PACKAGING CORP OF AMERICA - Quarter Report: 2020 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2020

or

For the transition period from          to          

Commission file number 1-15399

(Exact Name of Registrant as Specified in its Charter)

Registrant's telephone number, including area code

(847) 482-3000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of May 1, 2020 the Registrant had outstanding 94,842,778 shares of common stock, par value $0.01 per share.

Securities registered pursuant to Section 12(b) of the Exchange Act:

Table of Contents

All reports we file with the Securities and Exchange Commission (SEC) are available free of charge via the Electronic Data Gathering Analysis and Retrieval (EDGAR) System on the SEC website at www.sec.gov. We also provide copies of our SEC filings at no charge upon request and make electronic copies of our reports available through our website at www.packagingcorp.com as soon as reasonably practicable after filing such material with the SEC.

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PART I

FINANCIAL INFORMATION

Packaging Corporation of America

Consolidated Statements of Income and Comprehensive Income

(unaudited, dollars in millions, except per-share data)

See accompanying condensed notes to unaudited quarterly consolidated financial statements.

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Packaging Corporation of America

Consolidated Balance Sheets

(unaudited, dollars and shares in millions, except per-share data)

See accompanying condensed notes to unaudited quarterly consolidated financial statements.

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Packaging Corporation of America

Consolidated Statements of Cash Flows

(unaudited, dollars in millions)

See accompanying condensed notes to unaudited quarterly consolidated financial statements.

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Packaging Corporation of America

Consolidated Statements of Changes in Stockholders’ Equity

(unaudited, dollars in millions and shares in thousands)

See accompanying condensed notes to unaudited quarterly consolidated financial statements.

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Condensed Notes to Unaudited Quarterly Consolidated Financial Statements

Packaging Corporation of America ("we," "us," "our," PCA," or the "Company") was incorporated on January 25, 1999. In April 1999, PCA acquired the containerboard and corrugated packaging products business of Pactiv Corporation (Pactiv), formerly known as Tenneco Packaging, Inc. We are a large diverse manufacturer of both packaging and paper products. We are headquartered in Lake Forest, Illinois and we operate primarily in the United States.

We report our business in three reportable segments: Packaging, Paper, and Corporate and Other. Our Packaging segment produces a wide variety of containerboard and corrugated packaging products. The Paper segment manufactures and sells a range of communication-based papers. Corporate and Other includes support staff services and related assets and liabilities, transportation assets, and activity related to other ancillary support operations. For more information about our segments, see Note 18, Segment Information.

The consolidated financial statements of PCA as of March 31, 2020 and for the three months ended March 31, 2020 and 2019 are unaudited but include all adjustments (consisting only of normal recurring adjustments) that management considers necessary for a fair presentation of such financial statements. The preparation of the consolidated financial statements involves the use of estimates and accruals. Actual results may vary from those estimates. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with Article 10 of Regulation S-X of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete audited financial statements. Operating results for the three months ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. These consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2019.

The consolidated financial statements include the accounts of PCA and its majority-owned subsidiaries after elimination of intercompany balances and transactions.

Recently Adopted Accounting Standards

Effective January 1, 2020, we adopted Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 introduces the Current Expected Credit Losses (“CECL”) framework for evaluating credit losses on financial instruments measured at amortized cost. ASU 2016-13 was applied using the modified retrospective method, and as a result, amounts recorded prior to January 1, 2020 have not been retrospectively restated. This new framework requires entities to incorporate forward-looking information into their estimate of current expected credit loss as of each reporting date. Although available-for-sale (“AFS”) debt securities are not within the scope of the new CECL framework, the ASU includes an amended impairment model for evaluating losses related to AFS debt securities. The guidance in this update also includes enhanced requirements for disclosures related to credit loss estimates.

Prior to adoption of the new standard, the Company already incorporated forward-looking information into its estimate of credit losses for trade receivables. Due to the short duration of the Company’s trade receivables, the adoption of ASU 2016-13 did not have a material impact on trade receivables. The adoption of ASU 2016-13 also did not have a material impact on the Company’s AFS marketable debt securities, as the Company only invests in highly-rated AFS marketable debt securities. Overall, the adoption of ASU 2016-13 did not have a material impact on the Company’s financial condition, results of operations or cash flow for the period ended March 31, 2020.

