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Sonoco Products Company 10-K 2009 Documents found in this filing:Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
For the Fiscal Year Ended December 31, 2008 or
For the transition period from to Commission File No. 0-516
SONOCO PRODUCTS COMPANY
1 N. Second St. Hartsville, SC 29550 Telephone: 843/383-7000
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x The aggregate market value of voting common stock held by nonaffiliates of the registrant (based on the New York Stock Exchange closing price) on June 27, 2008, which was the last business day of the registrant’s most recently completed second fiscal quarter, was $2,970,969,646. Registrant does not (and did not at June 27, 2008) have any non-voting common stock outstanding. As of February 20, 2009, there were 99,789,952 shares of no par value common stock outstanding. Documents Incorporated by Reference Portions of the Proxy Statement for the annual meeting of shareholders to be held on April 15, 2009, which statement shall be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Report relates, are incorporated by reference in Part III.
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Forward-looking Statements Statements included in this Annual Report on Form 10-K that are not historical in nature, are intended to be, and are hereby identified as “forward-looking statements” for purposes of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934, as amended. The words “estimate,” “project,” “intend,” “expect,” “believe,” “consider,” “plan,” “anticipate,” “objective,” “goal,” “guidance,” “outlook,” “forecasts,” “future,” “will,” and similar expressions identify forward-looking statements. Forward-looking statements include, but are not limited to, statements regarding offsetting high raw material costs; improved productivity and cost containment; adequacy of income tax provisions; refinancing of debt; adequacy of cash flows; anticipated amounts and uses of cash flows; effects of acquisitions and dispositions; adequacy of provisions for environmental liabilities; financial strategies and the results expected from them; continued payments of dividends; stock repurchases; producing improvements in earnings; financial results for future periods; and creation of long-term value for shareholders. Such forward-looking statements are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management. Such information includes, without limitation, discussions as to guidance and other estimates, expectations, beliefs, plans, strategies and objectives concerning our future financial and operating performance. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed or forecasted in such forward-looking statements. The risks and uncertainties include, without limitation: Ÿ availability and pricing of raw materials; Ÿ success of new product development and introduction; Ÿ ability to maintain or increase productivity levels and contain or reduce costs; Ÿ international, national and local economic and market conditions; Ÿ availability of credit to us, our customers and/or suppliers in needed amounts and/or on reasonable terms; Ÿ fluctuations in obligations and earnings of pension and postretirement benefit plans; Ÿ ability to maintain market share; Ÿ pricing pressures and demand for products; Ÿ continued strength of our paperboard-based tubes and cores and composite can operations; Ÿ anticipated results of restructuring activities; Ÿ resolution of income tax contingencies; Ÿ ability to successfully integrate newly acquired businesses into the Company’s operations; Ÿ rate of growth in foreign markets; Ÿ foreign currency, interest rate and commodity price risk and the effectiveness of related hedges; Ÿ actions of government agencies and changes in laws and regulations affecting the Company; Ÿ liability for and anticipated costs of environmental remediation actions; Ÿ ability to weather the current economic downturn; Ÿ loss of consumer or investor confidence; and Ÿ economic disruptions resulting from terrorist activities. The Company undertakes no obligation to publicly update or revise forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Annual Report on Form 10-K might not occur. References to our Web Site Address References to our Web site address and domain names throughout this Annual Report on Form 10-K are for informational purposes only, or to fulfill specific disclosure requirements of the Securities and Exchange Commission’s rules or the New York Stock Exchange Listing Standards. These references are not intended to, and do not, incorporate the contents of our Web sites by reference into this Annual Report on Form 10-K.
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(a) General development of business – The Company is a South Carolina corporation founded in Hartsville, South Carolina, in 1899 as the Southern Novelty Company. The name was subsequently changed to Sonoco Products Company (the “Company” or “Sonoco”). Sonoco is a manufacturer of industrial and consumer packaging products and a provider of packaging services, with 327 locations in 35 countries. Information about the Company’s acquisitions, dispositions, joint ventures and restructuring activities is provided in Notes 2 and 3 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. (b) Financial information about segments – Information about the Company’s reportable segments is provided in Note 17 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. (c) Narrative description of business – Products and Services – The following discussion outlines the principal products produced and services provided by the Company. Consumer Packaging The Consumer Packaging segment accounted for approximately 38%, 36% and 36% of the Company’s net sales in 2008, 2007 and 2006, respectively. The operations in this segment consist of 61 plants throughout the world. The products, services and markets of the Consumer Packaging segment are as follows:
Sonoco’s rigid packaging – paper products are the Company’s second largest revenue-producing group of products and services, representing approximately 17%, 15% and 16% of consolidated net sales in 2008, 2007 and 2006, respectively. Tubes and Cores/Paper The Tubes and Cores/Paper segment accounted for approximately 41%, 42% and 42% of the Company’s net sales in 2008, 2007 and 2006, respectively. This segment serves its markets through 171 plants on five continents. Sonoco’s paper operations provide the primary raw material for the Company’s fiber-based packaging. Sonoco uses approximately 65% of the paper it manufactures and the remainder is sold to third parties. This vertical integration strategy is supported by 22 paper mills with 32 paper machines and 50 recycling facilities throughout the world. In 2008, Sonoco had the capacity to manufacture approximately 1.8 million tons of recycled paperboard. The products, services and markets of the Tubes and Cores/Paper segment are as follows:
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Sonoco’s tubes and cores products and services are the Company’s largest revenue-producing group of products and services, representing approximately 30%, 31% and 31% of consolidated net sales in 2008, 2007 and 2006, respectively. Packaging Services The Packaging Services segment accounted for approximately 12%, 13% and 12% of the Company’s consolidated net sales in 2008, 2007 and 2006, respectively. The products, services and markets of the Packaging Services segment are as follows:
All Other Sonoco All Other Sonoco accounted for approximately 9%, 9% and 10% of the Company’s net sales in 2008, 2007 and 2006, respectively. In addition to the products and services outlined in each of the segments above, the Company produces the following products:
Product Distribution – Each of the Company’s operating units has its own sales staff, and maintains direct sales relationships with its customers. For those customers that buy from more than one business unit, the Company often assigns a single representative or team of specialists to handle that customer’s needs. Some of the units have service staff at the manufacturing facility that interacts directly with customers. The Tubes and Cores/Paper segment also has a customer service center located in Hartsville, South Carolina, which is the main contact point between its North American business units and their customers. Divisional sales personnel also provide sales management, marketing and product development assistance as needed. Product distribution is normally directly from the manufacturing plant to the customer, but in some cases, product is warehoused in a mutually advantageous location to be shipped to the customer as needed. Raw Materials – The principal raw materials used by the Company are recoverd paper, paperboard, steel, aluminum and plastic resins. Raw materials are purchased from a number of outside sources. The Company considers the supply and availability of raw materials to be adequate to meet its needs. Patents, Trademarks and Related Contracts – Most inventions and product and process innovations are generated by Sonoco’s development and engineering staff, and are important to the Company’s internal growth. Patents have been granted on many inventions created by Sonoco staff in the United States and other
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countries. These patents are managed globally by a Sonoco intellectual capital management team through the Company’s subsidiary, Sonoco Development, Inc. (SDI). SDI globally manages patents, trade secrets, confidentiality agreements and license agreements. Some patents have been licensed to other manufacturers. Sonoco also licenses a few patents from outside companies and universities. U.S. patents expire after 17 or 20 years, depending on the patent issue date. New patents replace many of the abandoned or expired patents. A second intellectual capital subsidiary of Sonoco, SPC Resources, Inc., globally manages Sonoco’s trademarks, service marks, copyrights and Internet domain names. Most of Sonoco’s products are marketed worldwide under trademarks such as Sonoco®, Sonotube®, Safe-Top®, Sealed Safe®, Duro® and Durox®. Sonoco’s registered Web domain names such as www.sonoco.com and www.sonotube.com provide information about Sonoco, its people and products. Trademarks and domain names are licensed to outside companies where appropriate. Seasonality – The Company’s operations are not seasonal to any significant degree, although the Consumer Packaging and Packaging Services segments normally report slightly higher sales and operating profits in the second half of the year, when compared to the first half. Working Capital Practices – The Company is not required to carry any significant amounts of inventory to meet customer requirements or to assure itself continuous allotment of goods, nor does it provide extended terms to customers. Dependence on Customers – On an aggregate basis, the five largest customers in the Tubes and Cores/Paper segment accounted for approximately 7% of that segment’s sales and the five largest customers in the Consumer Packaging segment accounted for approximately 32% of that segment’s sales. The dependence on a few customers in the Packaging Services segment is more significant as the five largest customers in this segment accounted for approximately 68% of that segment’s sales. Sales to Procter & Gamble, the Company’s largest customer, represented approximately 12% of the Company’s consolidated revenues in 2008. In addition, this concentration of sales volume resulted in a corresponding concentration of credit, representing approximately 12% of the Company’s consolidated trade accounts receivable at December 31, 2008. No other customer comprised more than 5% of the Company’s consolidated revenues in 2008 or accounts receivable at December 31, 2008. Backlog – Most customer orders are manufactured with a lead time of three weeks or less. Therefore, the amount of backlog orders at December 31, 2008, was not material. The Company expects all backlog orders at December 31, 2008, to be