filings.toolsItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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INDEX TO FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors
Packaging Corporation of America:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Packaging Corporation of America and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively, the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
| /s/ KPMG LLP | |
|---|---|
| We have served as the Company’s auditor since 2014. | |
| Chicago, Illinois | |
| February 28, 2019 |
Packaging Corporation of America
Consolidated Statements of Income and Comprehensive Income
(dollars in millions, except per-share data)
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | 2016 | ||||||||||
| Statements of Income | ||||||||||||
| Net sales | $ | 7,014.6 | $ | 6,444.9 | $ | 5,779.0 | ||||||
| Cost of sales | (5,369.3 | ) | (4,974.1 | ) | (4,502.9 | ) | ||||||
| Gross profit | 1,645.3 | 1,470.8 | 1,276.1 | |||||||||
| Selling and administrative expenses | (536.4 | ) | (519.9 | ) | (468.5 | ) | ||||||
| Other expense, net | (41.2 | ) | (18.4 | ) | (24.3 | ) | ||||||
| Income from operations | 1,067.7 | 932.5 | 783.3 | |||||||||
| Interest expense, net and other | (97.2 | ) | (103.9 | ) | (94.8 | ) | ||||||
| Income before taxes | 970.5 | 828.6 | 688.5 | |||||||||
| (Provision) benefit for income taxes | (232.5 | ) | (160.0 | ) | (238.9 | ) | ||||||
| Net income | $ | 738.0 | $ | 668.6 | $ | 449.6 | ||||||
| Net income per common share: | ||||||||||||
| Basic | $ | 7.82 | $ | 7.09 | $ | 4.76 | ||||||
| Diluted | $ | 7.80 | $ | 7.07 | $ | 4.75 | ||||||
| Dividends declared per common share | $ | 3.00 | $ | 2.52 | $ | 2.36 | ||||||
| Statements of Comprehensive Income: | ||||||||||||
| Net income | $ | 738.0 | $ | 668.6 | $ | 449.6 | ||||||
| Other comprehensive income (loss), net of tax: | ||||||||||||
| Foreign currency translation adjustment | $ | (0.1 | ) | $ | (0.2 | ) | $ | — | ||||
| Reclassification adjustments to cash flow hedges included in net income, net of tax of $1.3 million, $2.2 million, and $2.2 million for 2018, 2017, and 2016, respectively | 4.0 | 3.5 | 3.5 | |||||||||
| Amortization of pension and postretirement plans actuarial loss and prior service cost, net of tax of $4.0 million, $4.9 million, and $4.2 million for 2018, 2017, and 2016, respectively | 11.8 | 8.2 | 6.7 | |||||||||
| Changes in unfunded employee benefit obligations, net of tax of ($0.8) million, $18.0 million, and $15.7 million for 2018, 2017, and 2016, respectively | 2.4 | (28.8 | ) | (24.9 | ) | |||||||
| Other comprehensive income (loss) | 18.1 | (17.3 | ) | (14.7 | ) | |||||||
| Comprehensive income | $ | 756.1 | $ | 651.3 | $ | 434.9 |
See notes to consolidated financial statements.
Packaging Corporation of America
Consolidated Balance Sheets
(dollars and shares in millions, except per-share data)
| December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | |||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 361.5 | $ | 216.9 | ||||
| Accounts receivable, net of allowance for doubtful accounts and customer deductions of $13.6 million and $12.6 million as of December 31, 2018 and 2017, respectively | 901.9 | 830.7 | ||||||
| Inventories | 795.6 | 762.5 | ||||||
| Prepaid expenses and other current assets | 39.4 | 35.5 | ||||||
| Federal and state income taxes receivable | 16.7 | 69.5 | ||||||
| Total current assets | 2,115.1 | 1,915.1 | ||||||
| Property, plant and equipment, net | 3,108.6 | 2,924.9 | ||||||
| Goodwill | 917.3 | 883.2 | ||||||
| Other intangible assets, net | 378.2 | 410.0 | ||||||
| Other long-term assets | 50.5 | 64.3 | ||||||
| Total assets | $ | 6,569.7 | $ | 6,197.5 | ||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
| Current liabilities: | ||||||||
| Current maturities of long-term debt | $ | — | $ | 150.0 | ||||
| Capital lease obligations | 1.4 | 1.3 | ||||||
| Accounts payable | 382.2 | 402.9 | ||||||
| Dividends payable | 76.1 | 60.5 | ||||||
| Accrued liabilities | 222.4 | 203.2 | ||||||
| Accrued interest | 11.5 | 14.8 | ||||||
| Total current liabilities | 693.6 | 832.7 | ||||||
| Long-term liabilities: | ||||||||
| Long-term debt | 2,483.7 | 2,480.4 | ||||||
| Capital lease obligations | 17.6 | 19.0 | ||||||
| Deferred income taxes | 285.2 | 239.5 | ||||||
| Compensation and benefits | 357.5 | 372.5 | ||||||
| Other long-term liabilities | 59.7 | 70.8 | ||||||
| Total long-term liabilities | 3,203.7 | 3,182.2 | ||||||
| Commitments and contingent liabilities | ||||||||
| Stockholders' equity: | ||||||||
| Common stock, par value $0.01 per share, 300.0 million shares authorized, 94.5 million and 94.3 million shares issued as of December 31, 2018 and 2017, respectively | 0.9 | 0.9 | ||||||
| Additional paid in capital | 494.5 | 471.2 | ||||||
| Retained earnings | 2,315.8 | 1,867.4 | ||||||
| Accumulated other comprehensive loss | (138.8 | ) | (156.9 | ) | ||||
| Total stockholders' equity | 2,672.4 | 2,182.6 | ||||||
| Total liabilities and stockholders' equity | $ | 6,569.7 | $ | 6,197.5 |
See notes to consolidated financial statements.
Packaging Corporation of America
Consolidated Statements of Cash Flows
(dollars in millions)
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | 2016 | ||||||||||
| Cash Flows from Operating Activities: | ||||||||||||
| Net income | $ | 738.0 | $ | 668.6 | $ | 449.6 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Depreciation, depletion, and amortization of intangibles | 410.9 | 391.4 | 358.0 | |||||||||
| Amortization of deferred financing costs | 8.6 | 10.0 | 7.8 | |||||||||
| Share-based compensation expense | 23.5 | 20.6 | 19.7 | |||||||||
| Deferred income tax (benefit) provision | 38.7 | (84.5 | ) | (4.0 | ) | |||||||
| Net loss on impairment of assets | 3.1 | 13.5 | — | |||||||||
| Pension and post-retirement benefits expense, net of contributions | 3.1 | (20.4 | ) | (30.5 | ) | |||||||
| Other, net | 7.1 | 3.0 | 1.4 | |||||||||
| Changes in operating assets and liabilities, net of acquisitions: | ||||||||||||
| Increase in assets — | ||||||||||||
| Accounts receivable | (56.1 | ) | (115.1 | ) | (3.6 | ) | ||||||
| Inventories | (35.6 | ) | (21.0 | ) | (25.7 | ) | ||||||
| Prepaid expenses and other current assets | (2.1 | ) | (5.2 | ) | — | |||||||
| (Decrease) increase in liabilities — | ||||||||||||
| Accounts payable | (17.6 | ) | 41.0 | 16.6 | ||||||||
| Accrued liabilities | 5.5 | 8.4 | (3.2 | ) | ||||||||
| Federal and state income tax payable / receivable | 53.0 | (54.2 | ) | 20.8 | ||||||||
| Net cash provided by operating activities | 1,180.1 | 856.1 | 806.9 | |||||||||
| Cash Flows from Investing Activities: | ||||||||||||
| Additions to property, plant, and equipment | (551.4 | ) | (343.0 | ) | (274.3 | ) | ||||||
| Acquisitions of businesses, net of cash acquired | (56.3 | ) | (273.8 | ) | (485.4 | ) | ||||||
| Additions to other long term assets | (4.5 | ) | (7.8 | ) | (10.4 | ) | ||||||
| Proceeds from asset disposals | 1.5 | 16.6 | 0.5 | |||||||||
| Other, net | 2.5 | (1.1 | ) | — | ||||||||
| Net cash used for investing activities | (608.2 | ) | (609.1 | ) | (769.6 | ) | ||||||
| Cash Flows from Financing Activities: | ||||||||||||
| Proceeds from issuance of debt | — | 997.8 | 385.0 | |||||||||
| Repayments of debt and capital lease obligations | (151.3 | ) | (1,011.9 | ) | (37.5 | ) | ||||||
| Financing costs paid | — | (6.8 | ) | (2.0 | ) | |||||||
| Common stock dividends paid | (268.1 | ) | (237.6 | ) | (216.1 | ) | ||||||
| Repurchases of common stock | — | — | (100.3 | ) | ||||||||
| Shares withheld to cover employee restricted stock taxes | (7.9 | ) | (10.8 | ) | (11.2 | ) | ||||||
| Other, net | — | (0.1 | ) | (0.1 | ) | |||||||
| Net cash (used for) provided by financing activities | (427.3 | ) | (269.4 | ) | 17.8 | |||||||
| Net increase (decrease) in cash and cash equivalents | 144.6 | (22.4 | ) | 55.1 | ||||||||
| Cash and cash equivalents, beginning of year | 216.9 | 239.3 | 184.2 | |||||||||
| Cash and cash equivalents, end of year | $ | 361.5 | $ | 216.9 | $ | 239.3 |
See notes to consolidated financial statements.
Packaging Corporation of America
Consolidated Statements of Changes in Stockholders' Equity
(dollars in millions and shares in thousands)
| Common Stock | Additional Paid in | Retained | Accumulated Other Comprehensive | Total Stockholders' | |||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Shares | Amount | Capital | Earnings | Loss | Equity | ||||||||||||||||||||
| Balance at January 1, 2016 | 96,129 | $ | 1.0 | $ | 439.9 | $ | 1,317.3 | $ | (124.9 | ) | $ | 1,633.3 | |||||||||||||
| Common stock repurchases and retirements | (1,987 | ) | (0.1 | ) | (13.1 | ) | (87.1 | ) | — | (100.3 | ) | ||||||||||||||
| Common stock withheld and retired to cover taxes on vested stock awards | (172 | ) | — | (1.1 | ) | (10.1 | ) | — | (11.2 | ) | |||||||||||||||
| Common stock dividends declared | — | — | — | (222.6 | ) | — | (222.6 | ) | |||||||||||||||||
| Restricted stock/performance unit grants and cancellations | 243 | — | 5.7 | — | — | 5.7 | |||||||||||||||||||
| Share-based compensation expense | — | — | 19.7 | — | — | 19.7 | |||||||||||||||||||
| Other | — | — | 0.3 | — | — | 0.3 | |||||||||||||||||||
| Comprehensive income | — | — | — | 449.6 | (14.7 | ) | 434.9 | ||||||||||||||||||
| Balance at December 31, 2016 | 94,213 | $ | 0.9 | $ | 451.4 | $ | 1,447.1 | $ | (139.6 | ) | $ | 1,759.8 | |||||||||||||
| Common stock withheld and retired to cover taxes on vested stock awards | (98 | ) | — | (0.7 | ) | (10.1 | ) | — | (10.8 | ) | |||||||||||||||
| Common stock dividends declared | — | — | — | (238.2 | ) | — | (238.2 | ) | |||||||||||||||||
| Share-based compensation expense | 235 | — | 20.6 | — | — | 20.6 | |||||||||||||||||||
| Other | — | — | (0.1 | ) | — | — | (0.1 | ) | |||||||||||||||||
| Comprehensive income | — | — | — | 668.6 | (17.3 | ) | 651.3 | ||||||||||||||||||
| Balance at December 31, 2017 | 94,350 | $ | 0.9 | $ | 471.2 | $ | 1,867.4 | $ | (156.9 | ) | $ | 2,182.6 | |||||||||||||
| Common stock withheld and retired to cover taxes on vested stock awards | (69 | ) | — | (0.5 | ) | (7.4 | ) | — | (7.9 | ) | |||||||||||||||
| Common stock dividends declared | — | — | (284.0 | ) | — | (284.0 | ) | ||||||||||||||||||
| Share-based compensation expense | 216 | — | 23.5 | — | — | 23.5 | |||||||||||||||||||
| Adoption of ASC 606 | — | — | — | 1.6 | — | 1.6 | |||||||||||||||||||
| Other | — | — | 0.3 | 0.2 | — | 0.5 | |||||||||||||||||||
| Comprehensive income | — | — | — | 738.0 | 18.1 | 756.1 | |||||||||||||||||||
| Balance at December 31, 2018 | 94,497 | $ | 0.9 | $ | 494.5 | $ | 2,315.8 | $ | (138.8 | ) | $ | 2,672.4 |
See notes to consolidated financial statements.
Notes to Consolidated Financial Statements
| 1. | Nature of Operations and Basis of Presentation |
|---|
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., a wholly owned subsidiary of Tenneco 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 have approximately 15,000 employees.
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 primarily manufactures and sells a range of communication-based papers. During the second quarter of 2018, the Company discontinued the production of uncoated free sheet and coated one-side grades at the Wallula, Washington mill and converted the No. 3 machine to a virgin kraft linerboard machine. Subsequent to the date of the conversion in May 2018, operating results for the Wallula mill are primarily included in the Packaging segment. 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.
In these consolidated financial statements, certain amounts in prior periods’ consolidated financial statements have been reclassified to conform with the current period presentation.
The consolidated financial statements include the accounts of PCA and its majority-owned subsidiaries after elimination of intercompany balances and transactions.
| 2. | Summary of Significant Accounting Policies |
|---|
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenues and expenses. These estimates and assumptions are based on management's best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. We adjust such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in these estimates will be reflected in the consolidated financial statements in future periods.
Revenue Recognition
We recognize revenue 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. The timing of revenue recognition for most goods and services occurs when performance obligations under the terms of a contract with the customer are satisfied. This occurs with the transfer of control of our products at a specific point in time. For most packaging and paper products, revenue is recognized when the product is shipped from the mill or from our manufacturing facility to our customer. 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 present taxes collected from customers and remitted to governmental authorities on a net basis in our Consolidated Statements of Income. In January 2018, the Company adopted ASU 2014-09 (Topic 606): Revenue from Contracts with Customers. See Note 3, Revenue, for more information.
Planned Major Maintenance Costs
The Company accounts for its planned major maintenance activities in accordance with ASC 360, Property, Plant, and Equipment, using the deferral method. All maintenance costs incurred during the year are expensed in the year in which the maintenance activity occurs.
Share-Based Compensation
We recognize compensation expense for awards granted under the PCA long-term equity incentive plans based on the fair value on the grant date. We recognize the cost of the equity awards expected to vest over the period the awards vest. See Note 13, Share-Based Compensation, for more information.
Research and Development
Research and development costs are expensed as incurred. The amount charged to expense was $14.4 million, $12.8 million, and $13.3 million for the years ended December 31, 2018, 2017, and 2016, respectively.
Cash and Cash Equivalents
Cash and cash equivalents include all cash balances and highly liquid investments with a stated maturity of three months or less. Cash equivalents are stated at cost, which approximates market. Cash and cash equivalents totaled $361.5 million and $216.9 million at December 31, 2018 and 2017, respectively, which included cash equivalents of $311.1 million and $160.2 million, respectively. At December 31, 2018 and 2017, we had $2.3 million and $1.8 million, respectively, of cash at our operations outside the United States.