Effective January 1, 2020, the Company adopted ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 removes or modifies certain disclosure requirements and adds additional requirements to improve the usefulness of the fair value measurement disclosure for financial statement users. Certain new requirements of ASU 2018-13 are required to be applied prospectively for the first interim period of the initial year of adoption. However, the modifications and removal of certain information needs to be applied retrospectively. The adoption of this Update did not have a significant impact on the Company’s related disclosures as reflected in this Quarterly Report on Form 10-Q.  

New Accounting Standards Not Yet Adopted

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. ASU 2020-04 provides optional guidance for a limited period of time to ease the potential burden in accounting for, or recognizing the effects of, reference rate reform on financial reporting. The amendments in this Update are elective and apply to all entities, subject to meeting certain criteria, that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. Companies can apply the ASU immediately, but the guidance will only be available until December 31, 2022. The Company is currently evaluating the impact of this guidance, but does not expect the guidance to have a significant impact on its related disclosures.

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In August 2018, the FASB issued ASU 2018-14, Compensation – Retirement Benefits – Defined Benefit Plans – General (Subtopic 715-20): Disclosure Framework – Changes to the Disclosure Requirements for Defined Benefit Plans. ASU 2018-14 removes certain disclosures that are not considered cost beneficial, clarifies certain required disclosures and adds additional disclosures. The ASU is effective for annual periods beginning after December 31, 2020, with early adoption permitted. The amendments in ASU 2018-14 would need to be applied on a retrospective basis.  The Company is currently evaluating the impact of this guidance, but does not expect the guidance will have a significant impact on its related disclosures.

There were no other accounting standards recently issued that had or are expected to have a material impact on our financial position or results of operations.

Revenue Recognition

Revenue is recognized when control of the promised goods or services is transferred to customers in an amount that reflects the consideration expected to be received in exchange for those goods or services. Sales, value added, and other taxes collected concurrently with revenue-producing activities are excluded from revenue.

The following table presents our revenues disaggregated by product line (dollars in millions):

Packaging Revenue

Our containerboard mills produce linerboard and corrugating medium which are papers primarily used in the production of corrugated products. The majority of our containerboard production is used internally by our corrugated products manufacturing facilities. The remaining containerboard is sold to outside domestic and export customers. Our corrugated products manufacturing plants produce a wide variety of corrugated packaging products and retail merchandise displays. We sell corrugated products to national, regional and local customers, which are broadly diversified across industries and geographic locations.

The Company recognizes revenue for its packaging products when performance obligations under the terms of a contract with a customer are satisfied. This occurs with the transfer of control of our products at a specific point in time. Based on our express terms and conditions of the sale of products to our customers, as well as terms included in contractual arrangements with our customers, we do not have an enforceable right of payment that includes a reasonable profit throughout the duration of the contract for products that do not have an alternative use. Revenue is recognized when the product is shipped from the mill or from our manufacturing facility to our customer. Certain customers may receive volume-based incentives, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenue recognized.

Certain customers receive a portion of their packaging products as consigned inventory with billing triggered once the customer uses or consumes the designated product. Prior to invoicing, these amounts are handled as unbilled receivables. Total unbilled receivables, which are immaterial in amount, are included in the accounts receivable financial statement caption.

Paper Revenue

We manufacture and sell a range of communication-based papers. Communication papers consist of cut-size office papers, and printing and converting papers.

The Company recognizes revenue for its paper products when performance obligations under the terms of a contract with a customer are satisfied. This occurs with the transfer of control of our products at a specific point in time. Revenue is recognized when the product is shipped from the mill or from our manufacturing facility or distribution center to our customer. Certain customers may receive volume-based incentives, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenue recognized.

Corporate and Other Revenue

Revenue in this segment primarily relates to Louisiana Timber Procurement Company, L.L.C. (LTP), a variable-interest entity that is 50% owned by PCA and 50% owned by Boise Cascade Company (Boise Cascade). PCA is the primary beneficiary of LTP and has the power to direct the

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activities that most significantly affect the economic performance of LTP. Therefore, we consolidate 100% of LTP in our financial statements. See Note 17, Transactions With Related Parties, for more information related to LTP.

The Company recognizes revenue within this segment when performance obligations under the terms of a contract with a customer are satisfied. This occurs with the transfer of control of our products at a specific point in time.