shipped during 2009. Competition – The Company sells its products in highly competitive markets, which include paper, textile, film, food, chemical, pharmaceutical, packaging, construction, and wire and cable. All of these markets are influenced by the overall rate of economic activity and their behavior is principally driven by supply and demand. Because we operate in highly competitive markets, we regularly bid for new and continuing business. Losses and/or awards of business from our largest customers, customer changes to alternative forms of packaging, and the repricing of business, can have a significant effect on our operating results. The Company manufactures and sells many of its products globally. The Company, having operated internationally since 1923, considers its ability to serve its customers worldwide in a timely and consistent manner a competitive advantage. The Company also believes that its technological leadership, reputation for quality and vertical integration are competitive advantages. Expansion of the Company’s product lines and global presence is driven by the rapidly changing needs of its major customers, who demand high-quality, state-of-the-art, environmentally compatible packaging, wherever they choose to do business. It is important to be a low-cost producer in order to compete effectively. The Company is constantly focused on productivity improvements and other cost-reduction initiatives utilizing the latest in technology. Research and Development – Company-sponsored research and development expenses totaled approximately $15.9 million in 2008, $15.6 million in 2007, and $12.7 million in 2006. Customer-sponsored research and development expenses were not material in any of these periods. Significant projects in Sonoco’s Tubes and Cores/Paper segment during 2008 included efforts to design and develop new products for the construction industry and for the film and tape industries. In addition, efforts were focused on enhancing performance characteristics of the Company’s tubes and cores in the textile, film and paper packaging areas, as well as on projects aimed at enhancing productivity. During 2008, the Consumer Packaging segment continued to invest in a broad range of cost-reduction projects, high-value flexible packaging enhancements, rigid plastic containers technology and next-generation composite packaging. Compliance with Environmental Laws – Information regarding compliance with environmental laws is provided in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption “Risk Management,” and in Note 15 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Number of Employees – Sonoco had approximately 17,500 employees worldwide as of December 31, 2008. (d) Financial information about geographic areas – Financial information about geographic areas is provided in Note 17 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K, and in the information about market risk in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption “Risk Management” of this Annual Report on Form 10-K. (e) Available information – The Company electronically files with the Securities and Exchange Commission (SEC) its annual reports on Form 10-K, its quarterly reports on Form 10-Q, its periodic reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 (the “1934 Act), and proxy materials pursuant to Section 14 of the 1934 Act. The SEC maintains a site on the Internet, www.sec.gov, that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. Sonoco also makes its filings available, free of charge, through its Web site, www.sonoco.com , as soon as reasonably practical after the electronic filing of such material with the SEC.
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Executive Officers of the Registrant –
Risk Factors Relating to Sonoco’s Business The Company is subject to environmental regulations and liabilities that could weaken operating results. Federal, state, provincial, foreign and local environmental requirements, including the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), and particularly those relating to air and water quality, are significant factors in the Company’s business and generally increase its costs of operations. The Company may be found to have environmental liability for the costs of remediating soil or water that is, or was, contaminated by the Company or a third party at various sites that are now, or were previously, owned, used or operated by the Company. Legal proceedings may result in the imposition of fines or penalties, as well as mandated remediation programs that require substantial, and in some instances, unplanned capital expenditures. The Company has incurred in the past, and may incur in the future, fines, penalties and legal costs relating to environmental matters, and costs relating to the damage of natural resources, lost property values and toxic tort claims. The Company has made expenditures to comply with environmental regulations and expects to make additional expenditures in the future. As of December 31, 2008, approximately $70.5 million was reserved for environmental liabilities. Such reserves are established when it is considered probable that the Company has some liability. In part because nearly all of the Company’s potential environmental liabilities are joint and severally shared with others, the Company’s maximum potential liability cannot be reasonably estimated. However, the Company’s actual liability in such cases may be substantially higher than the reserved amount. Additional charges could be incurred due to changes in law, or the discovery of new information, and those charges could have a material adverse effect on operating results. General economic conditions in the United States may change, having a negative impact on the Company’s earnings. Domestic sales accounted for approximately 63% of the Company’s consolidated revenues. Even with the Company’s diversification across various markets and customers, due to the nature of the
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Company’s products and services, general economic downturns can have an adverse impact on the Company’s reported results. Conditions in foreign countries where the Company operates may reduce earnings. The Company has operations throughout North and South America, Europe, Australia and Asia, with facilities in 35 countries. In 2008, approximately 37% of consolidated sales came from operations and sales outside of the United States. Accordingly, economic conditions, political situations, and changing laws and regulations in those countries may adversely affect revenues and income. Raw materials price increases may reduce net income. Most of the raw materials the Company uses are purchased from third parties. Principal examples are recovered paper, steel, aluminum and resin. Prices for these raw materials are subject to substantial fluctuations that are beyond the Company’s control and can adversely affect profitability. Many of the Company’s long-term contracts with customers permit limited price adjustments to reflect increased raw material costs. Although both contractual and non-contractual prices may be increased in an effort to offset increases in raw materials costs, such adjustments may not occur quickly enough, or be sufficient to prevent a materially adverse effect on net income and cash flow. The Company may encounter difficulties integrating acquisitions, restructuring operations or closing or disposing of facilities. The Company has made numerous acquisitions in recent years, and may actively seek new acquisitions that management believes will provide meaningful opportunities in the markets it serves. Acquired businesses may not achieve the expected levels of revenue, profit or productivity, or otherwise perform as expected. Acquisitions also involve special risks, including, without limitation, the potential assumption of unanticipated liabilities and contingencies, and difficulties in integrating acquired businesses. While management believes that acquisitions will improve the Company’s competitiveness and profitability, no assurance can be given that acquisitions will be successful or accretive to earnings. If actual performance in an acquisition falls significantly short of the projected results, or the assessment of the relevant facts and circumstances changes, it is possible that a noncash impairment charge of any related goodwill would be required. The Company has closed higher-cost facilities, sold non-core assets and otherwise restructured operations in an effort to improve cost competitiveness and profitability. Some of these activities are ongoing, and there is no guarantee that any such activities will achieve the Company’s goals and not divert the attention of management or disrupt the ordinary operations of the Company. Moreover, production capacity, or the actual amount of products produced, may be reduced as a result of these activities. Energy price increases may reduce net income. The Company’s manufacturing operations require the use of substantial amounts of electricity and natural gas, which may be subject to significant price increases as the result of changes in overall supply and demand. Energy usage is forecasted and monitored, and the Company may, from time to time, use commodity futures or swaps in an attempt to reduce the impact of energy price increases. The Company cannot guarantee success in these efforts, and could suffer adverse effects to net income and cash flow should the Company be unable to pass higher energy costs through to its customers. Changes in pension plan assets or liabilities may reduce net income and shareholders’ equity. The Company has an aggregate projected benefit obligation for its defined benefit plans in excess of $1.2 billion. The calculation of this obligation is sensitive to the underlying discount rate assumption. Reductions in the long-term yield of high-quality debt instruments would result in a higher projected benefit obligation and higher net periodic benefit cost. A higher projected benefit obligation may result in a change in funded status that significantly reduces shareholders’ equity. The Company has total assets of approximately $0.8 billion funding a portion of the projected benefit obligation. Decreases in fair value of these assets may result in a higher net periodic benefit cost and a change in the funded status that significantly reduces shareholders’ equity. The Company may not be able to develop new products acceptable to the market. For many of the Company’s businesses, organic growth depends meaningfully on new product development. If new products acceptable to the Company’s customers are not developed in a timely fashion, growth potential may be hindered. The Company may not be able to locate suitable acquisition candidates. If significant acquisition candidates that meet the Company’s specific criteria are not located, the Company’s potential for growth may be restricted. The Company, or its customers, may not be able to obtain necessary credit or, if so, on reasonable terms. The Company operates a $500 million commercial paper program supported by a five-year bank credit facility of an equal amount committed by a syndicate of lenders until May 2011. In the event that recent disruptions in global credit markets were to become so severe that the Company was unable to issue commercial paper, it has the contractual right to draw funds directly on the underlying bank credit facility. The Company believes that the lenders continue to have the ability to meet their obligations under the facility. However, if these obligations are not met, the Company may be forced to seek more costly or cumbersome forms of credit. Should such credit be unavailable for an extended time, it would significantly affect the Company’s ability to operate its business and execute its plans. In addition, the Company’s customers may experience liquidity problems as a result of the ongoing credit-driven economic recession that could negatively affect the Company’s ability to collect receivables and maintain business relationships.