Trade Accounts Receivable, Allowance for Doubtful Accounts, and Customer Deductions
Trade accounts receivable are stated at the amount we expect to collect. The collectability of our accounts receivable is based upon a combination of factors. In circumstances where a specific customer is unable to meet its financial obligations to PCA (e.g., bankruptcy filings, substantial downgrading of credit sources), a specific reserve for bad debts is recorded against amounts due to the Company to reduce the net recorded receivable to the amount the Company reasonably believes will be collected. For all other customers, reserves for bad debts are recognized based on historical collection experience. If collection experience deteriorates (i.e., higher than expected defaults or an unexpected material adverse change in a major customer’s ability to meet its financial obligations to the Company), the estimate of the recoverability of amounts due could be reduced by a material amount. We periodically review our allowance for doubtful accounts and adjustments to the valuation allowance are recorded as income or expense. Trade accounts receivable balances that remain outstanding after we have used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable. At December 31, 2018 and 2017, the allowance for doubtful accounts was $4.6 million and $4.2 million, respectively.
The customer deductions reserve represents the estimated amount required for customer returns, allowances, and earned discounts. Based on the Company’s experience, customer returns, allowances, and earned discounts have averaged approximately 1% of gross selling price. Accordingly, PCA reserves 1% of its open customer accounts receivable balance for these items. The reserves for customer deductions of $9.0 million and $8.4 million at December 31, 2018 and 2017, respectively, are also included as a reduction of the accounts receivable balance.
Derivative Instruments and Hedging Activities
The Company records its derivatives, if any, in accordance with ASC 815, Derivatives and Hedging. The guidance requires the Company to recognize derivative instruments as either assets or liabilities on the balance sheet at fair value. The accounting for changes in the fair value of a derivative depends on the intended use and designation of the derivative instrument. For a derivative designated as a fair value hedge, the gain or loss on the derivative is recognized in earnings in the period of change at fair value together with the offsetting gain or loss on the hedged item. For a derivative instrument designated as a cash flow hedge, the effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income (loss) (AOCI) and is subsequently recognized in earnings when the hedged exposure affects earnings. The ineffective portion of the gain or loss is recognized in earnings. We were not party to any derivative-based arrangements at December 31, 2018 and 2017.
Fair Value Measurements
PCA measures the fair value of its financial instruments in accordance with ASC 820, Fair Value Measurements and Disclosures. The guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. It is determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC 820 establishes the following hierarchy that prioritizes the inputs to valuation methodologies used to measure fair value:
Level 1 — Valuations based on quoted prices for identical assets and liabilities in active markets.
Level 2 — Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3 — Valuations based on unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
Assets that are measured at fair value using the net asset value (NAV) per share as a practical expedient are not categorized within the fair value hierarchy.
Financial instruments measured at fair value on a recurring basis include the fair value of our pension and postretirement benefit assets and liabilities. See Note 11, Employee Benefit Plans and Other Postretirement Benefits, for more information. Other assets and liabilities measured and recognized at fair value on a nonrecurring basis include assets acquired and liabilities assumed in acquisitions and our asset retirement obligations. Given the nature of these assets and liabilities, evaluating their fair value from the perspective of a market participant is inherently complex. Assumptions and estimates about future values can be affected by a variety of internal and external factors. Changes in these factors may require us to revise our estimates and could require us to retroactively adjust provisional amounts that we recorded for the fair values of assets acquired and liabilities assumed in connection with business combinations. These adjustments could have a material effect on our financial condition and results of operations. See Note 4, Acquisitions, and Note 12, Asset Retirement Obligations, for more information.
Inventory Valuation
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):
| December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | |||||||
| Raw materials | $ | 307.8 | $ | 279.8 | ||||
| Work in process | 13.9 | 12.6 | ||||||
| Finished goods | 199.0 | 217.0 | ||||||
| Supplies and materials | 274.9 | 253.1 | ||||||
| Inventories | $ | 795.6 | $ | 762.5 |
Property, Plant, and Equipment
Property, plant, and equipment are recorded at cost. Cost includes expenditures for major improvements and replacements and the amount of interest cost associated with significant capital additions. Repairs and maintenance costs are expensed as incurred. When property and equipment are retired, sold, or otherwise disposed of, the asset's carrying amount and related accumulated depreciation are removed from the accounts and any gain or loss is included in “Net income” in our Consolidated Statements of Income.
Property, plant, and equipment consisted of the following (dollars in millions):
| December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | |||||||
| Land and land improvements | $ | 161.9 | $ | 156.0 | ||||
| Buildings | 795.5 | 729.8 | ||||||
| Machinery and equipment | 5,481.6 | 5,162.5 | ||||||
| Construction in progress | 176.7 | 194.5 | ||||||
| Other | 75.4 | 68.4 | ||||||
| Property, plant and equipment, at cost | 6,691.1 | 6,311.2 | ||||||
| Less accumulated depreciation | (3,582.5 | ) | (3,386.3 | ) | ||||
| Property, plant and equipment, net | $ | 3,108.6 | $ | 2,924.9 |
The amount of interest capitalized from construction in progress was $4.5 million, $2.5 million, and $2.5 million for the years ended December 31, 2018, 2017, and 2016, respectively.
Depreciation is computed on the straight-line basis over the estimated useful lives of the related assets. Assets under capital leases are depreciated on the straight-line method over the term of the lease or the useful life, if shorter. The following lives are used for the various categories of assets:
| Buildings and land improvements | 5 to 40 years | |
|---|---|---|
| Machinery and equipment | 3 to 25 years | |
| Trucks and automobiles | 3 to 10 years | |
| Furniture and fixtures | 3 to 20 years | |
| Computers and hardware | 3 to 10 years | |
| Leasehold improvements | Period of the lease or useful life, if shorter |
The amount of depreciation expense was $361.7 million, $347.8 million, and $324.1 million for the years ended December 31, 2018, 2017, and 2016, respectively. In 2018 and 2017, we recognized incremental depreciation expense of $14.5 million and $10.5 million, respectively, primarily related to the second quarter 2018 discontinuation of uncoated free sheet and coated one-side grades at the Wallula, Washington mill associated with the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine. During the year ended December 31, 2016, we recognized $2.9 million of incremental depreciation expense primarily related to facilities closure costs and the Wallula, Washington mill restructuring due to the discontinuation of market pulp production.
Pursuant to the terms of an industrial revenue bond, title to certain property, plant, and equipment was transferred to a municipal development authority in 2009 in order to receive a property tax abatement. The title of these assets will revert back to PCA upon retirement or cancellation of the bond. The assets are included in the consolidated balance sheets under the caption “Property, plant, and equipment, net” as all risks and rewards remain with the Company.
Leases
We assess lease classification as either capital or operating at lease inception or upon modification. We lease some of our locations, as well as other property and equipment, under operating leases. For purposes of determining straight-line rent expense, the lease term is calculated from the date of possession of the facility, including any periods of free rent and any renewal option periods that are reasonably assured of being exercised. In February 2016, the FASB issued ASU 2016-02 (Topic 842): Leases, which amends a number of aspects of lease accounting. The guidance of ASU 2016-02 is effective for the Company beginning in January 2019.
Long-Lived Asset Impairment
Long-lived assets other than goodwill and other intangibles are reviewed for impairment in accordance with provisions of ASC 360, Property, Plant and Equipment. In the event that facts and circumstances indicate that the carrying amount of any long-lived assets may be impaired, an evaluation of recoverability is performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset (or group of assets) is compared to the assets (or group of assets) carrying amount to determine if a write-down to fair value is required.
Goodwill and Intangible Assets
The Company has capitalized certain intangible assets, primarily goodwill, customer relationships, and trademarks and trade names, based on their estimated fair value at the date of acquisition. Amortization is provided for customer relationships on a straight-line basis over periods ranging from ten to 40 years, and trademarks and trade names over periods ranging from five to 20 years.
Goodwill, which amounted to $917.3 million and $883.2 million for the years ended December 31, 2018 and 2017, respectively, is not amortized but is subject to an annual impairment test in accordance with ASC 350, Intangibles – Goodwill and Other. We test goodwill for impairment annually in the fourth quarter or sooner if events or changes in circumstances indicate that the carrying value of the asset may exceed fair value. Additionally, we evaluate the remaining useful lives of our finite-lived purchased intangible assets to determine whether any adjustments to the useful lives are necessary. The Company concluded that none of the goodwill or intangible assets were impaired in the 2018, 2017, and 2016 annual impairment tests. See Note 8, Goodwill and Intangible Assets, for additional information.
Pension and Postretirement Benefits
Several estimates and assumptions are required to record pension costs and liabilities, including discount rate, return on assets, and longevity and service lives of employees. We review and update these assumptions annually unless a plan curtailment or other event occurs, requiring that we update the estimates on an interim basis. While we believe the assumptions used to measure our pension and postretirement benefit obligations are reasonable, differences in actual experience or changes in assumptions may materially affect our pension and postretirement benefit obligations and future expense. See Note 11, Employee Benefit Plans and Other Postretirement Benefits, for additional information.
For postretirement health care plan accounting, the Company reviews external data and its own historical trends for health care costs to determine the health care cost trend rate assumption.
In January 2018, the Company adopted ASU 2017-07, Compensation – Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires the presentation of non-service cost components of net periodic benefits expense to be shown separately outside the subtotal of operating income in the Consolidated Statements of Income and Comprehensive Income.
Environmental Matters
Environmental expenditures that extend the life of the related property or mitigate or prevent future environmental contamination are capitalized. Liabilities are recorded for environmental contingencies when such costs are probable and reasonably estimable. These liabilities are adjusted as further information develops or circumstances change. Environmental expenditures related to existing conditions resulting from past or current operations from which no current or future benefit is discernible are expensed as incurred.
Asset Retirement Obligations
The Company accounts for its retirement obligations related predominantly to landfill closure, wastewater treatment pond dredging, closed-site monitoring costs, and certain leasehold improvements under ASC 410, Asset Retirement and Environmental Obligations, which requires recognition of legal obligations associated with the retirement of long-lived assets whether these assets are owned or leased. These legal obligations are recognized at fair value at the time that the obligations are incurred. When we record the liability, we capitalize the cost by increasing the carrying amount of the related long-lived asset, which is amortized to expense over the useful life of the asset. See Note 12, Asset Retirement Obligations, for additional information.
Deferred Debt Issuance Costs
PCA has capitalized certain costs related to obtaining its financing. These costs are amortized to interest expense using the effective interest rate method over the terms of the related financing, which range from three to ten years. At December 31, 2018 and 2017 deferred debt issuance costs were $12.6 million and $15.3 million, respectively, and were recorded in “Long-Term Debt” on our Consolidated Balance Sheets.
Cutting Rights and Fiber Farms
We lease the cutting rights to approximately 75,000 acres of timberland, and we lease 3,000 acres of land where we operate fiber farms as a source of future fiber supply. For our cutting rights and fiber farms, we capitalize the annual lease payments and reforestation costs associated with these leases. Costs are recorded as depletion when the timber or fiber is harvested and used in operations or sold to customers. Capitalized long-term lease costs for our cutting rights and fiber farms, primarily recorded in “Other long-term assets” on our Consolidated Balance Sheets, were $22.4 million and $31.5 million as of December 31, 2018 and 2017, respectively. The amount of depletion expense was $7.6 million, $5.2 million, and $4.7 million for the years ended December 31, 2018, 2017, and 2016, respectively. Additionally, in conjunction with the conversion of the No. 3 machine at the Wallula mill to kraft linerboard, management performed a recoverability test on associated fiber farms in 2018 and 2017 and deemed the asset group to not be fully recoverable. As a result of the recoverability calculation on the fiber farm asset group, the Company recorded an impairment loss of $3.1 million and $13.5 million during 2018 and 2017, respectively.
Deferred Software Costs
PCA capitalizes costs related to the purchase and development of software, which is used in its business operations. The costs attributable to these software systems are amortized over their estimated useful lives based on various factors such as the effects of obsolescence, technology, and other economic factors. Net capitalized software costs recorded in “Other long-term assets” on our Consolidated Balance Sheets were $1.6 million and $3.3 million for the years ended December 31, 2018 and 2017, respectively. Software amortization expense was $2.1 million, $2.3 million, and $2.5 million for the years ended December 31, 2018, 2017, and 2016, respectively.
Income Taxes
PCA utilizes the liability method of accounting for income taxes whereby it recognizes deferred tax assets and liabilities for the future tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets will be reduced by a valuation allowance if, based upon management’s estimates, it is more likely than not that a portion of the deferred tax assets will not be realized in a future period. The estimates utilized in the recognition of deferred tax assets are subject to revision in future periods based on new facts or circumstances. PCA’s practice is to recognize interest and penalties related to unrecognized tax benefits in income tax expense.
Trade Agreements
PCA regularly trades containerboard with other manufacturers primarily to reduce shipping costs. These agreements are entered into with other producers on an annual basis, pursuant to which both parties agree to ship an identical number of tons of containerboard to each other within the agreement period. These agreements lower transportation costs by allowing each party’s containerboard mills to ship containerboard to the other party’s closer corrugated products plant. PCA tracks each shipment to ensure that the other party’s shipments to PCA match PCA’s shipments to the other party during the agreement period. Such transfers are possible because containerboard is a commodity product with no distinguishing product characteristics. These transactions are accounted for at carrying value, and revenue is not recorded as the transactions do not represent the culmination of an earnings process. The transactions are recorded into inventory accounts, and no sale or income is recorded until such inventory is converted to a finished product and sold to an end-use customer.
Business Combinations
The Company accounts for acquisitions under ASC 805, Business Combinations, which requires separate recognition of assets acquired and liabilities assumed from goodwill, at the acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and liabilities assumed. During the measurement period, which may be up to one year from the acquisition date, the Company records adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the consolidated financial statements. In January 2018, the Company adopted ASU 2017-01, Clarifying the Definition of a Business, which adds guidance to assist entities with evaluating whether transfers of assets and activities should be accounted for as acquisitions of assets or businesses.
Recently Adopted Accounting Standards
Effective January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09 (Topic 606): Revenue from Contracts with Customers. This ASU supersedes the revenue recognition requirements in Topic 605 Revenue Recognition (Topic 605) and requires entities to recognize revenue when control of the promised goods or services is transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and estimates, and changes in those estimates. The Company adopted the standard utilizing the modified retrospective method, in which case the cumulative effect was recognized at the date of initial application on January 1, 2018. The adoption of the standard did not have a material effect on the Company’s financial position or results of operations; however, the following adjustment and reclassification of certain costs were made in 2018:
a. The Company ships a portion of its products to customers under consignment agreements. These products do not have an alternative use, and, under the new standard, revenue associated with these products is required to be recognized earlier than under prior revenue recognition standards. Utilizing the modified retrospective method, the cumulative impact of adopting the new standard resulted in an increase of approximately $1.6 million, net of tax, to opening retained earnings as of January 1, 2018.
b. The new revenue standard also provides additional clarity concerning contract fulfillment costs, which resulted in certain costs being classified as cost of sales rather than selling, general and administrative expenses beginning January 1, 2018. For the year ended December 31, 2018, this amount totaled $28.2 million.
See Note 3, Revenue, for more information.
Effective January 1, 2018, the Company adopted ASU 2017-07, Compensation: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The guidance in this update requires that an employer disaggregate the service cost component from the other components of net benefit cost. Non-service cost components of net periodic benefit cost are required to be presented in the income statement separately from the service cost component and outside the subtotal of operating income. The update also allows only the service cost component to be eligible for capitalization for internally developed capital projects. The amendments in this update are applied retrospectively for the income statement presentations and prospectively for the capitalization of service costs.
The adoption of this ASU retrospectively resulted in a $1.3 million and $3.0 million reclassification between cost of sales and selling, general and administrative expenses (both components of income from operations) and interest expense, net and other (a component outside of income from operations) for the years ended December 31, 2017 and 2016, respectively.
Effective January 1, 2018, the Company adopted ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, which clarifies what changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. This ASU will be applied prospectively when changes to the terms or conditions of a share-based payment award occur.