Practical Expedients and Exemption

Shipping and handling fees billed to a customer are recorded on a gross basis in "Net sales" with the corresponding shipping and handling costs included in "Cost of sales" in the concurrent period as the revenue is recorded. We expense sales commissions when incurred because the amortization period is one year or less. Sales commissions are recorded in "Selling, general, and administrative expenses".

We do not disclose the value of unsatisfied performance obligations for contracts with an original expected duration of one year or less.

The following table sets forth the computation of basic and diluted income per common share for the periods presented (dollars and shares in millions, except per share data):

The components of other expense, net, were as follows (dollars in millions):

________________

For the three months ended March 31, 2020 and 2019, we recorded $48.4 million and $62.5 million of income tax expense and had an effective tax rate of 25.5% and 25.1%, respectively. The increase in our effective tax rate for the three months ended March 31, 2020 compared with the same period in 2019 was primarily due to higher employee compensation related impacts from the elimination of the performance based compensation exclusion in tax reform and reduced benefit associated with Foreign Derived Intangible Income.

Our effective tax rate may differ from the federal statutory income tax rate of 21.0% due primarily to the effect of state and local income taxes. During the three months ended March 31, 2020 and 2019, cash paid for taxes, net of refunds received, was $4.7 million and $13.7 million, respectively. The decrease in cash tax payments between the periods is primarily due to lower taxable income.

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During the three months ended March 31, 2020, there were no significant changes to our uncertain tax positions. For more information, see Note 8, Income Taxes, of the Notes to Consolidated Financial Statements in “Part II, Item 8. Financial Statements and Supplementary Data” of our 2019 Annual Report on Form 10-K.

We value our raw materials, work in process, and finished goods inventories using lower of cost, as determined by the average cost method, or market. Supplies and materials are valued at the first-in, first-out (FIFO) or average cost methods.

The components of inventories were as follows (dollars in millions):

The components of property, plant, and equipment were as follows (dollars in millions):

Depreciation expense for the three months ended March 31, 2020 and 2019 was $89.8 million and $85.2 million, respectively. We did not recognize any incremental depreciation expense during the three months ended March 31, 2020. We recognized $0.2 million of incremental depreciation expense during the three months ended March 31, 2019 as a result of shortening the useful lives of certain assets primarily related to the Wallula mill restructuring.

At March 31, 2020 and December 31, 2019, purchases of property, plant, and equipment included in accounts payable were $35.3 million and $26.8 million, respectively.

Goodwill

Goodwill represents the excess of the cost of an acquired business over the fair value of the identifiable tangible and intangible assets acquired and liabilities assumed in a business combination. At both March 31, 2020 and December 31, 2019, we had $863.5 million of goodwill recorded in our Packaging segment and $55.2 million of goodwill recorded in our Paper segment.

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Intangible Assets

Intangible assets are primarily comprised of customer relationships and trademarks and trade names.

The weighted average remaining useful life, gross carrying amount, and accumulated amortization of our intangible assets were as follows (dollars in millions):

During the three months ended March 31, 2020 and 2019, amortization expense was $9.6 million and $9.5 million, respectively.

The components of accrued liabilities were as follows (dollars in millions):

For both the three months ended March 31, 2020 and 2019, cash payments for interest were $7.3 million.

Included in interest expense, net is the amortization of financing costs, and, for 2019 only, the amortization of treasury lock settlements. The remaining balances of the treasury lock settlements were written off in connection with the debt refinancing completed in December 2019. For the three months ended March 31, 2020 and 2019, amortization of financing costs was $0.5 million and $0.7 million, respectively. For the three months ended March 31, 2019, amortization of treasury lock settlements was $1.3 million.

At March 31, 2020, we had $2,493.2 million of fixed-rate senior notes outstanding. The fair value of our fixed-rate debt was estimated to be $2,615.4 million. The difference between the book value and fair value is due to the difference between the period-end market interest rate and the stated rate of our fixed-rate debt. We estimated the fair value of our fixed-rate debt using quoted market prices (Level 2 inputs) within the fair value hierarchy, which is further defined in Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of our 2019 Annual Report on Form 10-K.

For more information on our long-term debt and interest rates on that debt, see Note 11, Debt, of the Notes to Consolidated Financial Statements in "Part II, Item 8. Financial Statements and Supplementary Data" of our 2019 Annual Report on Form 10-K.