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Foreign exchange rate fluctuations may reduce the Company’s earnings. As a result of operating globally, the Company is exposed to changes in foreign exchange rates. Generally, each of the Company’s foreign operations both produces and sells in its respective local currency, limiting the Company’s exposure to foreign currency transactions. The Company monitors its exposures and, from time to time, may use forward currency contracts to hedge certain forecasted currency transactions or foreign currency denominated assets and liabilities. In addition to potential transaction losses, the Company’s reported results of operations and financial position could be negatively affected by exchange rates when the activities and balances of its foreign operations are translated into U.S. dollars for financial reporting purposes. Item 1B. Unresolved Staff Comments There are no unresolved written comments from the SEC staff regarding the Company’s periodic or current 1934 Act reports. The Company’s corporate offices are owned and operated in Hartsville, South Carolina. There are 101 owned and 70 leased facilities used by operations in the Tubes and Cores/Paper segment, 27 owned and 34 leased facilities used by operations in the Consumer Packaging segment, three owned and 17 leased facilities used by operations in the Packaging Services segment, and 18 owned and 32 leased facilities used by all other operations. Europe, the most significant foreign geographic region in which the Company operates, has 55 manufacturing locations. The Company has been named as a potentially responsible party (PRP) at several environmentally contaminated sites not owned by the Company. All of the sites are also the responsibility of other parties. The Company’s liability, if any, is shared with such other parties, but the Company’s share has not been finally determined in most cases. In some cases, the Company has cost-sharing agreements with other PRPs with respect to a particular site. Such agreements relate to the sharing of legal defense costs or cleanup costs, or both. The Company has assumed, for purposes of estimating amounts to be accrued, that the other parties to such cost-sharing agreements will perform as agreed. It appears that final resolution of some of the sites is years away, and actual costs to be incurred for these environmental matters in future periods is likely to vary from current estimates because of the inherent uncertainties in evaluating environmental exposures. Accordingly, the ultimate cost to the Company with respect to such sites cannot be determined. As of December 31, 2008 and 2007, the Company had accrued $70.5 million and $31.1 million, respectively, related to environmental contingencies. The Company periodically reevaluates the assumptions used in determining the appropriate reserves for environmental matters as additional information becomes available and, when warranted, makes appropriate adjustments.
Fox River The Company believes the issues regarding the Fox River, which are discussed in some detail below, currently represent the Company’s greatest loss exposure for environmental liability. The Company also believes that all of its exposure to such liability for the Fox River is contained within its wholly owned subsidiary, U.S. Paper Mills Corp. (U.S. Mills). Accordingly, regardless of the amount of liability that U.S. Mills may ultimately bear, Sonoco Products Company believes its maximum additional pre-tax loss for Fox River issues will essentially be limited to its investment in U.S. Mills, the book value of which was approximately $78 million at December 31, 2008. The extent of U.S. Mills’ potential liability remains subject to many uncertainties and the Company periodically reevaluates U.S. Mills’ potential liability and the appropriate reserves based on information available to it. U.S. Mills’ eventual liability, which may be paid out over several years, will depend on a number of factors. In general, the most significant factors include: (1) the total remediation costs for the sites for which U.S. Mills is found to have liability and the share of such costs U.S. Mills is required to bear; (2) the total natural resource damages for such sites and the share of such costs U.S. Mills is required to bear, and (3) U.S. Mills’ costs to defend itself in this matter. U.S. Mills was officially notified by governmental entities in 2003 that it, together with a number of other companies, had been identified as a PRP for environmental claims under CERCLA and other statutes, arising out of the presence of polychlorinated biphenyls (PCBs) in sediments in the lower Fox River and in the bay of Green Bay in Wisconsin. U.S. Mills was named as a PRP because scrap paper purchased by U.S. Mills as a raw material for its paper making processes more than 30 years ago allegedly included carbonless copy paper that contained PCBs, some of which were included in wastewater from U.S. Mills’ manufacturing processes that was discharged into the Fox River. The Company acquired the stock of U.S. Mills in 2001, and the alleged contamination predates the acquisition. Although Sonoco was also notified that it was a PRP, its only involvement is as a subsequent shareholder of U.S. Mills. As such, the Company has responded that it has no separate responsibility apart from U.S. Mills. The governmental entities making such claims against U.S. Mills and the other PRPs have been coordinating their actions, including the assertion of claims against the PRPs. Additionally, certain claimants have notified U.S. Mills and the other PRPs of their intent to commence a natural resource damage (NRD) lawsuit, but no such actions have been instituted. A review of the circumstances leading to U.S. Mills being named a PRP and the current status of the remediation effort is set forth below. In July 2003, the U.S. Environmental Protection Agency (EPA) and Wisconsin Department of Natural Resources (WDNR) issued their final cleanup plan (known as a Record of Decision, or ROD) for a portion of the Fox River. The ROD addressed the lower part of the Fox River and portions of Green Bay, where the EPA and WDNR (the Governments) estimate the bulk of the sediments that need to be remediated are located. In two portions of the lower part of the Fox River covered by the ROD – Operable Units (OUs) 3 and 4 – the
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Governments selected large-scale dredging as the cleanup approach. OU 3 is the section of the Fox River running downstream from Little Rapids to the De Pere dam, and OU 4 runs from the De Pere dam downstream to the mouth of the Fox River at Green Bay. U.S. Mills’ De Pere plant is just below the De Pere dam and, prior to 1972, discharged wastewater into the river downstream of the dam in OU 4. In the ROD, the Governments estimated that approximately 6.5 million cubic yards of sediment would be removed from OUs 3 and 4 at an estimated cost of approximately $284 million (approximately $26.5 million for OU 3 and approximately $257.5 million for OU 4). The Governments also identified “capping” the riverbed with appropriate materials as a “contingent remedy” to be evaluated during the remedial design process. For Green Bay (OU 5), the Governments selected monitored natural attenuation as the cleanup approach at an estimated cost of approximately $40 million. The Governments also indicated that some limited dredging near the mouth of the river might be required, which would ultimately be determined during the design stage of the project. Earlier, in January 2003, the Governments had issued their ROD for the upper portions of the Fox River – OUs 1 and 2. Combining the then current cost estimates from both RODs, it appeared that the Governments expected the selected remedies for all five OUs to cost approximately $400 million, exclusive of contingencies. In March 2004, NCR Corporation (NCR) and Georgia- Pacific Corporation (G-P) entered into an Administrative Order on Consent (AOC) with the Governments to perform engineering design work for the cleanup of OUs 2 – 5. In the course of the ongoing design work, additional sampling and data analysis identified elevated levels of PCBs in certain areas of OU 4 near the U.S. Mills’ De Pere plant (the OU 4 hotspot). In November 2005, the Governments notified U.S. Mills and NCR that they would be required to design and undertake a removal action that would involve dredging, dewatering and disposing of the PCB-contaminated sediments from the OU 4 hotspot. In furtherance of this notification, on April 12, 2006, the United States and the State of Wisconsin sued NCR and U.S. Mills in the U. S. District Court for the Eastern District of Wisconsin in Milwaukee (Civil Action No. 06-C-0484). NCR and U.S. Mills agreed to a Consent Decree with the United States and the State of Wisconsin pursuant to which the site is to be cleaned up on an expedited basis and NCR and U.S. Mills started removing contaminated sediment in May 2007. Although the defendants specifically did not admit liability for the allegations of the complaint, they are bound by the terms of the Consent Decree. NCR and U.S. Mills reached agreement between themselves that each would fund 50% of the costs of remediation of the OU 4 hotspot, which the Company currently estimates to be between $28 million and $41 million for the project as a whole. Project implementation began in 2006, but most of the project cost is expected to be incurred by the end of 2008. Although the funding agreement does not acknowledge responsibility or prevent either party from seeking reimbursement from any other parties (including each other), the Company has accrued a total of $17.7 million ($12.5 million in 2005 and $5.2 million in 2007), as its estimate of the portion of costs that U.S. Mills expects to incur under the funding agreement. The actual costs associated with cleanup of this particular site are dependent upon many factors and it is reasonably possible that remediation costs could be higher than the current estimate of project costs. Moreover, U.S. Mills and NCR are in the early stages of an arbitration proceeding with a contractor who claims additional compensation. At the time of the Company’s acquisition of U.S. Mills in 2001, U.S. Mills and the Company estimated U.S. Mills’ liability for the Fox River cleanup at a nominal amount based on Government reports and conversations with the Governments about the anticipated limited extent of U.S. Mills’ responsibility, the belief, based on U.S. Mills’ prior assertions, that no significant amount of PCB-contaminated raw materials had been used at the U.S. Mills plants, and the belief that any PCB contamination in the Fox River, other than a de minimis amount, was not caused by U.S. Mills. It appeared at that time that U.S. Mills and the Governments would be able to resolve the matter and dismiss U.S. Mills as a PRP for a nominal payment. Accordingly, no