Effective January 1, 2018, the Company adopted ASU 2017-01 (Topic 805): Clarifying the Definition of a Business, which amends the guidance in ASC 805, Business Combinations. The ASU changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. Under the new guidance, an entity first determines whether substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If this threshold is met, the set is not a business. If it is not met, the entity then evaluates whether the set meets the requirements that a business include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. The ASU defines an output as “the result of inputs and processes applied to those inputs that provide goods or services to customers, investment income (such as dividends or interest), or other revenues.” The ASU will be applied prospectively to any transactions subsequent to adoption.
Effective January 1, 2018, the Company adopted ASU 2016-15 (Topic 230), Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. This ASU adds or clarifies guidance on the classification of certain cash receipts and payments in the statement of cash flows. The adoption of this guidance did not have a material impact on the Company's financial condition, results of operations, or cash flows.
New Accounting Standards Not Yet Adopted
In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-02 (Topic 842): Leases, which requires lessees to recognize a right-of-use (“ROU”) asset and a lease liability on the balance sheet for all leases, with the exception of short-term leases, and expands disclosures about leasing arrangements for both lessees and lessors, among other items. The new standard is effective for the Company beginning January 1, 2019. In July 2018, the FASB issued ASU No. 2018-11, which provides a modified retrospective transition method where an entity can elect to apply the transition provisions at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Under this method, comparative prior period financial information is not restated.
Effective January 1, 2019, the Company will adopt the new lease accounting standard using the modified retrospective transition method at the adoption date with prior periods not restated. In addition, we will elect the package of practical expedients permitted under the transition guidance within the new standard, which permits us to not reassess our prior conclusions about lease identification, lease classification and initial direct costs. We will also elect the practical expedient related to land easements, allowing us to carry forward our current accounting treatment for existing agreements on land easements, which are not accounted for as leases. We will elect the short-term lease recognition exemption, which permits us to exclude short-term leases (i.e. leases with terms of 12 months or less) from the recognition requirements of this standard.
In preparing for the transition of the new standard, we identified and assessed appropriate changes to our business processes, systems and controls to support the new leasing accounting requirements and disclosures under the new standard. We expect that adoption of this standard will result in recognition of lease liabilities of approximately $220 million to $240 million as of January
1, 2019, with corresponding ROU assets of the same amount based on the present value of the remaining minimum rental payments for existing operating leases. We do not expect to make any cumulative-effect adjustment to retained earnings as a result of the adoption of this standard. We do not believe that adoption of this ASU will have a material impact on our consolidated net earnings, liquidity, or debt covenants under our current debt agreements.
In February 2018, the FASB issued ASU 2018-02 (Topic 220): Income Statement – Reporting Comprehensive Income – Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows for optional reclassification from accumulated other comprehensive income to retained earnings for the stranded tax effects resulting from the enactment of H.R.1 (P.L. 115-97), originally known as the “Tax Cuts and Jobs Act,” in December 2017. An entity that elects to reclassify these amounts must reclassify stranded tax effects related to the change in federal tax rate for all items accounted for in other comprehensive income (e.g., pension and postretirement benefits and cash flow hedges). Entities may also elect to reclassify other stranded tax effects that relate to the Act but do not directly relate to the change in the federal tax rate (e.g., state taxes). Upon adoption of ASU 2018-02, entities are required to disclose their policy for releasing the income tax effects from accumulated other comprehensive income. ASU 2018-02 is effective for annual periods beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently finalizing its evaluation of this guidance but does not expect this ASU to have a material impact on the Company’s financial position, results of operations, or cash flow.
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 this guidance will have on its related disclosures.
In August 2018, the FASB issued 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. The ASU is effective for annual and interim periods beginning after December 15, 2019, with early adoption permitted. Certain amendments of ASU 2018-13 are required to be applied prospectively for the first interim period of the initial year of adoption. All other amendments need to be applied retrospectively. The Company is currently evaluating the impact of the new guidance.
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.
| 3. | Revenue |
|---|
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):
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 (a) | 2016 (a) | ||||||||||
| Packaging | $ | 5,938.5 | $ | 5,312.3 | $ | 4,584.8 | ||||||
| Paper | 1,002.0 | 1,051.8 | 1,093.9 | |||||||||
| Corporate and Other | 74.1 | 80.8 | 100.3 | |||||||||
| Total revenue | $ | 7,014.6 | $ | 6,444.9 | $ | 5,779.0 |
| (a) | Prior periods have not been adjusted under the modified retrospective method for Topic 606. |
|---|
Packaging Revenue
Our containerboard mills produce linerboard and semi-chemical 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 accounts, 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. Pressure sensitive papers, including release liners, are used for specialty applications such as consumer and commercial product labels. Production of pressure sensitive papers was discontinued during the second quarter of 2018 as a result of the No. 3 paper machine conversion at the Wallula, Washington mill to virgin kraft linerboard machine.
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 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.
| 4. | Acquisitions |
|---|
Englander Acquisition
On October 9, 2018, PCA acquired the assets of Englander dZignPak (“Englander”), a corrugated products manufacturer, for $56.3 million. The assets include two sheet plants located in Waco, Texas and Carrollton, Texas. Sales and total assets of the acquired company are not material to our overall sales and total assets. Operating results of the acquired assets subsequent to October 9, 2018 are included in our Packaging segment’s 2018 operating results. We have estimated the allocation of the purchase price to the assets acquired and liabilities assumed based on estimates of the fair value at the date of acquisition, of which $28.6 million was allocated to goodwill (which is deductible for tax purposes) and $14.1 million to intangible assets (to be amortized over a weighted average life of approximately 9.7 years), primarily customer relationships, in the Packaging segment. The purchase price allocation continues to be preliminary, as estimates and assumptions are subject to change as more information becomes available.
Sacramento Container Acquisition
In October 2017, PCA acquired substantially all of the assets of Sacramento Container Corporation, and 100% of the membership interests of Northern Sheets, LLC and Central California Sheets, LLC (collectively referred to as “Sacramento Container”) for a purchase price of $274 million, including working capital adjustments. Funding for the acquisition came from available cash on hand. Assets acquired include full-line corrugated products and sheet feeder operations in both McClellan, California and Kingsburg, California. Sacramento Container provides packaging solutions to customers serving portions of California’s strong agricultural market. Sacramento Container’s financial results are included in the Packaging segment from the date of acquisition.
The Company accounted for the Sacramento Container acquisition using the acquisition method of accounting in accordance with ASC 805, Business Combinations. The total purchase price has been allocated to tangible and intangible assets acquired and liabilities assumed based on respective fair values, as follows (dollars in millions):
| 12/31/17 Allocation | Adjustments | Revised Allocation | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Goodwill | $ | 151.1 | $ | 5.5 | $ | 156.6 | ||||||
| Other intangible assets | 72.6 | (5.5 | ) | 67.1 | ||||||||
| Property, plant and equipment | 26.7 | — | 26.7 | |||||||||
| Other net assets | 23.4 | — | 23.4 | |||||||||
| Net assets acquired | $ | 273.8 | $ | — | $ | 273.8 |
During the second quarter ended June 30, 2018, we made a $5.5 million net adjustment based on the final valuation of the intangible assets. We recorded the adjustment as a decrease to other intangible assets with an offset to goodwill.
Goodwill is calculated as the excess of the purchase price over the fair value of the net assets acquired. Among the factors that contributed to the recognition of goodwill were Sacramento Container’s commitment to continuous improvement and regional synergies, as well as the expected increases in PCA's containerboard integration levels. Goodwill is deductible for tax purposes.
Other intangible assets, primarily customer relationships, were assigned an estimated weighted average useful life of 9.6 years.
Property, plant and equipment were assigned estimated useful lives ranging from one to 13 years.
| 5. | Earnings Per Share |
|---|
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).
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | 2016 | ||||||||||
| Numerator: | ||||||||||||
| Net income | $ | 738.0 | $ | 668.6 | $ | 449.6 | ||||||
| Less: distributed and undistributed earnings allocated to participating securities | (5.7 | ) | (5.6 | ) | (4.4 | ) | ||||||
| Net income attributable to common stockholders | $ | 732.3 | $ | 663.0 | $ | 445.2 | ||||||
| Denominator: | ||||||||||||
| Weighted average common shares outstanding | 93.7 | 93.5 | 93.5 | |||||||||
| Effect of dilutive securities | 0.2 | 0.2 | 0.2 | |||||||||
| Diluted common shares outstanding | 93.9 | 93.7 | 93.7 | |||||||||
| Basic income per common share | $ | 7.82 | $ | 7.09 | $ | 4.76 | ||||||
| Diluted income per common share | $ | 7.80 | $ | 7.07 | $ | 4.75 |
| 6. | Other (Expense) Income, Net |
|---|
The components of other (expense) income, net, were as follows (dollars in millions):
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | 2016 | ||||||||||
| Asset disposals and write-offs | $ | (17.3 | ) | $ | (10.5 | ) | $ | (11.9 | ) | |||
| Wallula mill restructuring (a) | (14.9 | ) | (23.1 | ) | — | |||||||
| Facilities closure and other costs (b) | (1.6 | ) | 5.9 | (10.3 | ) | |||||||
| Insurance deductible for property damage (c) | (0.5 | ) | — | — | ||||||||
| Acquisition and integration related costs (d) | (0.2 | ) | (0.8 | ) | (3.3 | ) | ||||||
| DeRidder mill incident (e) | — | 9.7 | — | |||||||||
| Hexacomb working capital adjustment (f) | — | 2.3 | — | |||||||||
| Expiration of timberland repurchase option (g) | — | 2.0 | — | |||||||||
| Ceased production of market pulp at Wallula (h) | — | — | (0.6 | ) | ||||||||
| Other | (6.7 | ) | (3.9 | ) | 1.8 | |||||||
| Total | $ | (41.2 | ) | $ | (18.4 | ) | $ | (24.3 | ) |
| (a) | Includes charges related to the discontinuation of production of uncoated free sheet and coated one-side grades at the Wallula, Washington mill in the second quarter of 2018 and the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine. |
|---|
| (b) | For 2018, includes charges consisting of closure costs related to corrugated products facilities. For 2017, includes income primarily related to the sale of land corresponding to the closure of a corrugated products facility, partially offset by closure costs related to corrugated products facilities, a paper administration facility, a corporate administration facility, and a lump sum settlement of a multiemployer pension plan withdrawal liability for one of our corrugated products facilities. For 2016, includes expenses related to the closure of corrugated products facilities and a paper administration facility and a lump sum settlement of a multiemployer pension plan withdrawal liability for one of our corrugated products facilities. |
|---|
| (c) | Includes charges for the property damage insurance deductible for a weather-related incident at one of our corrugated products facilities. |
|---|
| (d) | Includes charges for acquisition and integration costs related to recent acquisitions. |
|---|
| (e) | Includes the property damage and business interruption insurance recoveries and corresponding costs related to the February 2017 explosion at our DeRidder, Louisiana mill. |
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| (f) | Includes income related to a working capital adjustment from the April 2015 sale of our Hexacomb corrugated manufacturing operations in Europe and Mexico. |
|---|
| (g) | Includes a gain related to the expiration of a repurchase option corresponding to timberland previously sold. |
|---|
| (h) | Includes costs related to ceased softwood market pulp operations at our Wallula, Washington mill and the permanent shutdown of the No. 1 machine. |
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| 7. | Income Taxes |
|---|
On December 22, 2017, the President signed into law H.R.1 (P.L. 115-97), originally known as the “Tax Cuts and Jobs Act” (the “Tax Act”). The Tax Act significantly revised the U.S. tax code by, among other items, reducing the federal corporate tax rate from 35% to 21%, providing for the full expensing of certain depreciable property, eliminating the corporate alternative minimum tax, limiting the deductibility of interest expense, further limiting the deductibility of certain executive compensation, limiting the use of net operating loss carryforwards created in tax years beginning after December 31, 2017, and implementing a territorial tax system imposing a deemed repatriation transition tax (“Transition Tax”) on earnings of foreign subsidiaries.
Generally accepted accounting principles require companies to record the impact of the Tax Act in their financial statements for the period during which the Tax Act becomes law, even if provisions of the Tax Act become effective at a future date. The SEC staff issued Staff Accounting Bulletin No. 118 (SAB 118), Income Tax Accounting Implications of the Tax Cuts and Jobs Act, which provided guidance on accounting for the effects and included a measurement period that ends when a company has obtained, prepared and analyzed the information necessary to finalize its accounting of the Tax Act which cannot extend beyond one year. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740, Income Taxes, is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete, but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.
In accordance with SAB 118, the Company recorded a final adjustment for the income tax effects of the Tax Act in the fourth quarter of 2018 totaling a net tax benefit of $2.0 million, primarily related to the re-measurement of our U.S. deferred tax assets and liabilities to the lower enacted corporate tax rate as a result of the release of additional regulatory guidance and the completion and filing of the 2017 federal and state income tax returns during calendar year 2018. The Company recorded provisional estimates of the income tax effects of the Tax Act in the fourth quarter of 2017 totaling a net tax benefit of $122.1 million, primarily related to the re-measurement of our U.S. deferred tax assets and liabilities to the lower enacted corporate tax rate for $128.0 million offset by a reduction in the domestic manufacturers deduction for $5.1 million, the Transition Tax and other current year tax reform impacts of $0.8 million.
The following is an analysis of the components of the consolidated income tax provision (dollars in millions):
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | 2016 | ||||||||||
| Current income tax provision (benefit) - | ||||||||||||
| U.S. federal | $ | 150.7 | $ | 209.3 | $ | 213.6 | ||||||
| State and local | 42.9 | 34.9 | 29.1 | |||||||||
| Foreign | 0.2 | 0.3 | 0.2 | |||||||||
| Total current provision for taxes | 193.8 | 244.5 | 242.9 | |||||||||
| Deferred - | ||||||||||||
| U.S. federal | 34.7 | (90.2 | ) | (1.2 | ) | |||||||
| State and local | 4.0 | 5.7 | (3.0 | ) | ||||||||
| Foreign | — | — | 0.2 | |||||||||
| Total deferred provision (benefit) for taxes | 38.7 | (84.5 | ) | (4.0 | ) | |||||||
| Total provision for taxes | $ | 232.5 | $ | 160.0 | $ | 238.9 |
The effective tax rate varies from the U.S. federal statutory tax rate principally due to the following (dollars in millions):
| 2018 | 2017 | 2016 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Provision computed at U.S. federal statutory rate (a) | $ | 203.8 | $ | 290.0 | $ | 241.0 | ||||||
| Federal tax reform | (2.0 | ) | (127.2 | ) | — | |||||||
| State and local taxes, net of federal benefit | 36.9 | 24.0 | 19.8 | |||||||||
| Domestic manufacturers deduction (b) | — | (21.1 | ) | (21.1 | ) | |||||||
| Other | (6.2 | ) | (5.7 | ) | (0.8 | ) | ||||||
| Total | $ | 232.5 | $ | 160.0 | $ | 238.9 |
| (a) | U.S. federal statutory rate of 21% in 2018 and 35% in 2017 and 2016. |
|---|
| (b) | The domestic manufacturers deduction was eliminated after 2017 as a result of the Tax Cuts and Jobs Act. |
|---|
The following details the scheduled expiration dates of our tax effected net operating loss (NOL) and other tax carryforwards at December 31, 2018 (dollars in millions):
| 2019 Through 2028 | 2029 Through 2038 | Indefinite | Total | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| U.S. federal NOLs | $ | 28.6 | $ | 3.8 | $ | — | $ | 32.4 | ||||||||
| State taxing jurisdiction NOLs | 1.8 | 0.2 | — | 2.0 | ||||||||||||
| U.S. federal tax credit carryforwards | — | 0.1 | — | 0.1 | ||||||||||||
| U.S. federal and non-U.S. capital loss carryforwards | 3.1 | — | 0.1 | 3.2 | ||||||||||||
| Total | $ | 33.5 | $ | 4.1 | $ | 0.1 | $ | 37.7 |
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts for income tax purposes. Deferred income tax assets and liabilities at December 31 are summarized as follows (dollars in millions):
| December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | |||||||
| Deferred tax assets: | ||||||||
| Accrued liabilities | $ | 17.1 | $ | 13.7 | ||||
| Employee benefits and compensation | 37.7 | 21.1 | ||||||
| Inventories | 12.6 | 15.4 | ||||||
| Net operating loss carryforwards | 34.4 | 38.1 | ||||||
| Restricted stock and performance units | 10.2 | 9.0 | ||||||
| Pension and postretirement benefits | 87.4 | 90.6 | ||||||
| Derivatives | 4.7 | 6.1 | ||||||
| Capital loss and general business credit carryforwards | 3.3 | 3.2 | ||||||
| Gross deferred tax assets | 207.4 | 197.2 | ||||||
| Valuation allowance (c) | (3.1 | ) | (3.1 | ) | ||||
| Net deferred tax assets | $ | 204.3 | $ | 194.1 | ||||
| Deferred tax liabilities: | ||||||||
| Property, plant and equipment | $ | (422.3 | ) | $ | (368.6 | ) | ||
| Goodwill and intangible assets | (67.2 | ) | (65.0 | ) | ||||
| Total deferred tax liabilities | $ | (489.5 | ) | $ | (433.6 | ) | ||
| Net deferred tax liabilities (d) | $ | (285.2 | ) | $ | (239.5 | ) |
| (c) | Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion of the deferred tax assets will not be realized. Both the 2018 and 2017 valuation allowance relates to capital losses. We do not expect to generate capital gains before the capital losses expire. If or when recognized, the tax benefits relating to the reversal of any or all of the valuation allowance would be recognized as a benefit to income tax expense. |
|---|
| (d) | As of December 31, 2018, we did not recognize U.S. deferred income taxes on our cumulative total of undistributed foreign earnings for our foreign subsidiaries. We indefinitely reinvest our earnings in operations outside the United States. It is not practicable to determine the amount of unrecognized deferred tax liability on these undistributed earnings because the actual tax liability, if any, is dependent on circumstances existing when the repatriation occurs. |
|---|
Cash payments for federal, state, and foreign income taxes were $140.8 million, $298.7 million, and $222.1 million for the years ended December 31, 2018, 2017, and 2016, respectively.
