settlement charges of $31.1 million which did not recur in 2018. Year-to-date increases in working capital, driven largely by seasonal changes in business activity, consumed cash in both periods; however, this increase consumed $11.0 million less cash in 2018 due to improved collection efforts of trade accounts receivables in the first six months of 2018. Operating cash flow further benefited in the first six months of 2018 from collections of various other items outstanding at December 31, 2017 and increased accruals related to management incentives in 2018 compared to 2017. During the first six months of 2018, net capital expenditures and cash dividends were $82.7 million and $79.8 million, respectively, compared with $96.8 million and $75.6 million, respectively, in 2017.
Free cash flow for first six months of 2018 was $88.8 million, compared with a negative $69.3 million in the same period last year, reflecting the items impacting cash flow from operations discussed above. (See free cash flow description and reconciliation later in this release. Free cash flow is defined as cash flow from operations minus net capital expenditures and cash dividends. Net capital expenditures are defined as capital expenditures minus proceeds from, and/or plus costs incurred in, the disposition of capital assets.)
As of July 1, 2018, total debt was approximately $1.45 billion, compared with $1.45 billion as of December 31, 2017. At the end of the first half of 2018, the Company had a total-debt-to-total-capital ratio of 44.8 percent, compared with 45.6 percent at December 31, 2017. Cash and cash equivalents were $197.7 million as of July 1, 2018, compared with $254.9 million at December 31, 2017. The reduced cash balance reflects repatriation of $110 million of offshore cash, which was then used to repay short-term U.S. debt, helping offset borrowings to fund the April 12, 2018 acquisition of Highland Packaging Solutions for approximately $150 million, of which $8 million is deferred.
Third Quarter and Full-Year 2018 Outlook
Sonoco expects third-quarter 2018 base earnings to be in the range of $0.82 to $0.88 per diluted share. Base earnings in the third quarter of 2017 were $0.76 per diluted share. Full-year 2018 base earnings per diluted share are expected to be in a range of $3.27 to $3.37, which is an increase from the previous estimate of $3.22 to $3.32 per diluted share. This increase reflects the Company's strong second quarter results and expected solid performance in the second-half of the year despite additional expenses anticipated from recently enacted tariffs on steel, aluminum and other products along with higher than previously expected freight and other non-material inflation. This new guidance reflects an expected 26 percent effective tax rate and does not include possible benefits from the completion of the Conitex Sonoco acquisition. Operating and free cash flow guidance for 2018 has been raised and is expected to be in the range of $570 million to $590 million and $190 million to $210 million, respectively.
Although the Company believes the assumptions reflected in the range of guidance are reasonable, given uncertainty regarding the impact of new and potential tariffs, the future performance of the overall economy, potential changes in raw material prices and other costs, potential changes in the estimated impact of the Tax Act on the Company's effective tax rate, as well as other risks and uncertainties, including those described further below, actual results could vary substantially.
Commenting on the Company’s outlook, Tiede said, “Our team achieved a great deal in the first half of 2018, including driving record top-line and bottom-line consolidated results and producing strong cash flow from operations and free cash flow. The acquisition of Highland Packaging Solutions further enhances our capabilities and opportunities for continued expansion in the fast-growing, fresh-food perimeter of the supermarket. Looking forward, we’re projecting year-over-year improvement in the second half which, together with stronger than expected second quarter results, led us to raise our 2018 guidance. Our growth and margin improvement targets for 2018 remain on track, with sales up 10.7 percent and base operating margin up a solid 35 basis points from the first half of last year. We are excited about the Conitex Sonoco acquisition, which creates opportunities for us to further grow our Paper/Industrial Converted Products segment, especially in the fast-growing Asian markets.
“Like many companies, we are facing inflationary cost pressure from higher freight, wages, energy and material costs, particularly resins, along with uncertain headwinds from newly imposed or threatened tariffs. This is requiring us to drive cost-recovery through proactive price increases in many of our businesses. Although recovered paper prices appear to have stabilized for the time being, experts believe they could rise in the second half of the year, in which case we would not enjoy the same price/cost benefit we saw in the first half of the year. Overall, we remain optimistic about general economic activity and believe the breadth of our diversified consumer, industrial and protective operations across a number of markets enhances our ability to produce consistent earnings, improved returns and greater rewards for our shareholders."