significant reserve was established at the time. However, the Governments subsequently declined to enter into such a settlement. Nonetheless, U.S. Mills continued to believe that its liability exposure was very small based on its continuing beliefs that no significant amount of PCB-contaminated raw materials had been used at the U.S. Mills plants and that any significant amount of PCB contamination in the section of the Fox River located adjacent to its plant was not caused by U.S. Mills. In May/June 2005, U.S. Mills first learned of elevated levels of PCBs (the OU 4 hotspot) in the Fox River adjacent to its De Pere plant. U.S. Mills, while still not believing its De Pere plant was the source of this contamination, entered into the consent decree to remediate the OU 4 hotspot as discussed above. In June 2006, U.S. Mills first received the results of tests it initiated on the U.S. Mills property that suggest that the De Pere plant may have processed as part of its furnish more than the de minimis amounts of PCB-contaminated paper reflected in the records available to the Company. This information seemed to contradict the Company’s previous understanding of the history of the De Pere plant. Based on these most recent findings, it is possible that U.S. Mills might be responsible for a larger portion of the remediation than previously anticipated. The total estimated cost set forth in the ROD for remediation of OU 4 was approximately $257.5 million and the estimated cost of monitoring OU 5 was approximately $40 million (a 2007 amendment to the ROD estimated the cost of OUs 2 – 5 at $390 million). There are two alleged PRPs located in OU 4 (of which the smaller is the plant owned by U.S. Mills). It is possible that U.S. Mills and the owners of the other plant, together with NCR, the original generator of the carbonless copy paper, could be required to bear a majority of the remediation costs of OU 4, and share with other PRPs the cost of monitoring OU 5. U.S. Mills has discussed possible remediation scenarios with other PRPs who have indicated that they expect U.S. Mills to bear an unspecified but meaningful share of the costs of OU 4 and OU 5. In February 2007, the EPA and WDNR issued a general notice of potential liability under CERCLA and a request to participate in remedial action implementation negotiations relating to OUs 2 – 5 to eight PRPs, including U.S. Mills. The notice requested that the PRPs indicate their willingness to participate in negotiations concerning performance of the remaining elements of the remedial action for OUs 2 – 5 and the resolution of the government entities’ claims for
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unreimbursed costs and natural resource damages. On April 9, 2007, U.S. Mills, in conjunction with other PRPs, presented to the EPA and the WDNR a proposed schedule to mediate the allocation issues among eight PRPs, including U.S. Mills. Non-binding mediation began in May 2007 and continued as bilateral/multilateral negotiations until mid 2008. To date, no agreement among the parties has occurred. On June 12, 2008, NCR and Appleton Papers, Inc., as plaintiffs, commenced suit in the United States District Court for the Eastern District of Wisconsin (No. 08-CV-0016-WCG) against U.S. Mills, as one of a number of defendants, seeking a declaratory judgment allocating among all the parties the costs and damages associated with the pollution and cleanup of the Lower Fox River. The suit also seeks damages from the defendants for amounts already spent by the plaintiffs, including natural resource damages, and future amounts to be spent by all parties with regard to the pollution and cleanup of the Lower Fox River. The court has initially limited discovery to information regarding when each party knew, or should have known, that recycling NCR-brand carbonless paper would result in the discharge of PCBs to a water body and what action, if any, each party took to avoid the risk of further contamination. The court has set a trial date for those issues only for December 1, 2009. U.S. Mills plans to vigorously defend the suit. On November 13, 2007, the EPA issued a unilateral Administrative Order for Remedial Action pursuant to Section 106 of CERCLA. The order requires U.S. Mills and the seven other respondents to jointly take various actions to cleanup OUs 2 – 5. The order establishes two phases of work. The first phase consists of planning and design work as well as preparation for dredging and other remediation work and was initially required to be completed by December 31, 2008. The second phase consists primarily of dredging and disposing of contaminated sediments and the capping of dredged and less contaminated areas of the river bottom. The second phase is required to begin in 2009 when weather conditions permit and is expected to continue for several years. The order also provides for a $32,500 per day penalty for failure by a respondent to comply with its terms as well as exposing a non-complying respondent to potential treble damages. Although U.S. Mills has reserved its rights to contest liability for any portion of the work, it is cooperating with the other respondents to comply with the first phase of the order, although its financial contribution will likely be determined by the lawsuit commenced in June 2008. As of December 31, 2008, U.S. Mills had accrued a total of $60.8 million for potential liabilities associated with the remediation of OUs 2 – 5 (not including amounts accrued for remediation of the OU 4 hotspot). That amount represents the minimum of the range of probable loss that can be reasonably estimated based on information available through the date of this report. At December 31, 2007, the accrual had been $20.0 million. In two separate actions during 2008, U.S. Mills increased its estimate of the minimum amount of potential loss it believes it is likely to incur for all Fox River related liabilities (other than the OU 4 hotspot) from $20.0 million to $60.8 million. Accordingly, U.S. Mills recognized additional pre-tax charges of $40.8 million in 2008 for such potential liabilities. Also during 2008, settlements totaling $40.8 million were reached on certain of the insurance policies covering the Fox River contamination. The recognition of these insurance settlements effectively offset the impact to earnings of the additional charges in 2008. The actual costs associated with cleanup of the Fox River site are dependent upon many factors and it is reasonably possible that total remediation costs could be higher than the current estimates of project costs which range from $390 million to more than $600 million for OUs 2 – 5. Some, or all, of any costs incurred by U.S. Mills may be subject to recoupment from other parties, but no amounts have been recognized in the financial statements of the Company for any such potential recoveries. Given the ongoing remedial design work being conducted, and the initial stages of remediation, it is possible there could be some additional changes to some elements of the reserve within the next year or thereafter, although that is difficult to predict. Similarly, U.S. Mills does not have a basis for estimating the possible cost of any natural resource damage claims against it. Accordingly, reserves have not been provided for this potential liability. However, for the entire river remediation project, the lowest estimate in the Governments’ 2000 report on natural resource damages was $176 million. In addition to its potential liability for OUs 4 and 5, U.S. Mills may have a contingent liability to Menasha Corporation to indemnify it for any amount for which it may be held liable in excess of insurance coverage for any environmental liabilities of a plant on OU 1 that U.S. Mills purchased from Menasha. Due to the uncertainty of Menasha’s liability and the extent of the insurance coverage as well as any defenses that may be asserted to any such claim, U.S. Mills has not established a reserve for this contingency. Although the Company lacks a reasonable basis for identifying any amount within the range of possible loss as a better estimate than any other amount, as has previously been disclosed, the upper end of the range may exceed the net worth of U.S. Mills. However, because the discharges of hazardous materials into the environment occurred before the Company acquired U.S. Mills, and U.S. Mills has been operated as a separate subsidiary of the Company, the Company does not believe that it bears financial responsibility for these legacy environmental liabilities of U.S. Mills. Therefore, the Company continues to believe that the maximum additional exposure to its consolidated financial position is limited to the equity position of U.S. Mills, which was approximately $78 million at December 31, 2008. Other Legal Matters On July 7, 2008, the Company was served with a complaint filed in the United States District Court for South Carolina by the City of Ann Arbor Employees’ Retirement System, individually and on behalf of others similarly situated. The suit purports to be a class action on behalf of those who purchased the Company’s common stock between February 7, 2007 and September 18, 2007, except officers and directors of the Company. The complaint alleges that the Company issued press releases and made public statements during the class period that were materially false and misleading because the Company allegedly had no reasonable basis for the earnings projections contained in the press releases and statements, and that such information caused the market price of the Company’s common stock to be artificially inflated. The Complaint also names certain Company officers as
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defendants and seeks an unspecified amount of damages plus interest and attorneys’ fees. The Company believes that the claims are without merit and intends to vigorously defend itself against the suit. Additional information regarding legal proceedings is provided in Note 15 to the Consolidated Financial Statements of this Annual Report on Form 10-K. Item 4. Submission of Matters to a Vote of Security Holders Not applicable.
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Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The Company’s common stock is traded on the New York Stock Exchange under the stock symbol “SON.” As of December 31, 2008, there were approximately 42,000 shareholder accounts. Information required by Item 201(d) of Regulation S-K can be found in Part III, Item 12 of this Annual Report on Form 10-K. The following table indicates the high and low sales prices of the Company’s common stock for each full quarterly period within the last two years as reported on the New York Stock Exchange, as well as cash dividends declared per common share:
The Company did not make any unregistered sales of its securities during 2008, and did not purchase any of its securities during the fourth quarter of 2008.