The following table summarizes the changes related to PCA’s gross unrecognized tax benefits excluding interest and penalties (dollars in millions):
| 2018 | 2017 | 2016 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance as of January 1 | $ | (4.8 | ) | $ | (5.2 | ) | $ | (5.8 | ) | |||
| Increases related to prior years’ tax positions | (0.1 | ) | — | — | ||||||||
| Increases related to current year tax positions | (0.3 | ) | (0.4 | ) | (0.5 | ) | ||||||
| Decreases related to prior years' tax positions | — | — | 0.1 | |||||||||
| Settlements with taxing authorities | — | — | 0.3 | |||||||||
| Expiration of the statute of limitations | 0.6 | 0.8 | 0.7 | |||||||||
| Balance at December 31 | $ | (4.6 | ) | $ | (4.8 | ) | $ | (5.2 | ) |
At December 31, 2018, PCA had recorded a $4.6 million gross reserve for unrecognized tax benefits, excluding interest and penalties. Of the total, $4.0 million (net of the federal benefit for state taxes) would impact the effective tax rate if recognized.
PCA recognizes interest accrued related to unrecognized tax benefits and penalties as income tax expense. For both years ended December 31, 2018 and 2017, we had $1.1 million of interest and penalties recorded for unrecognized tax benefits. During the next 12 months, it is possible that PCA's unrecognized tax benefits related to state apportionment issues could decrease by approximately $3.1 million due to settlements with state taxing authorities.
PCA is subject to taxation in the United States, various state and local, and foreign jurisdictions. A federal examination of the 2013 tax year was concluded in November 2016. The tax years 2015 - 2018 remain open to federal examination. The tax years 2014 - 2018 remain open to state examinations. Some foreign tax jurisdictions are open to examination for the 2009 tax year forward. Through the Boise acquisition, PCA recorded net operating losses and credit carryforwards from 2008 through 2011 and 2013 that are subject to examinations and adjustments for at least three years following the year in which utilized.
| 8. | Goodwill and Intangible Assets |
|---|
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 December 31, 2018 and 2017, we had $862.1 million and $828.0 million, respectively, of goodwill recorded in our Packaging segment and $55.2 million for both years in our Paper segment on our Consolidated Balance Sheets.
Changes in the carrying amount of our goodwill were as follows (dollars in millions):
| Total | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Packaging | Paper | Goodwill | ||||||||||
| Balance at January 1, 2017 | $ | 682.7 | $ | 55.2 | $ | 737.9 | ||||||
| Acquisitions (a)(b) | 145.3 | — | 145.3 | |||||||||
| Balance at December 31, 2017 | $ | 828.0 | $ | 55.2 | $ | 883.2 | ||||||
| Acquisitions (c)(d) | 34.1 | — | 34.1 | |||||||||
| Balance at December 31, 2018 | $ | 862.1 | $ | 55.2 | $ | 917.3 |
| (a) | In connection with the October 2017 acquisition of Sacramento Container, the Company recorded $151.1 million of goodwill in the Packaging segment. |
|---|
| (b) | During 2017, the Company recorded opening balance sheet adjustments related to the TimBar and Columbus Container acquisitions resulting in a decrease to goodwill of $5.8 million. |
|---|
| (c) | During 2018, the Company recorded a $5.5 million adjustment to increase the goodwill balance for the Company’s October 2017 acquisition of Sacramento Container. |
|---|
| (d) | In connection with the October 2018 acquisition of Englander, the Company recorded $28.6 million of goodwill in the Packaging segment. |
|---|
See Note 4, Acquisitions, for more information.
Intangible Assets
Intangible assets are comprised of customer relationships and trademarks and trade names.
The weighted average useful life, gross carrying amount, and accumulated amortization of our intangible assets were as follows (dollars in millions):
| As of December 31, 2018 | As of December 31, 2017 | |||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Weighted Average Remaining Useful Life (in Years) | Gross Carrying Amount | Accumulated Amortization | Weighted Average Remaining Useful Life (in Years) | Gross Carrying Amount | Accumulated Amortization | |||||||||||||||||
| Customer relationships (e) | 10.9 | $ | 504.6 | $ | 144.5 | 11.8 | $ | 497.8 | $ | 109.8 | ||||||||||||
| Trademarks and trade names (e) | 10.1 | 34.8 | 18.3 | 9.8 | 32.9 | 13.2 | ||||||||||||||||
| Other (e) | 3.0 | 4.4 | 2.7 | 3.6 | 4.3 | 2.0 | ||||||||||||||||
| Total intangible assets (excluding goodwill) | 10.8 | $ | 543.7 | $ | 165.5 | 11.7 | $ | 535.0 | $ | 125.0 |
| (e) | In connection with the October 2018 acquisition of Englander, the Company recorded intangible assets of $13.2 million for customer relationships, $0.8 million for trade names, and $0.1 million for other intangibles. In October 2017, the Company acquired Sacramento Container and recorded intangible assets of $61.9 million for customer relationships, $5.1 million for trade names, and $0.1 million for other intangibles. |
|---|
Amortization expense was $40.5 million, $35.7 million, and $26.6 million for the years ended December 31, 2018, 2017, and 2016, respectively. Estimated amortization expense of intangible assets over the next five years is expected to approximate $38.8 million (2019), $38.8 million (2020), $38.0 million (2021), $35.5 million (2022), and $34.5 million (2023).
Impairment Testing
We test goodwill for impairment annually in the fourth quarter or sooner if events or changes in circumstances indicate that the carrying value of the asset may exceed fair value. Additionally, when we experience changes to our business or operating environment, we evaluate the remaining useful lives and recoverability of our finite-lived purchased intangible assets to determine whether any adjustments to the useful lives or impairment are necessary. We completed our test in the fourth quarter and there was no indication of goodwill or intangible asset impairment.
| 9. | Accrued Liabilities |
|---|
The components of accrued liabilities were as follows (dollars in millions):
| December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | |||||||
| Compensation and benefits | $ | 136.7 | $ | 127.5 | ||||
| Medical insurance and workers’ compensation | 27.5 | 23.9 | ||||||
| Customer volume discounts and rebates | 25.2 | 23.4 | ||||||
| Franchise, property, sales and use taxes | 13.4 | 16.0 | ||||||
| Environmental liabilities and asset retirement obligations | 5.0 | 4.0 | ||||||
| Severance, retention, and relocation | 2.2 | 3.1 | ||||||
| Other | 12.4 | 5.3 | ||||||
| Total | $ | 222.4 | $ | 203.2 |
| 10. | Debt |
|---|
At December 31, 2018 and 2017, our long-term debt and interest rates on that debt were as follows (dollars in millions):
| December 31, 2018 | December 31, 2017 | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Amount | Interest Rate | Amount | Interest rate | |||||||||||||
| Revolving Credit Facility, due August 2021 | $ | — | — | % | $ | — | — | % | ||||||||
| 6.50% Senior Notes due March 2018 | — | — | % | 150.0 | 6.50 | % | ||||||||||
| 2.45% Senior Notes, net of discount of $0.4 million and $0.5 million as of December 31, 2018 and 2017, respectively, due December 2020 | 499.6 | 2.45 | % | 499.5 | 2.45 | % | ||||||||||
| 3.90% Senior Notes, net of discounts of $0.1 million and $0.2 million as of December 31, 2018 and 2017, respectively, due June 2022 | 399.9 | 3.90 | % | 399.8 | 3.90 | % | ||||||||||
| 4.50% Senior Notes, net of discount of $1.0 million a $1.2 million as of December 31, 2018 and 2017, respectively, due November 2023 | 699.0 | 4.50 | % | 698.8 | 4.50 | % | ||||||||||
| 3.65% Senior Notes, net of discount of $0.7 million and $0.8 million as of December 31, 2018 and 2017, respectively, due September 2024 | 399.3 | 3.65 | % | 399.2 | 3.65 | % | ||||||||||
| 3.40% Senior Notes, net of discount of $1.5 million and $1.6 million as of December 31, 2018 and 2017, respectively, due December 2027 | 498.5 | 3.40 | % | 498.4 | 3.40 | % | ||||||||||
| Total | 2,496.3 | 3.64 | % | 2,645.7 | 3.80 | % | ||||||||||
| Less current portion | — | — | % | 150.0 | 6.50 | % | ||||||||||
| Less unamortized debt issuance costs | 12.6 | 15.3 | ||||||||||||||
| Total long-term debt | $ | 2,483.7 | 3.64 | % | $ | 2,480.4 | 3.64 | % |
On December 13, 2017, the Company issued $500.0 million of 2.45% senior notes due 2020 and $500.0 million of 3.40% senior notes due 2027, through a registered public offering. The net proceeds of $997.8 million were used to repay in full all amounts outstanding under our Seven-Year term loan due October 2020 of $625.6 million and our Five-Year term loan due August 2021 of $350.4 million. Any remaining net proceeds were used to pay $6.8 million of debt issuance costs and for general corporate purposes. The debt issuance costs will be amortized to interest expense using the effective interest method over the terms of the notes.
As of December 31, 2018, the details of our borrowings were as follows:
| • | Senior Unsecured Credit Agreement. On October 18, 2013, we entered into a $1.65 billion senior unsecured credit facility. Loans bear interest at LIBOR plus a margin that is determined based upon our credit ratings. On August 29, 2016, we amended and restated our five-year credit agreement dated October 18, 2013 to include a new term loan facility (that was subsequently repaid in full in 2017) to finance an acquisition and to extend the maturity of the revolving credit facility to 2021. We have repaid all amounts borrowed, and the current facility now only includes a $350.0 million unsecured revolving credit facility with variable interest (LIBOR plus a margin) due August 2021. During 2018, we did not borrow under the Revolving Credit Facility. At December 31, 2018, we had $23.1 million of outstanding letters of credit that were considered outstanding on the revolving credit facility, resulting in $326.9 million of unused borrowing capacity. The outstanding letters of credit were primarily for workers compensation. We are required to pay commitment fees on the unused portions of the credit facility. |
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| • | 3.90% Senior Notes. On June 26, 2012, we issued $400.0 million of 3.90% senior notes due June 15, 2022, through a registered public offering. |
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| • | 4.50% Senior Notes. On October 22, 2013, we issued $700.0 million of 4.50% senior notes due November 1, 2023, through a registered public offering. |
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| • | 3.65% Senior Notes. On September 5, 2014, we issued $400.0 million of 3.65% senior notes due September 15, 2024, through a registered public offering. |
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| • | 2.45% Senior Notes. On December 13, 2017, we issued $500.0 million of 2.45% senior notes due December 15, 2020, through a registered public offering. |
|---|
| • | 3.40% Senior Notes. On December 13, 2017, we issued $500.0 million of 3.40% senior notes due December 15, 2027, through a registered public offering. |
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The instruments governing our indebtedness contain financial and other covenants that limit the ability of PCA and its subsidiaries to enter into sale and leaseback transactions, incur liens, incur indebtedness at the subsidiary level, enter into certain transactions with affiliates, merge or consolidate with any other person or sell or otherwise dispose of all or substantially all of our assets. Our credit facility also requires us to comply with certain financial covenants, including maintaining a minimum interest coverage ratio and a maximum leverage ratio. A failure to comply with these restrictions could lead to an event of default, which could result in an acceleration of any outstanding indebtedness and/or prohibit us from drawing on the revolving credit facility. Such an acceleration may also constitute an event of default under the senior notes indenture. At December 31, 2018, we were in compliance with these covenants.
At December 31, 2018, we have $2,496.3 million of fixed-rate senior notes outstanding. At December 31, 2018, the fair value of our fixed-rate debt was estimated to be $2,468.8 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), discussed further in Note 2, Summary of Significant Accounting Policies.
Repayments, Interest, and Other
In 2018, we used cash on hand to repay debt outstanding of $150.0 million under the 6.50% Senior Notes due March 15, 2018 at maturity.
In 2017, we used the net proceeds from our 2.45% and 3.40% senior note offerings and other cash on hand to repay approximately $1.0 billion of borrowings outstanding under our term loans.
In 2016, we used cash on hand to make principal payments of $36.3 million under our term loans.
As of December 31, 2018, annual principal maturities for debt, excluding unamortized debt discount, are: none for 2019; $500.0 million for 2020; none for 2021; $400.0 million for 2022; and $1.6 billion for 2023 and thereafter.
Interest payments paid in connection with the Company’s debt obligations for the years ended December 31, 2018, 2017, and 2016, were $97.0 million, $96.3 million, and $88.3 million, respectively.
Included in interest expense, net, are amortization of financing costs and amortization of treasury lock settlements. Amortization of treasury lock settlements was a $5.3 million net loss in 2018 and a $5.7 million net loss in both 2017 and 2016. Amortization of financing costs in 2018, 2017, and 2016 was $2.7 million, $4.0 million (including a $1.8 million write-off of deferred debt issuance costs related to the December 2017 debt refinancing), and $1.8 million, respectively.
| 11. | Employee Benefit Plans and Other Postretirement Benefits |
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PCA has defined pension benefit plans for both salaried and hourly employees. The plans covering salaried employees are closed to new entrants with only certain current active participants still accruing benefits. The plans covering certain hourly employees are closed to new participants. We also have a Supplemental Executive Retirement Plan (SERP) and other nonqualified defined benefit pension plans that provide unfunded supplemental retirement benefits to certain of our executives and former executives. The SERP provides for incremental pension benefits in excess of those offered in our principal pension plans.
Other Postretirement Benefits
PCA provides postretirement medical benefits for certain retired salaried employees and postretirement medical and life insurance benefits for certain hourly employees. The plan covering salaried employees is closed to new participants.