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The following table shows the Company’s cash and available-for-sale (AFS) debt securities by major asset category at March 31, 2020 and December 31, 2019 (in millions):

For the three months ended March 31, 2020, net realized gains and losses on the sales and maturities of certain marketable debt securities were insignificant.  

The Company invests in highly rated securities, with the primary objective of minimizing the potential risk of principal loss. The Company’s investment policy requires securities to be investment grade and limits the amount of credit exposure to any one issuer. The maturities of the Company’s long-term marketable debt securities generally range from one to two years.

Fair values were determined for each individual marketable debt security in the investment portfolio. The Company evaluates each individual security to determine whether the security is impaired. An impairment exists when a security’s fair value is below its amortized cost basis. The Company reviews each impaired investment to determine if the decline in fair value below the amortized cost basis resulted from a credit loss or other factors. If the impairment of a marketable debt security (or a portion of the impairment) is due to credit factors of the issuer, the Company records an allowance for credit losses. Non-credit related impairments are recorded in Other Comprehensive Income (OCI). PCA reviews factors such as the duration and extent to which the fair value of the marketable debt security is less than its cost, the financial condition of the issuer and any changes thereto, the general market condition in which the issuer operates, and ability of the issuer to make all required payments of the marketable debt security. PCA utilizes various credit rating services to provide information on the impaired investment of a particular issuer.

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As of March 31, 2020 and December 31, 2019, we do not consider any of our marketable debt securities to be other-than-temporarily impaired. Any impairment existing at March 31, 2020 or December 31, 2019 is not related to credit losses. Therefore, we have not recorded an allowance for credit losses related to our marketable debt securities. All unrealized gains and losses were recorded in OCI.

The following table provides information about the Company’s marketable debt securities that have been in a continuous loss position as of March 31, 2020 and December 31, 2019 (in millions, except number of marketable debt securities in a loss position):

The components of net periodic benefit cost for our pension plans were as follows (dollars in millions):

PCA makes pension plan contributions that are sufficient to fund its actuarially determined costs, generally equal to the minimum amounts required by the Employee Retirement Income Security Act (ERISA). From time to time, PCA may make additional discretionary contributions based on the funded status of the plans, tax deductibility, income from operations, and other factors. During the three months ended March 31, 2020 and 2019, payments to our nonqualified pension plans were insignificant. For the three months ended March 31, 2020 and 2019, we made contributions of $3.9 million and $0.7 million, respectively, to our qualified pension plans. We expect to contribute at least the estimated required minimum contributions to our qualified plans of approximately $19.8 million in 2020.

For the three months ended March 31, 2020 and 2019, the net periodic benefit cost for our postretirement plans was insignificant.

The Company has a long-term equity incentive plan, which allows for grants of restricted stock, performance awards, stock appreciation rights, and stock options to directors, officers, and employees, as well as others who engage in services for PCA. On February 25, 2020, our board of directors approved and, on May 5, 2020, our stockholders approved, the amendment and restatement of the plan. The amendment extends the plan’s term to May 5, 2030 and increases the number of shares of common stock available for issuance under the plan by 1,400,000 shares. The total number of shares authorized for past and future awards will be 11,950,000 shares.

As of March 31, 2020, 0.1 million shares were available for future grants under the current plan. Forfeitures are added back to the pool of shares of common stock available to be granted at a future date.

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The following table presents restricted stock and performance unit award activity for the three months ended March 31, 2020:

Compensation Expense

Our share-based compensation expense is recorded in "Selling, general, and administrative expenses." Compensation expense for share-based awards recognized in the Consolidated Statements of Income, net of forfeitures, was as follows (dollars in millions):

The fair value of restricted stock is determined based on the closing price of the Company’s stock on the grant date. Compensation expense, net of estimated forfeitures, is recorded over the requisite service period. As PCA’s Board of Directors has the ability to accelerate the vesting of these awards upon an employee’s retirement, the Company accelerates the recognition of compensation expense for certain employees approaching normal retirement age.