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Item 6. Selected Financial Data The following table sets forth the Company’s selected consolidated financial information for the past five years. The information presented below should be read together with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of this Annual Report on Form 10-K and the Company’s historical Consolidated Financial Statements and the Notes thereto included in Item 8 of this Annual Report on Form 10-K. The selected statement of income data and balance sheet data are derived from the Company’s Consolidated Financial Statements.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations GENERAL OVERVIEW Sonoco is a leading manufacturer of consumer and industrial packaging products and provider of packaging services with 327 locations in 35 countries. The Company’s operations are organized and reported in three segments, Consumer Packaging, Tubes and Cores/Paper and Packaging Services, while a number of smaller businesses are discussed as All Other Sonoco. Generally, the Company serves two broad end-use markets: consumer and industrial. Consumer and industrial sales are split approximately 54% and 46%, respectively. Geographically, approximately 63% of sales are generated in the United States, 19% in Europe, 9% in Canada and 9% in other regions. The Company is a market-share leader in many of its product lines, particularly in tubes, cores and composite containers and competition in most of the Company’s businesses is intense. Demand for the Company’s products and services is primarily driven by the overall level of consumer consumption of non-durable goods, however, certain product groups are tied more directly to durable goods, such as appliances, and construction. As a result, our businesses that supply and/or service consumer product companies tend to be, on a relative basis, more recession resistant than those that service industrial markets. Despite the ongoing global economic recession and credit crisis, conditions in consumer markets have been relatively stable over the past several years, though deterioration in the Company’s domestic textile and paper markets has negatively impacted the Company’s industrial businesses. Many of our businesses operate in industries where excess marginal capacity works to restrain the pricing ability of all market participants. This condition can be magnified by a slowdown in the overall economy. Strategy and Opportunities Financially, the Company’s objective is to deliver average annual double-digit total returns to shareholders over time. To meet that target, the Company focuses on three major areas: driving profitable sales growth, improving margins, and leveraging the Company’s strong cash flow and financial position. Operationally, the Company’s goal is to be the low-cost global leader in customer-preferred packaging solutions within targeted customer market segments. In December 2007, the Company shared its five-year plan to grow revenue, improve margins and more effectively utilize assets. The five-year plan continues the Company’s recent focus on growing its consumer-related business faster than the industrial-related business, with the goal of transitioning the Company’s overall mix of business to approximately 60% consumer and 40% industrial by 2012. The Company’s primary growth drivers are increasing organic sales, geographic expansion, strategic acquisitions and providing total packaging solutions for customers. Over the next five years, revenue growth is expected to be equally split between organic growth and acquisitions. Some of the organic growth is expected to occur in the form of new products. The five-year plan targets average annual sales from new products (those on the market for two years or less) at $100 million to $150 million. Sales from new products were $136 million in 2008, $100 million in 2007, and $111 million in 2006. Management believes the Company’s financial position and strong cash flow provide a competitive advantage in the current recessionary environment as the ability of some competitors to reliably meet customer needs is threatened by liquidity constraints and profitability concerns. The Company’s plan to improve margins focuses on leveraging fixed costs, improving productivity, maintaining a positive price/cost relationship (raising selling price at least enough to recover inflation of material, energy and freight costs), and improving underperforming operations. RESULTS OF OPERATIONS 2008 Overview Despite its many challenges, 2008 saw the Company’s sales reach a record $4.12 billion, up 2% from 2007. Net income was $164.6 million compared to $214.2 million for 2007. Raw material and energy costs rose dramatically in the first half of 2008 and, in the second half, the global recession, intensified by the onset of the credit crisis, led to a steep reversal in those same costs and a sharp decline in sales volume. In the end, overall volumes were down for the year and increased selling prices were more than offset by higher average costs. Productivity gains were strong, but fell short of recent levels due to the inefficiencies associated with lower capacity utilization. The weakened economy affected the Company’s industrial related businesses more than its consumer businesses. Volume declines in the Tubes and Cores/Paper segment resulted in segment sales being down $37 million from the prior year. In the Consumer Packaging segment, where volume declines have been more modest, price increases and acquisitions led to an increase in sales of $132 million. Year-to-year sales in the Packaging Services segment were essentially flat, and lower volume in the businesses comprising All Other Sonoco resulted in reduced sales of $11 million. Overall gross profit margin declined to 17.6% compared to 18.7% in 2007 and 19.3% in 2006. The sequential declines track the decay in the overall economy, beginning in 2007 with the drop off in housing sales and construction and spreading more broadly in 2008, and the soaring increase in commodity costs from mid-2007 through mid-2008. As noted above, declines in volume and the Company’s inability to consistently adjust selling prices as quickly and to the same degree as the rise in costs have pressured margins throughout this period. In December 2008, the Company announced and substantially executed a realignment of manufacturing capacity to more closely match market conditions and to establish an affordable fixed cost structure that is expected to aid margins going forward. Net income for 2008 was negatively impacted by largely noncash restructuring and restructuring-related asset impairment charges totaling $30.8 million, net of tax, and a noncash financial asset impairment charge of $31.0 million, net of tax. Net income in 2007 included similar restructuring charges totaling $25.3 million, net of tax, and an increase in environmental reserves of $14.8 million, net of tax, related to a subsidiary’s paper operations in Wisconsin. Net income in 2007 benefited from a lower effective tax rate primarily due to the release of tax reserves and foreign tax rate reductions.
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Due primarily to the investment losses incurred on its benefit plan assets during 2008, the aggregate unfunded position of the Company’s various benefit plans increased by $318 million. While the change in the funded status of the plans did not impact 2008 earnings, it did result in a reduction to shareholders’ equity of approximately $200 million, net of tax. The Company generated $379 million in cash from operations during 2008, which was used to fund capital expenditures, pay down debt, and return value to shareholders through increased dividends. Cash on hand increased more than $30 million during the year ended December 31, 2008. The Company believes that cash on hand, cash generated from operations, and the available borrowing capacity under its commercial paper program provide adequate liquidity to fund operations, meet its financial obligations and pursue its strategic objectives. Outlook The Company expects that it will be able to hold, and in some cases expand, market share across its businesses in 2009. Volumes will largely depend on the direction of the economy, which is very uncertain at this time. Changes in raw material and energy costs are expected to be less volatile than in 2008 and move in line with changes in the economy, for the most part allowing the Company to more effectively manage the price/cost relationship. The Company is bracing itself for the economic weakness experienced in late 2008 to continue well into 2009. Under these conditions, most of our businesses would likely see annual sales volumes well below 2008 levels. However, barring any substantial worsening of the economy, new products and customers in rigid containers are expected to benefit sales and profits in Consumer Packaging. The Company also expects that productivity improvements, recent restructuring actions and other cost control measures will aid 2009 results and leave the Company well positioned for an eventual economic turnaround. Reduced nominal returns due to lower asset levels, together with the amortization of losses on plan assets, will result in a year-over-year increase in pension and postretirement benefit plan expenses of approximately $59 million in 2009. Cash contributions to these plans in 2009 are expected to total approximately $20 million. The consolidated effective tax rate, which was 27.1% in 2008, is expected to be approximately 32% in 2009. As discussed below under “Critical Accounting Policies and Estimates,” should certain of the Company’s businesses fail to perform up to expectations, the outlook for those businesses deteriorate, or other circumstances or assumptions adversely change, goodwill impairment charges may be recognized. Restructuring Charges, Unusual Items and Other Activities Restructuring/Asset Impairment Charges During 2008, the Company recognized restructuring and restructuring-related asset impairment charges totaling $57.4 million ($34.9 million after tax). These charges were comprised of severance and termination benefits of $24.2 million, asset impairment charges of $20.6 million, and other exit costs of $12.6 million. The charges resulted from a number of plant closures, some of which were initiated in 2007, as well as the permanent elimination of an additional 125 salaried positions. Plant closures which gave rise to significant costs in 2008 include the following: three rigid packaging plants in the United States; three paper mills, one each in the United States, Canada and China; a specialty paper machine in the United States; a metal ends plant in Brazil; and three tube and core plants, one each in Canada, Spain and China. Asset impairment charges related primarily to the closures of the metal ends plant in Brazil, the rigid packaging plants in the United States, the paper mills in the United States and Canada, and the tube and cores plant in Spain. Impairment charges of $3.2 million were also