Obligations and Funded Status of Defined Benefit Pension and Other Postretirement Benefits Plans
The funded status of PCA's plans change from year to year based on the plan asset investment return, contributions, benefit payments, the discount rate used to measure the liability, and expected participant longevity. The following table, which includes only company-sponsored defined benefit and other postretirement benefit plans, reconciles the beginning and ending
balances of the projected benefit obligation and the fair value of plan assets. We recognize the unfunded status of these plans on the Consolidated Balance Sheets, and we recognize changes in funded status in the year changes occur through the Consolidated Statements of Comprehensive Income (dollars in millions):
| Pension Plans | Postretirement Plans | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Year Ended December 31 | Year Ended December 31 | |||||||||||||||
| 2018 | 2017 | 2018 | 2017 | |||||||||||||
| Change in Benefit Obligation | ||||||||||||||||
| Benefit obligation at beginning of period | $ | 1,300.2 | $ | 1,158.4 | $ | 16.5 | $ | 19.5 | ||||||||
| Service cost | 25.0 | 23.7 | 0.3 | 0.3 | ||||||||||||
| Interest cost | 42.4 | 41.6 | 0.5 | 0.6 | ||||||||||||
| Plan amendments | 3.0 | 17.3 | (0.4 | ) | (0.5 | ) | ||||||||||
| Actuarial (gain) loss (a) | (121.1 | ) | 99.3 | (1.2 | ) | (2.2 | ) | |||||||||
| Participant contributions | — | — | 1.1 | 1.3 | ||||||||||||
| Benefits paid | (44.6 | ) | (40.1 | ) | (2.2 | ) | (2.5 | ) | ||||||||
| Benefit obligation at plan year end | $ | 1,204.9 | $ | 1,300.2 | $ | 14.6 | $ | 16.5 | ||||||||
| Accumulated benefit obligation portion of above | $ | 1,163.3 | $ | 1,237.7 | ||||||||||||
| Change in Fair Value of Plan Assets | ||||||||||||||||
| Plan assets at fair value at beginning of period | $ | 954.8 | $ | 830.4 | $ | — | $ | — | ||||||||
| Actual return on plan assets | (59.9 | ) | 121.0 | — | — | |||||||||||
| Company contributions | 22.9 | 43.5 | 1.1 | 1.2 | ||||||||||||
| Participant contributions | — | — | 1.1 | 1.3 | ||||||||||||
| Benefits paid | (44.6 | ) | (40.1 | ) | (2.2 | ) | (2.5 | ) | ||||||||
| Fair value of plan assets at plan year end | $ | 873.2 | $ | 954.8 | $ | — | $ | — | ||||||||
| Underfunded status | $ | (331.7 | ) | $ | (345.4 | ) | $ | (14.6 | ) | $ | (16.5 | ) | ||||
| Amounts Recognized on Consolidated Balance Sheets | ||||||||||||||||
| Current liabilities | (1.4 | ) | (1.4 | ) | (0.8 | ) | (1.0 | ) | ||||||||
| Noncurrent liabilities | (330.3 | ) | (344.0 | ) | (13.8 | ) | (15.5 | ) | ||||||||
| Accrued obligation recognized at December 31 | $ | (331.7 | ) | $ | (345.4 | ) | $ | (14.6 | ) | $ | (16.5 | ) | ||||
| Amounts Recognized in Accumulated Other Comprehensive Loss (Income) (Pre-Tax) | ||||||||||||||||
| Prior service cost (credit) | $ | 28.7 | $ | 32.7 | $ | (5.4 | ) | $ | (5.3 | ) | ||||||
| Actuarial loss (gain) | 194.6 | 208.5 | (5.0 | ) | (4.0 | ) | ||||||||||
| Total | $ | 223.3 | $ | 241.2 | $ | (10.4 | ) | $ | (9.3 | ) |
| (a) | The actuarial gain in 2018 was due primarily to an increase in the weighted average discount rate used to estimate pension benefit obligations. The actuarial loss in 2017 was due primarily to a decrease in the weighted average discount rate used to estimate our pension benefit obligations. |
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Components of Net Periodic Benefit Cost and Other Comprehensive (Income) Loss
The components of net periodic benefit cost and other comprehensive (income) loss (pretax) were as follows (dollars in millions):
| Pension Plans | Postretirement Plans | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | |||||||||||||||||||
| Service cost | $ | 25.0 | $ | 23.7 | $ | 24.5 | $ | 0.3 | $ | 0.3 | $ | 0.5 | ||||||||||||
| Interest cost | 42.4 | 41.6 | 40.9 | 0.5 | 0.6 | 0.6 | ||||||||||||||||||
| Expected return on plan assets | (56.7 | ) | (53.9 | ) | (49.5 | ) | — | — | — | |||||||||||||||
| Net amortization of unrecognized amounts | ||||||||||||||||||||||||
| Prior service cost (credit) | 6.9 | 5.8 | 5.7 | (0.3 | ) | (0.2 | ) | (0.1 | ) | |||||||||||||||
| Actuarial loss (gain) | 9.4 | 7.6 | 5.8 | (0.2 | ) | (0.1 | ) | (0.4 | ) | |||||||||||||||
| Net periodic benefit cost | $ | 27.0 | $ | 24.8 | $ | 27.4 | $ | 0.3 | $ | 0.6 | $ | 0.6 | ||||||||||||
| Changes in plan assets and benefit obligations recognized in other comprehensive (income) loss | ||||||||||||||||||||||||
| Actuarial net loss (gain) | $ | (4.6 | ) | $ | 32.2 | $ | 40.4 | $ | (1.2 | ) | $ | (2.2 | ) | $ | 3.6 | |||||||||
| Prior service cost (credit) | 3.0 | 17.4 | 1.8 | (0.3 | ) | (0.6 | ) | (5.3 | ) | |||||||||||||||
| Amortization of prior service cost (credit) | (6.9 | ) | (5.8 | ) | (5.7 | ) | 0.3 | 0.2 | 0.1 | |||||||||||||||
| Amortization of actuarial loss (gain) | (9.4 | ) | (7.6 | ) | (5.8 | ) | 0.2 | 0.1 | 0.4 | |||||||||||||||
| Total recognized in other comprehensive loss (income) (b) | $ | (17.9 | ) | $ | 36.2 | $ | 30.7 | $ | (1.0 | ) | $ | (2.5 | ) | $ | (1.2 | ) | ||||||||
| Total recognized in net periodic benefit cost and other comprehensive loss (income) (pre-tax) | $ | 9.2 | $ | 61.0 | $ | 58.1 | $ | (0.7 | ) | $ | (1.9 | ) | $ | (0.6 | ) |
| (b) | Accumulated losses in excess of 10% of the greater of the projected benefit obligation or the market-related value of assets will be recognized on a straight-line basis over the average remaining service period of active employees in PCA plans (which is between seven and ten years) and over the average remaining lifetime of inactive participants of Boise plans (which is between 24 and 27 years), to the extent that losses are not offset by gains in subsequent years. The estimated net loss and prior service cost that will be amortized from “Accumulated other comprehensive loss” into net periodic benefit in 2019 is $12.7 million. |
|---|
The accumulated benefit obligations for the plans with obligations in excess of plan assets is $1.1 billion.
Assumptions
The following table presents the assumptions used in the measurement of our benefits obligations:
| Pension Plans | Postretirement Plans | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | December 31, | |||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | |||||||||||||||||||
| Weighted-Average Assumptions Used to Determine Benefit Obligations at December 31 | ||||||||||||||||||||||||
| Discount rate | 4.31% | 3.66% | 4.24% | 4.21% | 3.55% | 3.91% | ||||||||||||||||||
| Rate of compensation increase | 4.00% | 4.00% | 4.00% | N/A | N/A | N/A | ||||||||||||||||||
| Weighted-Average Assumptions Used to Determine Net Periodic Benefit Cost for the Years Ended December 31 | ||||||||||||||||||||||||
| Discount rate | 3.66% | 4.24% | 4.49% | 3.57% | 3.92% | 4.17% | ||||||||||||||||||
| Expected return on plan assets | 6.06% | 6.55% | 6.57% | N/A | N/A | N/A | ||||||||||||||||||
| Rate of compensation increase | 4.00% | 4.00% | 4.00% | N/A | N/A | N/A |
Discount Rate Assumption. The discount rate reflects the current rate at which the pension obligations could be settled on the measurement date: December 31. The discount rate assumption used to calculate the present value of pension and
postretirement benefit obligations reflects the rates available on high-quality, fixed-income debt instruments at December 31. In all periods, the bonds included in the models reflect anticipated investments that would be made to match the expected monthly benefit payments over time. The plans' projected cash flows were duration-matched to these models to develop an appropriate discount rate.
Beginning in 2016, we refined the method used to determine the service and interest cost components of our net periodic benefit cost. Previously, the cost was determined using a single weighted-average discount rate derived from the yield curve. Under the refined method, known as the spot rate approach, we use individual spot rates along the yield curve that correspond with the timing of each benefit payment. We believe this change provides a more precise measurement of service and interest costs by improving the correlation between projected cash outflows and corresponding spot rates on the yield curve.
Asset Return Assumption. The expected return on plan assets reflects the expected long-term rates of return for the categories of investments currently held in the plans as well as anticipated returns for additional contributions made in the future. The expected long-term rate of return is adjusted when there are fundamental changes in expected returns on the plan investments. The weighted-average expected return on plan assets we will use in our calculation of 2019 net periodic pension benefit cost is 6.06%.
Rate of Compensation Increase. The rate of compensation increase is determined by PCA based upon annual reviews. The compensation increase assumption is not applicable for all plans as many of our pension plans are frozen and not accruing benefits.
Health Care Cost Trend Rate Assumptions. PCA assumed health care cost trend rates for its postretirement benefits plans were as follows:
| 2018 | 2017 | 2016 | |||||||
|---|---|---|---|---|---|---|---|---|---|
| Health care cost trend rate assumed for next year | 7.24% | 7.57% | 7.35% | ||||||
| Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) | 4.44% | 4.44% | 4.50% | ||||||
| Year that the rate reaches the ultimate trend rate | 2028 | 2027 | 2025 |
Postretirement Health Care Plan Assumptions. For postretirement health care plan accounting, PCA reviews external data and its own historical trends for health care costs to determine the health care cost trend rate assumption.
A one-percentage point change in assumed health care cost trend rates would have the following effects on the 2018 postretirement benefit obligation and the 2017 net postretirement benefit cost (dollars in millions):
| 1-Percentage Point Increase | 1-Percentage Point Decrease | |||||||
| Effect on postretirement benefit obligation | $ | 0.7 | $ | (0.6 | ) | |||
| Effect on net postretirement benefit cost | 0.1 | (0.1 | ) |
Investment Policies and Strategies
PCA has retained the services of professional advisors to oversee pension investments and provide recommendations regarding investment strategy. PCA’s overall strategy and related apportionments between equity and debt securities may change from time to time based on market conditions, external economic factors, and the funded status of the plans. The general investment objective for all of our plan assets is to optimize growth of the pension plan trust assets, while minimizing the risk of significant losses to enable the plans to satisfy their benefit payment obligations over time. The objectives take into account the long-term nature of the benefit obligations, the liquidity needs of the plans, and the expected risk/return trade-offs of the asset classes in which the plans may choose to invest. Assets of our pension plans were invested in the following classes of securities at December 31, 2018 and 2017:
| Percentage of Fair Value at December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | |||||||
| Fixed income securities | 53 | % | 21 | % | ||||
| International equity securities | 27 | % | 6 | % | ||||
| Domestic equity securities | 18 | % | 9 | % | ||||
| Other | 2 | % | 64 | % |
At December 31, 2017, the Company was in the process of consolidating the Boise pension plan assets with the PCA pension plans under one trustee. Due to this timing, 100% of the Boise pension plan assets were classified as Other (Cash) on December 31, 2017. Upon completion of the transfer on January 5, 2018, the pension plan assets were invested in the following classes of securities:
| Percentage of Fair Value at January 5, 2018 | ||||
|---|---|---|---|---|
| Fixed income securities | 52 | % | ||
| International equity securities | 28 | % | ||
| Domestic equity securities | 20 | % |
At December 31, 2018, the targeted investment allocations differed between the acquired Boise plans and PCA’s historical plans based on funded status. At December 31, 2018, PCA’s historical plans, which comprised $384.3 million of the total fair value of plan assets, targeted 50% invested in equities, 49% invested in fixed income securities, and 1% in other, whereas the Boise plans, which comprised $488.9 million of the total fair value of plan assets, targeted 54% invested in fixed income securities, 44% invested in equities, and 2% in other. Our retirement committee reviews the investment allocations for reasonableness at a minimum, semi-annually.
Investment securities, in general, are exposed to various risks, such as interest rate, credit, and overall market volatility risk, all of which are subject to change. Due to the level of risk associated with some investment securities, it is reasonably possible that changes in the values of investment securities will occur in the near term, and such changes could materially affect the reported amounts.
Fair Value Measurements of Plan Assets
The following tables set forth, by level within the fair value hierarchy, discussed in Note 2, Summary of Significant Accounting Policies, the pension plan assets, by major asset category, at fair value at December 31, 2018 and 2017 (dollars in millions):
| Fair Value Measurements at December 31, 2018 | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Asset Category | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Net Asset Value (NAV) (a) | Total | |||||||||||||||
| Cash and short-term investments | $ | 0.4 | $ | 11.6 | $ | — | $ | — | $ | 12.0 | ||||||||||
| Common/collective trust funds: | ||||||||||||||||||||
| Domestic equities | — | 154.5 | — | — | 154.5 | |||||||||||||||
| International equities | 136.9 | 17.8 | — | 84.1 | 238.8 | |||||||||||||||
| Corporate and government bonds: | ||||||||||||||||||||
| Government bonds | 155.0 | 9.4 | — | — | 164.4 | |||||||||||||||
| Corporate bonds | — | 64.4 | — | — | 64.4 | |||||||||||||||
| Fixed income | 95.7 | 138.8 | — | — | 234.5 | |||||||||||||||
| Private equity securities (c) | — | — | 3.3 | — | 3.3 | |||||||||||||||
| Total securities at fair value | $ | 388.0 | $ | 396.5 | $ | 3.3 | $ | 84.1 | $ | 871.9 | ||||||||||
| Receivables and accrued expenses | 1.3 | |||||||||||||||||||
| Total fair value of plan assets | $ | 873.2 |
| Fair Value Measurements at December 31, 2017 | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Asset Category | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Net Asset Value (NAV) (a) | Total | |||||||||||||||
| Cash and short-term investments (b) | $ | 602.4 | $ | 5.7 | $ | — | $ | — | $ | 608.1 | ||||||||||
| Mutual funds: | ||||||||||||||||||||
| International equities | 56.1 | — | — | — | 56.1 | |||||||||||||||
| Fixed income | 95.4 | — | — | — | 95.4 | |||||||||||||||
| Common/collective trust funds: | ||||||||||||||||||||
| Domestic equities | — | 84.1 | — | — | 84.1 | |||||||||||||||
| International equities | — | 5.6 | — | — | 5.6 | |||||||||||||||
| Fixed income | — | 59.8 | — | — | 59.8 | |||||||||||||||
| Corporate and government bonds: | ||||||||||||||||||||
| Fixed income | 41.3 | — | — | — | 41.3 | |||||||||||||||
| Private equity securities (c) | — | — | 4.2 | — | 4.2 | |||||||||||||||
| Total securities at fair value | $ | 795.2 | $ | 155.2 | $ | 4.2 | $ | — | $ | 954.6 | ||||||||||
| Receivables and accrued expenses | 0.2 | |||||||||||||||||||
| Total fair value of plan assets | $ | 954.8 |
| (a) | In accordance with ASC 820, Fair Value Measurement, certain investments that do not have readily-determinable fair values are measured at fair value using the net asset value (NAV) per share practical expedient and are not classified within the fair value hierarchy. |
|---|
| (b) | As of December 31, 2017, the cash and short-term investments asset category contained both short-term investments and the Boise pension plan assets classified as cash. Of the $551.3 million of Boise pension plan assets classified as Level 1 at December 31, 2017, $449.8 million of the pension plan assets were reclassified to Level 2 equities and fixed income securities on or about January 5, 2018 after consolidating with the PCA pension plan assets under one trustee. |
|---|
| (c) | Investments in this category are invested in the Pantheon Global Secondary Fund IV, LP. The fund specializes in investments in the private equity secondary market and occasionally directly in private companies to maximize capital growth. Fund investments are carried at fair value as determined quarterly using the market approach to estimate the fair value of private investments. The market approach utilizes prices and other relevant information generated by market transactions, type of security, size of the position, degree of liquidity, restrictions on the disposition, latest round of financing data, current financial position, and operating results, among other factors. In circumstances where fair values are not provided with respect to any of the company's fund investments, the investment advisor will seek to determine the fair value of such investments based on information provided by the general partners or managers of such funds or from other sources. Audited financial statements are provided by fund management annually. Notwithstanding the above, the variety of valuation bases adopted and quality of management data of the ultimate underlying investee companies means that there are inherent difficulties in determining the value of the investments. Amounts realized on the sale of these investments may differ from the calculated values. Boise had originally committed to a $15.0 million investment, with $5.0 million of the commitment unfunded at December 31, 2018. |
|---|
The following table sets forth a summary of changes in the fair value of the pension plans' Level 3 assets for the year ended December 31, 2018 (dollars in millions):
| 2018 | ||||
|---|---|---|---|---|
| Balance, beginning of year | $ | 4.2 | ||
| Acquisitions | — | |||
| Purchases | — | |||
| Sales | (0.9 | ) | ||
| Unrealized gain | — | |||
| Balance, end of year | $ | 3.3 |
Funding and Cash Flows
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 discretionary contributions based on the funded status of the plans, tax deductibility, income from operations, and other factors. In 2018, 2017, and 2016, we made contributions of $21.8 million, $42.1 million, and $57.1 million, respectively, to our qualified pension plans. We expect to contribute at least the estimated required minimum contributions to our qualified pension plans of approximately $15.8 million in 2019.