Performance unit awards are earned based on the achievement of defined performance rankings of Return on Invested Capital (ROIC) or Total Shareholder Return (TSR) compared to ROIC and TSR for peer companies. For performance unit awards made in 2020 and 2019, in terms of grant date value, 50% used TSR as the performance measure and 50% used ROIC as the performance measure. The ROIC component of performance unit awards is valued based on the closing price of the stock on the grant date. As the ROIC component contains a performance condition, compensation expense, net of estimated forfeitures, is recorded over the requisite service period based on the most probable number of awards expected to vest. The TSR component of performance unit awards is valued using a Monte Carlo simulation as the TSR component contains a market condition. The Monte Carlo simulation estimates the fair value of the TSR component based on the expected term of the award, a risk-free interest rate, expected dividends, and expected volatility of the Company’s common stock and the common stock of the peer companies. Compensation expense is recorded ratably over the expected term of the award.

The unrecognized compensation expense for all share-based awards at March 31, 2020 was as follows (dollars in millions):

Dividends

During the three months ended March 31, 2020, we paid $74.8 million of dividends to shareholders. On February 25, 2020, PCA’s Board of Directors declared a regular quarterly cash dividend of $0.79 per share of common stock, which was paid on April 15, 2020 to shareholders of record as of March 13, 2020. The dividend payment was $74.9 million.

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Repurchases of Common Stock

On February 25, 2016, PCA announced that its Board of Directors authorized the repurchase of $200.0 million of the Company’s outstanding common stock. Repurchases may be made from time to time in open market or privately negotiated transactions in accordance with applicable securities regulations. The timing and amount of repurchases will be determined by the Company in its discretion based on factors such as PCA’s stock price and market and business conditions.

The Company did not repurchase any shares of its common stock under this authority during the three months ended March 31, 2020. At March 31, 2020, $193.0 million of the authorized amount remained available for repurchase of the Company’s common stock.

Accumulated Other Comprehensive Income (Loss)

Changes in accumulated other comprehensive income (loss) (AOCI) by component were as follows (dollars in millions). Amounts in parentheses indicate losses:

Reclassifications out of AOCI were as follows (dollars in millions). Amounts in parentheses indicate expenses in the Consolidated Statements of Income:

Our Paper segment has a long-standing commercial and contractual relationship with Office Depot, our largest customer in the paper business. This relationship exposes us to a significant concentration of business and financial risk. Our sales to Office Depot represent approximately 5% and 7% of our total Company sales revenue for the three month periods ended March 31, 2020 and 2019, respectively, and approximately 43% and 52% of our Paper segment sales revenue for both of those periods, respectively. For full year 2019, sales to Office Depot represented 50% of our Paper segment sales. At March 31, 2020 and December 31, 2019, we had $56.8 million and $76.2 million of accounts receivable due from Office Depot, respectively, which represents 6% and 9% of our total Company accounts receivable, respectively.

Louisiana Timber Procurement Company, L.L.C. (LTP) is a variable-interest entity that is 50% owned by PCA and 50% owned by Boise Cascade Company (Boise Cascade). LTP procures sawtimber, pulpwood, residual chips, and other residual wood fiber to meet the wood and fiber requirements of PCA and Boise Cascade in Louisiana. PCA is the primary beneficiary of LTP and has the power to direct the activities that most

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significantly affect the economic performance of LTP. Therefore, we consolidate 100% of LTP in our financial statements in our Corporate and Other segment. The carrying amounts of LTP's assets and liabilities (which relate primarily to non-inventory working capital items) on our Consolidated Balance Sheets were $5.0 million at March 31, 2020 and $3.9 million at December 31, 2019. During the three months ended March 31, 2020 and 2019, we recorded $22.6 million and $20.0 million, respectively, of LTP sales to Boise Cascade in "Net Sales" in the Consolidated Statements of Income and approximately the same amount of expenses in "Cost of Sales".

During the three months ended March 31, 2020 and 2019, fiber purchases from related parties were $4.2 million and $4.4 million, respectively. Most of these purchases related to chip and log purchases by LTP from Boise Cascade's wood products business. These purchases are recorded in "Cost of Sales" in the Consolidated Statements of Income.

We report our business in three reportable segments: Packaging, Paper, and Corporate and Other. These segments represent distinct businesses that are managed separately because of differing products and services. Each of these businesses requires distinct operating and marketing strategies.

Each segment’s profits and losses are measured on operating profits before interest expense, net, non-operating pension expense, and income taxes. For certain allocated expenses, the related assets and liabilities remain in the Corporate and Other segment.

Selected financial information by reportable segment was as follows (dollars in millions):