recognized on other continuing long-lived assets. Impaired assets were written down to the lower of carrying amount or fair value, less estimated costs to sell, if applicable. Other exit costs consist of building lease termination charges and other miscellaneous costs related to plant closings as well as pension curtailment and settlement costs related to defined benefit pension plans at certain closed facilities in Canada. Also in 2008, the Company recorded a noncash financial asset impairment charge of $42.7 million ($31.0 million after tax). This charge resulted from writing off two financial instruments, a preferred equity interest and a subordinated note receivable, which had been obtained in the Company’s 2003 sale of its High Density Film business. The Company’s year-end 2007 financial review of the buyer indicated that collectibility was probable. Accordingly, the instruments were included in “Other Assets” in the Company’s Consolidated Balance Sheets at December 31, 2007. However, based on updated information provided by the buyer late in the first quarter of 2008, the Company concluded that neither the collection of its subordinated note receivable nor redemption of its preferred equity interest was probable, and that their value was likely zero. Accordingly, the Company recognized an asset impairment charge for the full carrying amount of the instruments in the first quarter of 2008. The buyer subsequently filed a petition for relief under Chapter 11 with the United States Bankruptcy Court for the District of Delaware that included a plan of reorganization, which was approved by the court June 26, 2008. As part of the plan of reorganization, the Company’s preferred equity interest and its subordinated note receivable were extinguished. During 2007, the Company recognized restructuring and asset impairment charges totaling $36.2 million ($25.4 million after tax). These charges resulted primarily from closing the following facilities: a metal ends plant in Brazil; two rigid packaging plants, one in the United States and one in Germany; rigid packaging production lines in the United Kingdom; two paper mills, one in China and one in France; three tube and core plants, one in the United States and two in Canada; two molded plastics plants, one in the United States and one in Turkey; and a point-of-purchase display manufacturing plant in the United States. Five of these closures were not part of a formal restructuring plan. The remaining closures were part of restructuring plans announced in 2006 and 2003. The charges were comprised of severance and termination benefits of $11.9 million, other exit costs of $7.6 million, and asset impairment charges of $16.7 million. Other exit costs consist of building lease termination charges and other miscellaneous costs related to closing these facilities. Asset impairment charges
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related primarily to the closures of the metal ends plant in Brazil and the rigid packaging plant in the United States. Impaired assets were written down to the lower of carrying amount or fair value, less estimated costs to sell, if applicable. During 2006, pursuant to restructuring plans announced in 2006 and 2003, the Company recognized restructuring and asset impairment charges totaling $26.0 million ($21.3 million after tax). These charges resulted primarily from the following plant closures: a paper mill in France; four tube and core plants, three in the United States and one in Canada; two flexible packaging operations, one in the United States and one in Canada; a wooden reels facility in the United States; and a molded plastics operation in the United States. In addition, the charges reflect the impact of downsizing actions primarily in the Company’s European tubes and cores/paper operations. These charges were comprised of severance and termination benefits of $11.8 million, other exit costs of $6.4 million, and asset impairment charges of $7.8 million. Other exit costs consist of building lease termination charges and other miscellaneous costs related to closing these facilities. Asset impairment charges related primarily to the closure of the paper mill in France. Impaired assets were written down to the lower of carrying amount or fair value, less estimated costs to sell, if applicable. The Company also recorded noncash, after-tax income in the amount of $4.1 million in 2008, $0.1 million in 2007 and $0.4 million in 2006 to reflect minority shareholders’ portions of restructuring costs that were charged to expense. This income is included in “Equity in earnings of affiliates/minority interest in subsidiaries, net of tax” in the Company’s Consolidated Statements of Income. The Company expects to recognize future additional restructuring costs of approximately $11 million associated with previously announced restructuring actions. The Company believes the majority of these charges will be incurred and paid by the end of 2009. Acquisitions/Joint Ventures The Company completed two acquisitions during 2008 at an aggregate cost of $5.5 million in cash. These acquisitions consisted of Amtex Packaging, Inc., a packaging fulfillment company included in the Packaging Services segment, and VoidForm International Ltd., a Canada-based construction tube business included in the Tubes and Cores/Paper segment. The acquisition of these businesses is expected to generate annual sales of approximately $6 million. The Company has accounted for these acquisitions as purchases and, accordingly, has included their results of operations in consolidated net income from the respective dates of acquisition. Pro forma results have not been provided, as the acquisitions were not material to the Company’s financial statements, individually or in the aggregate. The Company completed four acquisitions during 2007, and purchased the remaining 51.1% interest in a small joint venture in Europe, at an aggregate cost of $236.3 million, all of which was paid in cash. Acquisitions made in the Consumer Packaging segment included Matrix Packaging, Inc., a leading manufacturer of custom-designed blow molded rigid plastic containers and injection molded products with operations in the United States and Canada, and the fiber and plastic container business of Caraustar Industries, Inc. Additional acquisitions in 2007 consisted of a small tube and core business in Mexico, which is included in the Tubes and Cores/Paper segment, and a small protective packaging business in the United States, which is included in All Other Sonoco. The Company also purchased the remaining 51.1% interest in AT-Spiral OY, a European tubes and cores joint venture. Annual sales from these acquisitions are expected to total approximately $200 million. As these acquisitions were not material to the Company’s financial statements, individually or in the aggregate, pro forma results have not been provided. The Company completed six acquisitions during 2006, and purchased the remaining 35.5% minority interest of its Sonoco-Alcore S.a.r.l. joint venture, at an aggregate cost of $227.3 million, all of which was paid in cash. Annual sales from these acquisitions, excluding the joint venture interest, are expected to total $130 million. The Company had previously consolidated the joint venture, which was included in the Tubes and Cores/Paper segment, so no additional sales were reported as a result of the purchase of the remaining interest. Other Special Charges, Income Items and Contingencies In two separate actions during 2008, U.S. Paper Mills Corp. (U.S. Mills), a wholly owned subsidiary of the Company, recognized additional pre-tax charges of $40.8 million as the Company increased its estimate of the minimum amount of potential loss it believes U.S. Mills is likely to incur for all Fox River related environmental liabilities. Also during 2008, settlements totaling $40.8 million were reached on certain of the insurance policies covering the Fox River contamination. The recognition of these insurance settlements offset the impact to earnings of the additional charges in 2008. In 2007, U.S. Mills recorded charges totaling $25.2 million ($14.8 million after tax) in association with environmental remediation liabilities for various sites in the lower Fox River in Wisconsin. In 2005, U.S. Mills recorded a $12.5 million charge ($7.6 million after tax) related to one of the sites. The charges are included in “Selling, general and administrative expenses” in the Company’s Consolidated Statements of Income. The 2005 charge and $5.2 million of the 2007 charge related to a particular site on the lower Fox River in which remediation of PCB-contaminated sediments has already begun. The total charge of $17.7 million represents the Company’s best estimate of what it is likely to pay to complete the project; however, the actual costs associated with remediation of this particular site are dependent upon many factors, and it is possible that actual costs could exceed current estimates. The Company acquired U.S. Mills in 2001, and the identified contamination predates the acquisition. Some or all of any costs incurred may be recoverable from third parties; however, there can be no assurance that such claims for recovery will be successful. Accordingly, no amounts have been recognized in the financial statements for such recovery. In February 2007, U.S. Mills and seven other potentially responsible parties received a general notice of potential liability under the Comprehensive Environmental Response, Compensation, and Liability Act from the Environmental Protection Agency (EPA) and the Wisconsin Department of Natural Resources relating to a stretch of the lower Fox River, including the bay at Green Bay. The contamination referred to in this notice covers a vastly larger area than the
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site referred to in the paragraph above. Non-binding mediation among some of the potentially responsible parties began in May 2007 and continued as bilateral/multilateral negotiations until mid 2008. To date, no agreement among the parties has occurred, but the parties are now involved in litigation to determine their relative responsibility for the costs of remediation. Although U.S. Mills’ ultimate share of the liability could conceivably exceed its net worth, the Company believes the maximum additional exposure to Sonoco’s consolidated financial position is limited to the equity position of U.S. Mills which was approximately $78 million as of December 31, 2008, excluding any tax benefits that may reduce the net charge. For a more detailed discussion of the Fox River environmental matters, see “Item 3. Legal Proceedings” above. Results of Operations 2008 versus 2007 Operating Revenue Consolidated net sales for 2008 were $4.12 billion, an $82 million, or 2.0%, increase over 2007. The components of the sales change were:
Average selling prices were generally higher throughout the Company, with the exceptions of Sonoco Recycling and point-of-purchase and fulfillment operations, as the Company was able to implement price increases in response to higher costs of labor, energy, freight and materials. Companywide volume, excluding service center revenue, which was on a pass-through basis, decreased approximately 4.4% from 2007 levels. The overall volume decrease was driven by declines in Tubes and Cores/Paper, Packaging Services and All Other Sonoco. In Consumer Packaging, global rigid paper and plastic volume increased slightly despite the harsh economic conditions in the second half of the year. Total domestic sales were $2.6 billion, up 3% from 2007. International sales were $1.5 billion, basically flat with 2007 levels. Costs and Expenses In 2008, aggregate pension and postretirement expenses decreased $8.4 million to $25.8 million, versus $34.2 million in 2007. Approximately 75% of these expenses are reflected in cost of sales and the balance in selling, general and administrative expenses. The Company expects pension and postretirement expenses to increase by approximately $59 million in 2009 as a result of decreased investment gains due to lower plan asset levels and the amortization of losses on plan assets. There was a negative return on the assets of U.S.-based defined benefit plans of 24.3% in 2008, compared with a positive return of 8.4% in 2007. Future years’ expense will depend largely on the performance of plan assets and the general level of long-term interest rates. Selling, general and administrative expenses as a percentage of sales decreased to 9.1% for the year from 10.1% in 2007. In total, these expenses declined $35.3 million year over year. Of the decline, $15.6 million is due primarily to lower 2008 incentive compensation costs related to diminished current year operating results, reduced pension and postretirement expenses and to fixed cost management pursued in response to the sharp economic downturn. The remaining change, $19.7 million, is attributable to last year’s $25.2 million U.S. Mills environmental charge, as discussed above, which was partially offset by a $5.5 million recovery from an outside party of certain benefit costs. Operating results also reflect restructuring and restructuring-related asset impairment charges of $57.4 million and $36.2 million in 2008 and 2007, respectively. In addition, 2008 results include a $42.7 million noncash financial asset impairment charge for the Company’s remaining financial interest related to the 2003 sale of its high-density film business. These items are discussed in more detail in the section above titled, “Restructuring Charges, Unusual Items and Other Activities.” Research and development costs, all of which were charged to expense, totaled $15.9 million and $15.6 million in 2008 and 2007, respectively. Management expects research and development spending in 2009 to be consistent with these levels. Net interest expense totaled $47.2 million for the year ended December 31, 2008, compared with $52.3 million in 2007. The decrease was due primarily to lower average debt levels and lower average interest rates. The 2008 effective tax rate was 27.1%, compared with 21.6% in 2007. The year-over-year increase in the effective tax rate was due primarily to the 2007 release of tax reserves on expiration of statutory assessment periods in an amount greater than in 2008, and foreign tax rate reductions due to tax law changes in 2007. The 2008 results also included favorable adjustments to the basis of acquired assets resulting from a tax law change in Italy and the unfavorable impact of a capital loss for which the ultimate recognition of a benefit is uncertain and a valuation allowance had to be established. The estimate for the potential outcome for any uncertain tax issue is highly judgmental. The Company believes it has adequately provided for any reasonably foreseeable outcome related to these matters. However, future results may include favorable or unfavorable adjustments to estimated tax liabilities in the period the assessments are made or resolved or when statutes of limitations on potential assessments expire. Additionally, the jurisdictions in which earnings or deductions are realized may differ from current estimates. As a result, the effective tax rate may fluctuate significantly.
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Reportable Segments Consolidated operating profits, also referred to as “Income before income taxes” on the Consolidated Statements of Income, are comprised of the following:
Segment results viewed by Company management to evaluate segment performance do not include restructuring and impairment charges and net interest charges. Accordingly, the term “segment operating profits” is defined as the segment’s portion of “Income before income taxes” excluding restructuring charges, asset impairment charges and net interest expense. General corporate expenses, with the exception of restructuring charges, interest and income taxes, have been allocated as operating costs to each of the Company’s reportable segments and All Other Sonoco. See Note 17 to the Company’s Consolidated Financial Statements for more information on reportable segments. Consumer Packaging
Sales in this segment increased due to the full year impact of the May 2007 acquisition of Matrix Packaging, Inc. along with increased selling prices throughout the segment. In addition, even though the dollar strengthened during the second half of the year, the total year impact of exchange rates was favorable by $4.6 million. These favorable impacts were partially offset by lower volume in flexible packaging, closures and rigid plastic packaging. Overall segment volumes, excluding the impact of acquisitions, were down less than 1%. Domestic sales were approximately $1,180 million, up 15.0% from 2007, and international sales were approximately $390 million, down 5.2% from 2007. The decline in international sales reflects the shutdown of a metal ends plant in Brazil and the subsequent transfer of a majority of its business into the United States. Segment operating profits increased primarily due to the impact of productivity and purchasing initiatives along with the full year impact of the May 2007 acquisition of Matrix Packaging, Inc. Current year earnings benefited from the shutdown of two plants that contributed negatively to 2007 results, partially offset by the negative impact of a plant startup in Ohio. The productivity and purchasing gains were partially offset by the small overall decline in volume and an unfavorable shift in the mix of business. In 2008, selling price increases were able to effectively offset increased costs of raw materials, freight, energy and labor. A significant increase in the Company’s cost of tinplate steel, which is reset periodically under contract, took effect at the beginning of 2009. Due to customer contract limitations, the Company expects to recover only a part of the cost increase through selling price adjustments during the first half of the year. Due to the timing of the offsetting price increases, the Company expects that approximately $5 million of these higher costs will not be recovered during 2009. Significant capital spending included increasing rigid plastic container production capacity in the United States and productivity projects throughout the segment. Tubes and Cores/Paper
The decrease in sales was due to volume shortfalls throughout the segment and the closure of an under-performing paper mill in China. The volume shortfalls were partially offset by increased selling prices for converted products and the effect of favorable exchange rates. The impact of lower volume, the majority of which occurred during the fourth quarter of the year, was felt throughout the segment, but most significantly in domestic and European tube and core operations. Excluding the net impact of divestitures, volume in the segment decreased by approximately 6%. Domestic sales decreased approximately $25 million, or 3.0%, to approximately $800 million. International sales decreased approximately $12 million, or 1.4% to approximately $875 million, with the lower decline reflecting the benefit of a weaker dollar throughout much of the year. Due to last year’s $25.2 million charge for environmental reserves, the slight increase in year-over-year segment operating profits is not fully indicative of actual current year performance. Lower volumes and an unfavorable shift in the mix of business hampered current year results, and, if not for last year’s environmental charge, segment operating profits would have posted a year-over-year decline. Productivity and purchasing initiatives along with the impact of closing the paper facility in China favorably impacted current year results. Somewhat offsetting these benefits were higher energy, freight, material and labor costs that were not fully recovered by selling price increases. Significant capital spending included the modification of several paper machines, primarily in the United States and Europe, and productivity projects throughout the segment.
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Packaging Services
Sales decreased slightly as volume shortfalls and lower selling prices were mostly offset by a favorable impact from exchange rates and added sales from a small acquisition. The selling price decreases were primarily the result of competitive bidding activity in the latter half of 2007, the impacts of which were not fully realized until 2008. Domestic sales decreased to approximately $334 million, a 10.7% reduction, while international sales increased to approximately $183 million, up 26.8%, primarily as a result of increased service center volume in Poland. The decrease in segment operating profits is attributable to lower selling prices and volume decreases in point-of-purchase and fulfillment operations. In addition, lower capacity utilization negatively impacted productivity. Although service center volume increased, it had very little impact on profits as these sales were on a pass-through basis with no significant additional gross margin. Capital spending included capacity expansion in Europe as well as numerous productivity and customer development projects in the United States and Europe. All Other Sonoco
Sales for All Other Sonoco decreased on lower volumes in molded plastics, protective packaging and wire and cable reels, which were partially offset by selling price increases and the effect of favorable exchange rates. Domestic sales were approximately $282 million, down 4.1% from 2007, and international sales were approximately $78 million, an increase of 1.2%. Operating profits in All Other Sonoco decreased due to volume declines and an unfavorable shift in the mix of business, partially offset by manufacturing productivity and purchasing initiatives. Through higher selling prices, the Company was able to recover increases in raw material costs but not higher costs of energy, freight and labor. Capital spending included investing in productivity and customer development projects in the United States, Europe and Asia for molded and extruded plastics, protective packaging and wire and cable reels.