The following are estimated benefit payments to be paid to current plan participants by year (dollars in millions). Qualified pension benefit payments are paid from plan assets, while nonqualified pension benefit payments are paid by the Company.
| Pension Plans | Postretirement Plans | |||||||
|---|---|---|---|---|---|---|---|---|
| 2019 | $ | 48.5 | $ | 0.8 | ||||
| 2020 | 52.3 | 0.8 | ||||||
| 2021 | 56.2 | 0.8 | ||||||
| 2022 | 59.8 | 0.9 | ||||||
| 2023 - 2028 | 421.4 | 5.5 |
Defined Contribution Plans
Some of our employees participate in contributory defined contribution savings plans, available to most of our salaried and hourly employees. The defined contribution plans permit participants to make contributions by salary reduction pursuant to Section 401(k) of the Code. PCA made employer-matching contributions of $45.6 million, $42.8 million, and $40.4 million in 2018, 2017, and 2016, respectively. All company-matching contributions to all employees were made in cash. We expense employer matching contributions and charge dividends on shares held by the ESOP to retained earnings. Shares of company stock held by the ESOP are included in basic shares for earnings-per-share computations. At December 31, 2018 and 2017, the ESOP held 1.9 million and 1.8 million shares of Company stock, respectively.
Certain salaried and hourly employees that are not participating in a PCA sponsored defined benefit pension plan receive a service-related company retirement contribution to their defined contribution plan account in addition to any employer
matching contribution. This contribution increases with years of service and ranges from 3% to 5% of base pay. We contributed $24.5 million, $22.4 million, and $14.9 million for this retirement contribution during the years ended December 31, 2018, 2017, and 2016, respectively.
Deferred Compensation Plans
Key managers can elect to participate in a deferred compensation plan. The deferred compensation plan is unfunded; therefore, benefits are paid from our general assets. At December 31, 2018 and 2017, we had $14.2 million and $13.6 million, respectively, of liabilities attributable to participation in our deferred compensation plan on our Consolidated Balance Sheets.
| 12. | Asset Retirement Obligations |
|---|
Our asset retirement obligations relate predominantly to landfill closure, wastewater treatment pond dredging, closed-site monitoring costs, and certain leasehold improvements. In accordance with ASC 410, Asset Retirement and Environmental Obligations, we recognize the fair value of these liabilities as an asset retirement obligation and capitalize that cost as part of the cost basis of the related asset in the period in which the costs are incurred if sufficient information is available to reasonably estimate the fair value of the obligation. Fair value estimates are determined using Level 3 inputs in the fair value hierarchy. The fair value of our asset retirement obligations is measured using expected future cash outflows discounted using the company's credit-adjusted risk-free interest rate. Over time, the liability is accreted to its settlement value, and the capitalized cost is depreciated over the useful life of the related asset. These liabilities are based on the best estimate of costs and are updated periodically to reflect current technology, laws and regulations, inflation, and other economic factors. Occasionally, we become aware of events or circumstances that require us to revise our future estimated cash flows. When revisions become necessary, we recalculate our obligation and adjust our asset and liability accounts utilizing appropriate discount rates. No assets are legally restricted for purposes of settling asset retirement obligations. Upon settlement of the liability, we will recognize a gain or loss for any difference between the settlement amount and the liability recorded.
The following table describes changes to the asset retirement obligation liability (dollars in millions):
| Year Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | |||||||
| Asset retirement obligation at beginning of period | $ | 35.1 | $ | 28.0 | ||||
| Accretion expense | 1.6 | 1.3 | ||||||
| Payments | (7.9 | ) | (2.3 | ) | ||||
| Revisions in estimated cash flows | 1.2 | 7.9 | ||||||
| Liabilities incurred | — | 0.2 | ||||||
| Asset retirement obligation at end of period | $ | 30.0 | $ | 35.1 |
We have additional asset retirement obligations with indeterminate settlement dates. The fair value of these asset retirement obligations cannot be estimated due to the lack of sufficient information to estimate the settlement dates of the obligations. These asset retirement obligations include, for example, (i) removal and disposal of potentially hazardous materials related to equipment and/or an operating facility if the equipment and/or facilities were to undergo major maintenance, renovation, or demolition and (ii) storage sites or owned facilities for which removal and/or disposal of chemicals and other related materials are required if the operating facility is closed. We will recognize a liability in the period in which sufficient information becomes available to reasonably estimate the fair value of these obligations.
| 13. | Share-Based Compensation |
|---|
The Company has a long-term equity incentive plan, which allows for grants of stock options, stock appreciation rights, restricted stock, and performance awards to directors, officers, and employees, as well as others who engage in services for PCA. The plan, as amended, terminates May 1, 2023, and authorizes 10.6 million shares of common stock for grant over the life of the plan. As of December 31, 2018, 0.7 million shares remained available for future issuance under the plan. Forfeitures are added back to the pool of shares of common stock available to be granted at a future date.
Restricted Stock
Restricted stock awards granted to officers and employees generally vest at the end of a four-year period, and restricted stock awards granted to directors vest immediately. The fair value of restricted stock is determined based on the closing price of the Company’s stock on the grant date. A summary of the Company’s restricted stock activity follows:
| 2018 | 2017 | 2016 | ||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Shares | Weighted Average Grant- Date Fair Value | Shares | Weighted Average Grant- Date Fair Value | Shares | Weighted Average Grant- Date Fair Value | |||||||||||||||||||
| Restricted stock at January 1 | 739,732 | $ | 77.23 | 786,079 | $ | 63.44 | 1,007,794 | $ | 49.47 | |||||||||||||||
| Granted | 173,144 | 114.63 | 173,199 | 107.57 | 242,835 | 67.48 | ||||||||||||||||||
| Vested (a) | (165,547 | ) | 72.84 | (213,992 | ) | 51.37 | (443,627 | ) | 34.11 | |||||||||||||||
| Forfeitures | (3,738 | ) | 78.66 | (5,554 | ) | 69.03 | (20,923 | ) | 59.63 | |||||||||||||||
| Restricted stock at December 31 | 743,591 | $ | 86.90 | 739,732 | $ | 77.23 | 786,079 | $ | 63.44 |
| (a) | The total fair value of awards upon vesting for the years ended December 31, 2018, 2017, and 2016 was $18.9 million, $23.3 million, and $28.8 million, respectively. |
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Performance Units
Performance unit awards granted to certain key employees 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. ROIC performance unit awards vest four years after the grant date, while TSR performance unit awards vest approximately three years after the grant date. Both ROIC and TSR performance units are paid out entirely in shares of the Company’s common stock. The ROIC performance unit awards are valued at the closing price of the Company’s stock on the grant date and expensed over the requisite service period based on the most probable number of awards expected to vest. The TSR performance unit awards are valued using a Monte Carlo simulation, as the TSR component contains a market condition. A summary of the Company’s performance unit activity follows:
| 2018 | 2017 | 2016 | ||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Units | Weighted Average Grant- Date Fair Value | Units | Weighted Average Grant- Date Fair Value | Units | Weighted Average Grant- Date Fair Value | |||||||||||||||||||
| Performance units at January 1 | 226,558 | $ | 77.07 | 232,088 | $ | 62.68 | 175,675 | $ | 59.94 | |||||||||||||||
| Granted | 83,515 | 115.35 | 53,070 | 108.19 | 77,017 | 67.57 | ||||||||||||||||||
| Vested (a) | (43,369 | ) | 71.19 | (58,600 | ) | 56.08 | (20,604 | ) | 57.58 | |||||||||||||||
| Performance units at December 31 | 266,704 | $ | 90.01 | 226,558 | $ | 77.07 | 232,088 | $ | 62.68 |
| (a) | The total fair value of awards upon vesting for the years ended December 31, 2018, 2017, and 2016 was $5.4 million, $7.5 million, and $1.1 million, respectively. Upon vesting of the awards in 2018, 2017, and 2016, PCA issued 46,876 shares, 67,391 shares, and 21,111 shares, respectively. For 2018, 2017, and 2016, these amounts included 3,507 shares, 8,791 shares, and 507 shares, respectively, for dividends accrued during the vesting period. |
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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):
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | 2016 | ||||||||||
| Restricted stock | $ | 18.6 | $ | 15.0 | $ | 15.8 | ||||||
| Performance units | 4.9 | 5.6 | 3.9 | |||||||||
| Impact on income before income taxes | 23.5 | 20.6 | 19.7 | |||||||||
| Income tax benefit | (5.9 | ) | (7.9 | ) | (7.7 | ) | ||||||
| Impact on net income | $ | 17.6 | $ | 12.7 | $ | 12.0 |
The fair value of restricted stock is determined based on the closing price of the Company’s common stock on the grant date. As PCA’s Board of Directors has the ability to accelerate vesting of share-based awards upon an employee’s retirement, the Company accelerates the recognition of compensation expense for certain employees approaching normal retirement age.
For performance unit awards made in 2018, 50% used TSR as the performance measure and 50% used ROIC as the performance measure. All units awarded before 2018 used ROIC as the performance measure. The ROIC component of performance unit awards are 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 was as follows (dollars in millions):
| December 31, 2018 | ||||||
|---|---|---|---|---|---|---|
| Unrecognized Compensation Expense | Remaining Weighted Average Recognition Period (in years) | |||||
| Restricted stock | $ | 31.7 | 2.4 | |||
| Performance units | 14.1 | 2.6 | ||||
| Total unrecognized share-based compensation expense | $ | 45.8 | 2.5 |
We evaluate share-based compensation expense on a quarterly basis based on our estimate of expected forfeitures, review of recent forfeiture activity, and expected future turnover. We recognize the effect of adjusting the forfeiture rate for all expense amortization in the period that we change the forfeiture estimate. The effect of forfeiture adjustments was insignificant in all periods presented.
| 14. | Derivative Instruments and Hedging Activities |
|---|
Hedging Strategy
When appropriate, we use derivatives as a risk management tool to mitigate the potential impact of certain market risks. The primary risks managed by using derivative financial instruments are interest rate risks. We do not enter into derivative financial instruments for trading or speculative purposes.
Interest Rate Risk
The Company has used treasury lock derivative instruments to manage interest costs and the risk associated with changing interest rates. In connection with contemplated issuances of ten-year debt securities, PCA entered into interest rate protection agreements with counterparties in 2008, 2010, and 2011 to protect against increases in the ten-year U.S. Treasury Note rate. These treasury rates served as references in determining the interest rates applicable to the debt securities the
Company issued in March 2008, February 2011, and June 2012. As a result of changes in the interest rates on those treasury securities between the time PCA entered into the derivative agreements and the time PCA priced and issued the debt securities, the Company: (1) made a payment of $4.4 million to the counterparty upon settlement of the 2008 interest rate protection agreement on March 25, 2008; (2) received a payment of $9.9 million from the counterparties upon settlement of the 2010 interest rate protection agreements on February 4, 2011; and (3) made a payment of $65.5 million to the counterparty upon settlement of the 2011 interest rate protection agreement on June 26, 2012. The Company recorded the effective portion of the settlements in accumulated OCI, and these amounts are being amortized over the terms of the respective notes.
Derivative Instruments
The impact of derivative instruments on the consolidated statements of income and accumulated OCI was as follows (dollars in millions):
| Net Loss Recognized in Accumulated OCI (Effective Portion) December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | |||||||
| Treasury locks, net of tax | $ | (10.2 | ) | $ | (14.2 | ) |
| Loss Reclassified from Accumulated OCI into Income (Effective Portion) Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | 2016 | ||||||||||
| Amortization of treasury locks (included in interest expense, net and other) | $ | (5.3 | ) | $ | (5.7 | ) | $ | (5.7 | ) |
The net amount of settlement gains or losses on derivative instruments included in accumulated OCI to be amortized over the next 12 months is a net loss of $5.2 million ($3.9 million after-tax).
| 15. | Stockholders' Equity |
|---|
Dividends
During the year ended December 31, 2018, we paid $268.1 million of dividends to shareholders. On December 4, 2018, PCA's Board of Directors approved a regular quarterly cash dividend of $0.79 per share of common stock, which was paid on January 15, 2019 to shareholders of record as of December 17, 2018. The dividend payment was $74.7 million.
On May 15, 2018, PCA announced an increase of its quarterly cash dividend on its common stock from an annual payout of $2.52 per share to an annual payout of $3.16 per share. The first quarterly dividend of $0.79 per share was paid on July 13, 2018 to shareholders of record as of June 15, 2018.
Share Repurchase Program
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 twelve months ended December 31, 2018 and 2017. Share repurchase activity in 2016 follows (in millions, except share and per share amounts).
| Shares | Weighted Average Price Per Share | Total | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2016 | 1,987,187 | $ | 50.49 | $ | 100.3 |
All shares repurchased have been retired. At December 31, 2018, $193.0 million of the authorized amount remained available for repurchase of the Company's common stock.
Accumulated Other Comprehensive Income (Loss)
Changes in AOCI, net of taxes, by component follows (dollars in millions). Amounts in parentheses indicate losses.
| Foreign Currency Translation Adjustments | Unrealized Loss On Treasury Locks, Net | Unrealized Loss on Foreign Exchange Contracts | Unfunded Employee Benefit Obligations | Total | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Balance at December 31, 2017 | $ | (0.3 | ) | $ | (14.2 | ) | $ | (0.3 | ) | $ | (142.1 | ) | $ | (156.9 | ) | |||||
| Other comprehensive income before reclassifications | — | — | — | 2.4 | 2.4 | |||||||||||||||
| Amounts reclassified from AOCI | (0.1 | ) | 4.0 | — | 11.8 | 15.7 | ||||||||||||||
| Net current-period other comprehensive income | (0.1 | ) | 4.0 | — | 14.2 | 18.1 | ||||||||||||||
| Balance at December 31, 2018 | $ | (0.4 | ) | $ | (10.2 | ) | $ | (0.3 | ) | $ | (127.9 | ) | $ | (138.8 | ) |
The following table presents information about reclassifications out of AOCI (dollars in millions). Amounts in parentheses indicate expenses in the Consolidated Statements of Income.
| Amounts Reclassified from AOCI Year Ended December 31, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Details about AOCI Components | 2018 | 2017 | ||||||||
| Unrealized loss on treasury locks, net (a) | $ | (5.3 | ) | $ | (5.7 | ) | ||||
| 1.3 | 2.2 | Tax benefit | ||||||||
| $ | (4.0 | ) | $ | (3.5 | ) | Net of tax | ||||
| Unfunded employee benefit obligations (b) | ||||||||||
| Amortization of prior service costs | $ | (6.6 | ) | $ | (5.6 | ) | ||||
| Amortization of actuarial gains / (losses) | (9.2 | ) | (7.5 | ) | ||||||
| (15.8 | ) | (13.1 | ) | Total before tax | ||||||
| 4.0 | 4.9 | Tax benefit | ||||||||
| $ | (11.8 | ) | $ | (8.2 | ) | Net of tax |
| (a) | This AOCI component is included in interest expense, net and other. Amount relates to the amortization of the effective portion of treasury lock derivative instruments recorded in AOCI. The net amount of settlement gains or losses on derivative instruments included in AOCI to be amortized over the next 12 months is a net loss of $5.2 million ($3.9 million after-tax). For a discussion of treasury lock derivative instrument activity, see Note 14, Derivative Instruments and Hedging Activities, for additional information. |
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| (b) | These AOCI components are included in the computation of net pension and postretirement benefit costs. See Note 11, Employee Benefit Plans and Other Postretirement Benefits, for additional information. |
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| 16. | Concentrations of Risk |
|---|
Our Paper segment has had 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 represented 7% of our total company sales for both 2018 and 2017 and about 47% and 43% of our Paper segment sales revenue for those periods, respectively. At December 31, 2018 and 2017, we had $66.7 million and $33.3 million of accounts receivable due from Office Depot, respectively, which represents 7% and 4% of our total Company receivables, respectively.
In 2018, sales to Office Depot represented 47% of our Paper segment sales. If these sales are reduced, we would need to find new customers. We may not be able to fully replace any lost sales, and any new sales may be at lower prices or higher costs. Any significant deterioration in the financial condition of Office Depot affecting its ability to pay or any other change that affects its willingness to purchase our products will harm our business and results of operations.
Labor
At December 31, 2018, we had approximately 15,000 employees and approximately 44% of these employees worked pursuant to collective bargaining agreements. Approximately 63% of our hourly employees are represented by unions. The majority of our unionized employees are represented by the United Steel Workers (USW), the International Brotherhood of Teamsters (IBT), the International Association of Machinists (IAM), and the Association of Western Pulp and Paper Workers
(AWPPW). Approximately 11% of our employees work pursuant to collective bargaining agreements that will expire within the next twelve months.
| 17. | Transactions With Related Parties |
|---|
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 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 both $2.7 million at December 31, 2018 and $3.0 million at December 31, 2017. For 2018, 2017, and 2016, we recorded $83.1 million, $86.4 million, and $86.9 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”.
For 2018, 2017, and 2016, fiber purchases from related parties were $16.8 million, $16.6 million, and $17.2 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.
| 18. | Segment Information |
|---|
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.
During the second quarter of 2018, the Company discontinued the production of uncoated free sheet and coated one-side grades at the Wallula, Washington mill and converted the No. 3 machine to a virgin kraft linerboard machine. Subsequent to the date of conversion in May 2018, operating results for the Wallula mill are primarily included in the Packaging segment.
Packaging. We manufacture and sell a wide variety of corrugated packaging products, including conventional shipping containers used to protect and transport manufactured goods, multi-color boxes and displays with strong visual appeal that help to merchandise the packaged product in retail locations. In addition, we are a large producer of packaging for meat, fresh fruit and vegetables, processed food, beverages, and other industrial and consumer products.
Paper. We manufacture and sell a range of white papers, including communication-based papers, and pressure sensitive papers. Our white papers can be manufactured as either commodity papers or specialty papers with specialized or custom features, such as colors, coatings, high brightness, or recycled content. Sales for market pulp decreased in 2016 as we ceased softwood market pulp operations at our Wallula, Washington mill with the permanent shutdown of the No.1 machine.
Corporate and Other. Our Corporate and Other segment includes corporate support staff services and related assets and liabilities, and foreign exchange gains and losses. This segment also includes transportation assets, such as rail cars and trucks, which we use to transport our products from some of our manufacturing sites and assets related to LTP. See Note 17, Transactions with Related Parties, for more information related to LTP. Sales in this segment relate primarily to LTP and our rail and truck business. We provide transportation services not only to our own facilities but also, on a limited basis, to third parties when geographic proximity and logistics are favorable. Rail cars and trucks are generally leased.
Each segments' profits and losses are measured on operating profits before interest expense, net and other and income taxes. For many of these allocated expenses, the related assets and liabilities remain in the Corporate and Other segment.
Segment sales to external customers by product line were as follows (dollars in millions):
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | 2016 | ||||||||||
| Packaging sales | ||||||||||||
| Packaging sales | $ | 5,938.5 | $ | 5,312.3 | $ | 4,584.8 | ||||||
| Paper | ||||||||||||
| White papers | 1,002.0 | 1,051.8 | 1,065.8 | |||||||||
| Market pulp | — | — | 28.1 | |||||||||
| 1,002.0 | 1,051.8 | 1,093.9 | ||||||||||
| Corporate and Other | 74.1 | 80.8 | 100.3 | |||||||||
| $ | 7,014.6 | $ | 6,444.9 | $ | 5,779.0 |
Sales to foreign unaffiliated customers during the years ended December 31, 2018, 2017, and 2016 were $487.8 million, $390.3 million, and $289.5 million, respectively. At December 31, 2018 and 2017, we did not have any significant long-lived assets held by foreign operations.
An analysis of operations by reportable segment is as follows (dollars in millions):
| Sales, net | Operating | Depreciation, | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Year Ended December 31, 2018 | Trade | Inter- segment | Total | Income (Loss) (a) | Amortization, and Depletion | Capital Expenditures (l) | Assets | |||||||||||||||||||||
| Packaging | $ | 5,912.3 | $ | 26.2 | $ | 5,938.5 | $ | 1,045.4 | (b) | $ | 342.0 | $ | 504.0 | $ | 5,347.0 | |||||||||||||
| Paper | 1,002.0 | — | 1,002.0 | 97.7 | (c) | 62.0 | 12.6 | 760.1 | ||||||||||||||||||||
| Corporate and Other | 100.3 | 129.4 | 229.7 | (75.4 | ) | (d) | 6.9 | 34.8 | 462.6 | |||||||||||||||||||
| Intersegment eliminations | — | (155.6 | ) | (155.6 | ) | — | — | — | — | |||||||||||||||||||
| $ | 7,014.6 | $ | — | $ | 7,014.6 | 1,067.7 | $ | 410.9 | $ | 551.4 | $ | 6,569.7 | ||||||||||||||||
| Interest expense, net and other | (97.2 | ) | ||||||||||||||||||||||||||
| Income before taxes | $ | 970.5 |
| Sales, net | Operating | Depreciation, | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Year Ended December 31, 2017 | Trade | Inter- segment | Total | Income (Loss) (a) | Amortization, and Depletion | Capital Expenditures (l) | Assets | |||||||||||||||||||||
| Packaging | $ | 5,288.6 | $ | 23.7 | $ | 5,312.3 | $ | 950.3 | (e) | $ | 317.5 | $ | 305.1 | $ | 4,933.6 | |||||||||||||
| Paper | 1,051.8 | — | 1,051.8 | 54.0 | (f) | 67.6 | 22.6 | 945.2 | ||||||||||||||||||||
| Corporate and Other | 104.5 | 124.7 | 229.2 | (71.8 | ) | (g) | 6.3 | 15.3 | 318.7 | |||||||||||||||||||
| Intersegment eliminations | — | (148.4 | ) | (148.4 | ) | — | — | — | — | |||||||||||||||||||
| $ | 6,444.9 | $ | — | $ | 6,444.9 | 932.5 | $ | 391.4 | $ | 343.0 | $ | 6,197.5 | ||||||||||||||||
| Interest expense, net and other | (103.9 | ) | (h) | |||||||||||||||||||||||||
| Income before taxes | $ | 828.6 |
| Sales, net | Operating | Depreciation, | ||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Year Ended December 31, 2016 | Trade | Inter- segment | Total | Income (Loss) (a) | Amortization, and Depletion | Capital Expenditures (l) | Assets | |||||||||||||||||||||
| Packaging | $ | 4,577.4 | $ | 7.4 | $ | 4,584.8 | $ | 718.5 | (i) | $ | 293.3 | $ | 239.9 | $ | 4,530.5 | |||||||||||||
| Paper | 1,093.9 | — | 1,093.9 | 131.7 | (j) | 59.6 | 31.6 | 946.2 | ||||||||||||||||||||
| Corporate and Other | 107.7 | 139.2 | 246.9 | (66.9 | ) | (k) | 5.1 | 2.8 | 300.3 | |||||||||||||||||||
| Intersegment eliminations | — | (146.6 | ) | (146.6 | ) | — | — | — | — | |||||||||||||||||||
| $ | 5,779.0 | $ | — | $ | 5,779.0 | 783.3 | $ | 358.0 | $ | 274.3 | $ | 5,777.0 | ||||||||||||||||
| Interest expense, net and other | (94.8 | ) | ||||||||||||||||||||||||||
| Income before taxes | $ | 688.5 |
| (a) | Effective January 1, 2018, the Company adopted ASU 2017-07, Compensation: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost and applied this standard retrospectively to the prior period reflected herein. This new standard requires the presentation of non-service cost components of net periodic benefits expense to be shown separately outside the subtotal of operating income in the income statement. See Note 2, Summary of Significant Accounting Policies, for more information. |
|---|
The components of our financial statements affected by the change in presentation of operating and non-operating pension expense as originally reported in 2017 and 2016 and as adjusted for the requirements per the new standard are as follows (dollars in millions):
| Segment income (loss) | Year Ended December 31, 2017 As Reported | Non-Operating Pension Adjustment | Year Ended December 31, 2017 Adjusted | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Packaging | $ | 943.7 | $ | 6.6 | $ | 950.3 | ||||||
| Paper | 61.5 | (7.5 | ) | 54.0 | ||||||||
| Corporate | (74.0 | ) | 2.2 | (71.8 | ) | |||||||
| Income from operations | 931.2 | 1.3 | 932.5 | |||||||||
| Interest expense, net and other | (102.6 | ) | (1.3 | ) | (103.9 | ) | ||||||
| Income before taxes | $ | 828.6 | $ | — | $ | 828.6 |
| Segment income (loss) | Year Ended December 31, 2016 As Reported | Non-Operating Pension Adjustment | Year Ended December 31, 2016 Adjusted | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Packaging | $ | 711.1 | $ | 7.4 | $ | 718.5 | ||||||
| Paper | 138.1 | (6.4 | ) | 131.7 | ||||||||
| Corporate | (68.9 | ) | 2.0 | (66.9 | ) | |||||||
| Income from operations | 780.3 | 3.0 | 783.3 | |||||||||
| Interest expense, net and other | (91.8 | ) | (3.0 | ) | (94.8 | ) | ||||||
| Income before taxes | $ | 688.5 | $ | — | $ | 688.5 |
| (b) | Includes the following: |
|---|
| o | $12.3 million of charges related to the second quarter discontinuation of uncoated free sheet and coated one-side grades at the Wallula, Washington mill associated with the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine. |
|---|
| o | $1.6 million of charges consisting of closure costs related to corrugated products facilities. |
|---|
| o | $0.5 million of costs for the property damage insurance deductible for a weather-related incident at one of the corrugated products facilities. |
|---|
| o | $0.2 million of charges for acquisition and integration costs related to recent acquisitions. |
|---|
| (c) | Includes $17.7 million of charges related to the second quarter discontinuation of uncoated free sheet and coated one-side grades at the Wallula, Washington mill associated with the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine. |
|---|
| (d) | Includes $0.2 million of charges consisting of closure costs related to a corporate administration facility. |
|---|
| (e) | Includes the following: |
|---|
| o | $7.2 million of income, net, primarily related to the sale of land corresponding to the closure of a corrugated products facility, partially offset by closure costs related to corrugated products facilities, and a lump sum settlement of a multiemployer pension plan withdrawal liability for one of our corrugated products facilities. |
|---|
| o | $1.7 million of charges for acquisition and integration costs related to recent acquisitions. |
|---|
| o | $2.0 million gain related to the expiration of a repurchase option corresponding to timberland previously sold. |
|---|
| o | $1.6 million of income related to a working capital adjustment from the April 2015 sale of our Hexacomb corrugated manufacturing operations in Europe and Mexico. |
|---|
| o | $5.0 million of costs for the property damage and business interruption insurance deductible corresponding to the February 2017 explosion at our DeRidder, Louisiana mill. |
|---|
| (f) | Includes $33.4 million of charges related to the second quarter 2018 discontinuation of uncoated free sheet and coated one-side grades at the Wallula, Washington mill associated with the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine and $0.4 million of charges related to the closure costs of a paper administration facility. |
|---|
| (g) | Includes $1.0 million of charges related to the closure costs of a corporate administration facility and $0.7 million of income related to a working capital adjustment from the April 2015 sale of our Hexacomb corrugated manufacturing operations in Europe and Mexico. |
|---|
| (h) | Includes $1.8 million of expense related to the write-off of deferred debt issuance costs in connection with the December 2017 debt refinancing. |
|---|
| (i) | Includes $10.2 million of closure costs related to corrugated product facilities and a lump sum settlement of a multiemployer pension plan withdrawal liability for one of our corrugated products facilities and $4.2 million of acquisition-related costs for recent acquisitions. |
|---|
| (j) | Includes $2.7 million of costs related to ceased softwood market pulp operations at our Wallula, Washington mill and the permanent shut down of the No.1 machine and $1.7 million of closure costs related to a paper products facility. |
|---|
| (k) | Includes $0.3 million of acquisition-related costs related to recent acquisitions. |
|---|
| (l) | Includes “Additions to property, plant, and equipment” and excludes cash used for “Acquisitions of businesses, net of cash acquired” as reported on our Consolidated Statements of Cash Flows. |
|---|
| 19. | Commitments, Guarantees, Indemnifications, and Legal Proceedings |
|---|
We have financial commitments and obligations that arise in the ordinary course of our business. These include long-term debt (discussed in Note 10, Debt), capital commitments, lease obligations, purchase commitments for goods and services, and legal proceedings (discussed below).
Capital Commitments
The Company had capital commitments of approximately $112.8 million and $281.3 million as of December 31, 2018 and 2017, respectively, in connection with the expansion and replacement of existing facilities and equipment.
Lease Obligations
PCA leases space for certain facilities, cutting rights to approximately 75,000 acres of timberland, land for a fiber farm, and equipment, primarily vehicles and rolling stock. Remaining lease terms average four years and may contain renewal options or escalation clauses. Substantially all lease agreements have fixed payment terms based on the passage of time. Some lease agreements provide us with the option to purchase the leased property. Additionally, some agreements contain renewal options averaging approximately six years. Some leases may require the Company to pay executory costs, which may include property taxes, maintenance and insurance. The minimum lease payments under non-cancelable operating leases with lease terms in excess of one year were as follows (dollars in millions):
| 2019 | $ | 70.1 | ||
|---|---|---|---|---|
| 2020 | 58.7 | |||
| 2021 | 47.4 | |||
| 2022 | 29.9 | |||
| 2023 | 17.8 | |||
| Thereafter | 46.4 | |||
| Total | $ | 270.3 |
Total lease expense, including base rent on all leases and executory costs, such as insurance, taxes, and maintenance, for the years ended December 31, 2018, 2017, and 2016, was $115.1 million, $100.6 million and $88.3 million, respectively. These costs are included in “Cost of sales” and “Selling, general, and administrative expenses” in our Consolidated Statements of Income. We had no sublease rental income for the years ended December 31, 2018 and 2017 and an insignificant amount of sublease rental income in the year ended December 31, 2016.
PCA was obligated under capital leases covering buildings and machinery and equipment in the amount of $19.0 million and $20.3 million at December 31, 2018 and 2017, respectively. Assets held under capital lease obligations were included in property, plant, and equipment as follows (dollars in millions):
| Year Ended December 31, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2018 | 2017 | |||||||
| Buildings | $ | 0.3 | $ | 0.3 | ||||
| Machinery and equipment | 28.5 | 28.5 | ||||||
| Total | 28.8 | 28.8 | ||||||
| Less accumulated amortization | (16.7 | ) | (15.2 | ) | ||||
| Total | $ | 12.1 | $ | 13.6 |
Amortization of assets under capital lease obligations is included in depreciation expense.
The future minimum payments under capitalized leases at December 31, 2018 were as follows (dollars in millions):
| 2019 | $ | 2.7 | ||
|---|---|---|---|---|
| 2020 | 2.7 | |||
| 2021 | 2.7 | |||
| 2022 | 2.7 | |||
| 2023 | 2.7 | |||
| Thereafter | 12.4 | |||
| Total minimum capital lease payments | 25.9 | |||
| Less amounts representing interest | (6.9 | ) | ||
| Present value of net minimum capital lease payments | 19.0 | |||
| Less current maturities of capital lease obligations | (1.4 | ) | ||
| Total long-term capital lease obligations | $ | 17.6 |
Interest expense related to capital lease obligations for the years ended December 31, 2018, 2017, and 2016 was $1.3 million, $1.4 million, and $1.5 million, respectively.
Purchase Commitments
In the table below, we set forth our enforceable and legally binding purchase obligations as of December 31, 2018. Some of the amounts are based on management's estimates and assumptions about these obligations, including their duration, the possibility of renewal, anticipated actions by third parties, and other factors. Because these estimates and assumptions are necessarily subjective, our actual payments may vary from those reflected in the table. Purchase orders made in the ordinary course of business are excluded below. Any amounts for which we are liable under purchase orders are reflected on the Consolidated Balance Sheets as accounts payable and accrued liabilities. These obligations relate to various purchase agreements for items such as minimum amounts of energy and fiber purchases over periods ranging from one year to 22 years. Total purchase commitments were as follows (dollars in millions):
| 2019 | $ | 75.3 | ||
|---|---|---|---|---|
| 2020 | 48.6 | |||
| 2021 | 43.1 | |||
| 2022 | 42.6 | |||
| 2023 | 43.7 | |||
| Thereafter | 117.5 | |||
| Total | $ | 370.8 |
The Company purchased a total of $341.9 million, $339.1 million, and $362.0 million during the years ended December 31, 2018, 2017, and 2016, respectively, under these purchase agreements.
Environmental Liabilities
The potential costs for various environmental matters are uncertain due to such factors as the unknown magnitude of possible cleanup costs, the complexity and evolving nature of governmental laws and regulations and their interpretations, and the timing, varying costs and effectiveness of alternative cleanup technologies. From 2006 through 2018, there were no significant environmental remediation costs at PCA's mills and corrugated plants. At December 31, 2018, the Company had $27.3 million of environmental-related reserves recorded on its Consolidated Balance Sheet. Of the $27.3 million, approximately $18.3 million related to environmental-related asset retirement obligations discussed in Note 12, Asset Retirement Obligations, and $9.0 million related to our estimate of other environmental contingencies. The Company recorded $5.0 million in “Accrued liabilities” and $22.3 million in “Other long-term liabilities” on the Consolidated Balance Sheet. Liabilities recorded for environmental contingencies are estimates of the probable costs based upon available information and assumptions. Because of these uncertainties, PCA’s estimates may change. The Company believes that it is not reasonably possible that future environmental expenditures for remediation costs and asset retirement obligations above the $27.3 million accrued as of December 31, 2018, will have a material impact on its financial condition, results of operations, or cash flows.
Guarantees and Indemnifications
We provide guarantees, indemnifications, and other assurances to third parties in the normal course of our business. These include tort indemnifications, environmental assurances, and representations and warranties in commercial agreements. At December 31, 2018, we are not aware of any material liabilities arising from any guarantee, indemnification, or financial assurance we have provided. If we determined such a liability was probable and subject to reasonable determination, we would accrue for it at that time.
DeRidder Mill Incident
On February 8, 2017, a tank located in the pulp mill at the Company's DeRidder, Louisiana facility exploded, resulting in three contractor fatalities and other injuries. The Company has been served with multiple lawsuits involving the decedents and other allegedly injured parties, alleging negligence on the part of the Company and claiming compensatory and punitive damages. The Company is vigorously defending these lawsuits. The Company believes that these suits are covered by its liability insurance policies, subject to an aggregate $1.0 million deductible. The incident remains under investigation and all lawsuits are in the early stages. Accordingly, the Company is unable to estimate a range of reasonable possible losses at this time.
The Company has also incurred property damage and business interruption losses and has claimed these losses, subject to a $5.0 million deductible, under its property damage and business interruption insurance policy. As of December 31, 2017, the Company finalized the claim with the insurance carrier and received $17.0 million in insurance proceeds during the first quarter of 2018. The insurance proceeds are included in net cash provided by operating activities ($14.5 million) and in net cash used for investing activities ($2.5 million) based on the nature of the reimbursement.
The Company has cooperated with investigations from the U.S. Occupational Health and Safety Administration (OSHA), the U.S. Chemical Safety Board (CSB) and the U.S. Environmental Protection Agency (EPA). The U.S. Chemical Safety Board completed its investigation and issued its report during the second quarter of 2018. The Company settled with OSHA during the second quarter of 2018 and paid approximately $40,000 in penalties for citations. The EPA investigation is ongoing.
Legal proceedings
We are also a party to various legal actions arising in the ordinary course of our business. These legal actions include commercial liability claims, premises liability claims, and employment-related claims, among others. As of the date of this filing, we believe it is not reasonably possible that any of the legal actions against us will, either individually or in the aggregate, have a material adverse effect on our financial condition, results of operations, or cash flows.
| 20. | Quarterly Results of Operations (unaudited, dollars in millions, except per-share and stock price information) |
|---|
| 2018: | First (b) | Second (c) | Third (d) | Fourth (e) | Total | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net sales | $ | 1,690.6 | $ | 1,767.5 | $ | 1,809.9 | $ | 1,746.6 | $ | 7,014.6 | ||||||||||
| Gross profit | 356.1 | 420.6 | 443.2 | 425.4 | 1,645.3 | |||||||||||||||
| Income from operations | 212.9 | 269.6 | 298.5 | 286.7 | 1,067.7 | |||||||||||||||
| Net income | 140.1 | 186.6 | 206.7 | 204.6 | 738.0 | |||||||||||||||
| Basic earnings per share | 1.48 | 1.98 | 2.19 | 2.17 | 7.82 | |||||||||||||||
| Diluted earnings per share | 1.48 | 1.97 | 2.18 | 2.16 | 7.80 | |||||||||||||||
| Stock price - high | 131.13 | 124.70 | 118.88 | 110.62 | 131.13 | |||||||||||||||
| Stock price - low | 109.04 | 107.96 | 107.39 | 77.90 | 77.90 |
| 2017: | First (f) | Second (g) | Third (h) | Fourth (i) | Total | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Net sales | $ | 1,536.5 | $ | 1,584.0 | $ | 1,640.1 | $ | 1,684.3 | $ | 6,444.9 | ||||||||||
| Gross profit (a) | 338.2 | 364.3 | 397.0 | 371.4 | 1,470.8 | |||||||||||||||
| Income from operations (a) | 203.4 | 234.1 | 242.6 | 252.3 | 932.5 | |||||||||||||||
| Net income | 117.4 | 143.2 | 139.1 | 268.9 | 668.6 | |||||||||||||||
| Basic earnings per share | 1.25 | 1.52 | 1.47 | 2.85 | 7.09 | |||||||||||||||
| Diluted earnings per share | 1.24 | 1.52 | 1.47 | 2.84 | 7.07 | |||||||||||||||
| Stock price - high | 96.87 | 113.52 | 119.43 | 121.38 | 121.38 | |||||||||||||||
| Stock price - low | 84.01 | 89.73 | 105.81 | 108.49 | 84.01 |
Note: The sum of the quarters may not equal the total of the respective year's earnings per share on either a basic or diluted basis due to changes in the weighted average shares outstanding throughout the year.
| (a) | Effective January 1, 2018, the Company adopted ASU 2017-07, Compensation: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost and applied this standard retrospectively to the prior period reflected herein. This new standard requires the presentation of non-service cost components of net periodic benefits expense to be shown separately outside the subtotal of operating income in the income statement. See Note 2, Summary of Significant Accounting Policies, for more information. |
|---|
The components of our financial statements affected by the change in presentation of operating and non-operating pension expense as originally reported in 2017 and as adjusted for the requirements per the new standard are as follows (dollars in millions):
| First quarter, 2017 | As Reported | Non-Operating Pension Adjustment | Adjusted | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Gross profit | $ | 338.5 | $ | (0.3 | ) | $ | 338.2 | |||||
| Income from operations | 203.1 | 0.3 | 203.4 | |||||||||
| Second quarter, 2017 | ||||||||||||
| Gross profit | $ | 364.6 | $ | (0.3 | ) | $ | 364.3 | |||||
| Income from operations | 233.8 | 0.3 | 234.1 | |||||||||
| Third quarter, 2017 | ||||||||||||
| Gross profit | $ | 397.3 | $ | (0.3 | ) | $ | 397.0 | |||||
| Income from operations | 242.3 | 0.3 | 242.6 | |||||||||
| Fourth quarter, 2017 | ||||||||||||
| Gross profit | $ | 371.7 | $ | (0.3 | ) | $ | 371.4 | |||||
| Income from operations | 252.0 | 0.3 | 252.3 | |||||||||
| Full year 2017 | ||||||||||||
| Gross profit | $ | 1,472.2 | $ | (1.4 | ) | $ | 1,470.8 | |||||
| Income from operations | 931.2 | 1.3 | 932.5 |
| (b) | Includes $0.3 million of charges consisting of closure costs related to corrugated products facilities and a corporate administration facility ($0.2 million after-tax or $0.0 per diluted share) and $8.8 million of charges related to the second |
|---|
| quarter 2018 discontinuation of uncoated free sheet and coated one-side grades at the Wallula Washington mill associated with the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine ($6.6 million after-tax or $0.07 per diluted share). |
|---|
| (c) | Includes $0.2 million of charges consisting of closure costs related to corrugated products facilities and a corporate administration facility ($0.2 million after-tax and $0.0 per diluted share) and $13.6 million of charges related to the second quarter 2018 discontinuation of uncoated free sheet and coated one-side grades at the Wallula Washington mill associated with the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine ($10.2 million after-tax or $0.11 per diluted share). |
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| (d) | Includes $4.0 million of charges related to the second quarter 2018 discontinuation of uncoated free sheet and coated one-side grades at the Wallula Washington mill associated with the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine ($2.9 million after-tax or $0.04 per diluted share) and $1.3 million of charges consisting of closure costs related to corrugated products facilities and a corporate administration facility ($1.0 million after-tax or $0.01 per diluted share). Also includes $0.5 million of costs for the property damage insurance deductible for a weather-related incident at one of the corrugated products facilities ($0.4 million after-tax or $0.0 per diluted share) and $0.1 million of charges for acquisition and integration costs related to recent acquisitions ($0.01 million after-tax or $0.0 per diluted share). |
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| (e) | Includes $3.6 million of charges related to the second quarter 2018 discontinuation of uncoated free sheet and coated one-side grades at the Wallula, Washington mill associated with the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine ($2.7 million after-tax or $0.03 per diluted share) and $0.1 million of charges for acquisition and integration costs related to recent acquisitions ($0.1 million after-tax or $0.0 per diluted share). Also includes $2.0 million of income tax benefit for the re-measurement of our net deferred tax liability to our 2017 measurement period adjustments in accordance with SEC Staff Accounting Bulletin No. 118 (SAB 118), Income Tax Accounting Implications of the Tax Cuts and Jobs Act ($0.02 per diluted share). |
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| (f) | Includes $0.6 million of charges related to the closure of corrugated products facilities and lump sum settlement of a multiemployer pension plan withdrawal liability for one of corrugated products facilities ($0.4 million after-tax or $0.01 per diluted share) and $0.2 million of charges for integration costs related to recent acquisitions ($0.1 million after-tax or $0.0 per diluted share). Also includes $5.0 million of costs for the property damage and business interruption insurance deductible corresponding to the February 2017 explosion at our DeRidder, Louisiana mill ($3.1 million after-tax or $0.03 per diluted share) and $2.3 million of income related to a working capital adjustment from the April 2015 sale of our Hexacomb corrugated manufacturing operations in Europe and Mexico ($1.4 million after-tax or $0.01 per diluted share). |
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| (g) | Includes $0.3 million of charges related to the closure of corrugated products facilities ($0.3 million after-tax or $0.0 per diluted share) and $0.2 million of charges for integration costs related to recent acquisitions ($0.1 after-tax or $0.0 per diluted share). |
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| (h) | Includes $0.9 million of charges related to the closure of corrugated products facilities, a paper administration facility, and a lump sum settlement of a multiemployer pension plan withdrawal liability for one of our corrugated products facilities ($0.6 million after-tax or $0.01 per diluted share) and $0.5 million of charges for acquisition and integration costs related to recent acquisitions ($0.3 million after-tax or $0.0 per diluted share). Also includes $25.3 million of charges related to the announced second quarter 2018 discontinuation of uncoated free sheet and coated one-side grades at the Wallula Washington mill associated with the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine ($15.5 million after-tax or $0.16 per diluted share) and $3.3 million of tax expense for the change in value of deferred taxes as a result of an internal legal entity consolidation that will simplify future operating activities ($0.04 per diluted share). |
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| (i) | Includes $7.6 million of income primarily related to the sale of land corresponding to the closure of a corrugated products facility, partially offset by closure costs related to corrugated products facilities, a paper administration facility, and a corporate administration facility ($4.7 million after-tax or $0.05 per diluted share) and $0.9 million of charges for acquisition and integration costs related to recent acquisitions ($0.5 million after-tax or $0.01 per diluted share), and $8.0 million of charges related to the announced second quarter 2018 discontinuation of uncoated free sheet and coated one-side grades at the Wallula Washington mill associated with the conversion of the No. 3 paper machine to a high-performance 100% virgin kraft linerboard machine ($4.6 million after-tax or $0.05 per diluted share). Also includes $1.8 million of expense related to the write-off of deferred debt issuance costs in connection with the December 2017 debt refinancing ($1.1 million after-tax or $0.01 per diluted share), $2.0 million gain related to the expiration of a repurchase option corresponding to timberland previously sold ($1.2 million after-tax or $0.01 per diluted share), and $122.1 million of estimated income tax benefit related to the enactment in December 2017 of the Tax Cuts and Jobs Act (H.R.1) primarily for the re-measurement of our net deferred tax liability as a result of the reduction in the U.S. corporate income tax rate ($1.29 per diluted share). |
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