Financial Position, Liquidity and Capital Resources Cash Flow Cash flow from operations totaled $379.4 million in 2008, compared with $445.1 million in 2007. The decline was due largely to a lower level of working capital improvement in 2008 than in the preceding year due in part to the timing of certain payments at the end of 2008. Cash flows used by investing activities decreased to $110.2 million in 2008, from $379.6 million in 2007. The decrease was primarily due to a $230.7 million decrease in year-over-year acquisition spending combined with a $46.3 million year-over-year decrease in capital spending. Capital spending of $123.1 million in 2008 marked a return to more historic levels, compared with the $169.4 million spent in 2007. Capital spending is expected to be approximately $120 million—$130 million in 2009. Net cash used by financing activities totaled $241.4 million in 2008, compared with $75.0 million in 2007. The Company repaid a net $153.0 million of debt during 2008 whereas it had increased net borrowings by $78.7 million in 2007 due principally to the repurchase of 3.0 million shares of the Company’s common stock and prior year acquisition spending of $236.3 million. Current assets decreased by $97.7 million to $930.0 million at December 31, 2008. This decrease is largely attributable to lower levels of inventory and accounts receivable at December 31, 2008, stemming from slower business conditions in the fourth quarter of 2008 compared with the same period last year and from the impact of foreign currency translation due to a stronger U.S. dollar relative to most other major currencies at the end of 2008 compared to the end of 2007. Current liabilities decreased by $59.9 million to $698.2 million at December 31, 2008. This decrease was due in part to lower accounts payable for the same reasons noted above, as well as lower accrued wages and notes payable. These decreases were partially offset by a higher year-over-year balance in accrued expenses due primarily to increased environmental and restructuring reserves. The current ratio was 1.3 at December 31, 2008 and 1.4 at December 31, 2007. The Company uses a notional pooling arrangement with an international bank to help manage global liquidity requirements. Under this pooling arrangement, the Company and its participating subsidiaries may maintain either a cash deposit or borrowing position through local currency accounts with the bank, so long as the aggregate position of the global pool is a notionally calculated net cash deposit. Because it maintains a security interest in the cash deposits, and has the right to offset the cash deposits against the borrowings, the bank provides the Company and its participating subsidiaries favorable interest terms on both.
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Contractual Obligations The following table summarizes contractual obligations at December 31, 2008:
Capital Resources The Company reduced its total debt by $159.7 million during 2008 to a total of $689.8 million at December 31, 2008. This reduction was accomplished through net repayments of outstanding debt during the year of $153.0 million and a foreign currency translation impact of $6.7 million. During the latter part of 2008, the Internal Revenue Service issued a temporary rule extending to 60 days the period that U.S. corporations may borrow funds from foreign subsidiaries without unfavorable tax consequences. The Company utilized this rule during the final two months of the year to access approximately $72 million of offshore cash on hand, which was used to reduce commercial paper outstanding. These short-term lending arrangements were subsequently settled in 2009, resulting in equivalent increases in commercial paper outstanding and cash on hand. Depending on its immediate offshore cash needs, the Company may choose to access such funds again as allowed by the temporary rule. The Company operates a $500 million commercial paper program that provides a flexible source of domestic liquidity. The program is supported by the Company’s five-year committed bank credit facility of an equal amount established May 3, 2006, with a syndicate of lenders that is committed until May 2011. The commercial paper program has continued to operate efficiently during the recent disruption of global credit markets. In the event that the disruption of global credit markets were to become so severe that the Company was unable to issue commercial paper, it has the contractual right to draw funds directly on the underlying bank credit facility. Based on the information currently available to it, the Company believes that the lenders continue to have the ability to meet their obligations under the facility. At the Company’s discretion, the borrowing rate for such loans could be based on either the agent bank’s prime rate, or a pre-established spread over the London InterBank Offered Rate (LIBOR). Outstanding commercial paper, a component of the Company’s long-term debt, totaled $95.0 million at December 31, 2008. On January 2 and April 1, 2008, the Company prepaid its 6.125% and 6.0% industrial revenue bonds, respectively. The combined $70.1 million redemptions were financed with commercial paper. Acquisitions and internal investments are key elements of the Company’s growth strategy. The Company believes that cash on hand, cash generated from operations, and the available borrowing capacity under its existing credit agreement will enable it to support this strategy. Although the Company currently has no intent to do so, it may obtain additional financing in order pursue its growth strategy. Although the Company believes that it has excess borrowing capacity beyond its current lines, there can be no assurance, especially in light of current credit market conditions, that such financing would be available or, if so, at terms that are acceptable to the Company. The Company’s various U.S and international defined benefit pension and postretirement plans were underfunded at the end of 2008 by $459.6 million. Based on current actuarial estimates, the Company anticipates that total 2009 contributions to its benefit plans will be comparable to 2008 levels which were approximately $20 million. This amount reflects the full utilization of the remaining funding credits available for the U.S. qualified defined benefit pension plan that resulted from having previously funded the plan in excess of minimum requirements. Funding requirements beyond 2009 will depend largely on actual investment returns and future actuarial assumptions. Assuming the actual return on plan assets is 8.5%, and there is no change in applicable interest rates, the required funding for the U.S. qualified defined benefit plan is estimated to be approximately $60 million and $75 million in 2010 and 2011, respectively. Participation in the U.S. qualified defined benefit pension plan is frozen for salaried and non-union hourly U.S. employees hired on or after January 1, 2004. In February 2009, the plan was further amended to freeze service credit earned effective December 31, 2018. This change is expected to moderately reduce the volatility of long-term funding exposure and expenses. Shareholders’ equity decreased $278.6 million during 2008 as net income of $164.6 million was more than offset by cash dividends of $106.6 million and an increase in the accumulated other comprehensive loss component of shareholders’ equity. This increase included a $141.2 million translation loss stemming from the impact of the strong U.S. dollar on the Company’s foreign investments and a $194.1
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million defined benefit plan adjustment stemming primarily from the 2008 investment losses incurred on the assets in the Company’s various pension plans. Shareholders’ equity increased $222.5 million during 2007. The increase resulted mainly from net income of $214.2 million in 2007, stock option exercises of $59.8 million, a foreign currency translation gain of $95.4 million, and defined benefit plan adjustments, net of tax, of $59.0 million, offset by cash dividends of $102.7 million, and the repurchase of $109.2 million of the Company’s common stock. The Company’s Board of Directors has authorized the repurchase of up to 5.0 million shares of the Company’s common stock. During 2007, the Company purchased a total of 3.0 million shares of its common stock under this authorization at a total cost of $109.2 million. The Board of Directors subsequently approved the reinstatement of those shares to the original repurchase authorization. No shares were repurchased under this authorization during 2008. Accordingly, at December 31, 2008, a total of 5.0 million shares remain available for repurchase. Although the ultimate determination of whether to pay dividends is within the sole discretion of the Board of Directors, the Company plans to increase dividends as earnings grow. Dividends per common share were $1.07 in 2008, $1.02 in 2007 and $.95 in 2006. On February 4, 2009, the Company declared a regular quarterly dividend of $0.27 per common share payable on March 10, 2009, to shareholders of record on February 20, 2009. Off-Balance Sheet Arrangements The Company had no material off-balance sheet arrangements at December 31, 2008. Risk Management As a result of operating globally, the Company is exposed to changes in foreign exchange rates. The exposure is well diversified as the Company’s facilities are spread throughout the world, and the Company generally sells in the same countries where it produces. The Company monitors these exposures and may use traditional currency swaps and forward foreign exchange contracts to hedge a portion of the forecasted transactions that are denominated in foreign currencies, foreign currency assets and liabilities or net investment in foreign subsidiaries. The Company’s foreign operations are exposed to political and cultural risks, but the risks are mitigated by diversification and the relative stability of the countries in which the Company has significant operations. The Company is exposed to interest-rate fluctuations as a result of using debt as a source of financing for its operations. The Company may from time to time use traditional, unleveraged interest-rate swaps to manage its mix of fixed and variable rate debt and to control its exposure to interest rate movements within selected ranges. No such instruments were outstanding at December 31, 2008. The Company is a purchaser of various inputs such as recovered paper, energy, steel, aluminum and resin. The Company generally does not engage in significant hedging activities, other than for energy and, from time to time, aluminum, because there is usually a high correlation between the primary input costs and the ultimate selling price of its products. Inputs are generally purchased at market or fixed prices that are established with individual vendors as part of the purchase process for quantities expected to be consumed in the ordinary course of business. On occasion, where the correlation between selling price and input price is less direct, the Company may enter into derivative contracts such as futures or swaps to reduce the effect of price fluctuations. At December 31, 2008, the Company had contracts outstanding to fix the costs of a portion of commodity, energy and foreign exchange risks for 2009 through July 2012. Of these, the Company had swaps to cover approximately 6.3 million MMBTUs of natural gas representing approximately 75%, 57% and 32% of anticipated U.S. and Canadian natural gas usage for 2009, 2010 and 2011, respectively. The Company also had hedges to cover the purchase of approximately 7,920 metric tons of aluminum representing approximately 49% of anticipated usage for 2009. At December 31, 2008, the Company had a number of foreign currency swaps in place as both designated and undesignated hedges of either anticipated foreign currency denominated transactions or existing financial assets and liabilities. The fair market value of derivatives was a net unfavorable position of $14.9 million ($7.2 million after tax) at December 31, 2008, and a net unfavorable position of $2.4 million ($1.5 million after tax) at December 31, 2007. Derivatives are marked to fair value using published market prices, if available, or estimated values based on current price quotes and a discounted cash flow model. See Note 11 to the Consolidated Financial Statements for more information on financial instruments. The Company is subject to various federal, state and local environmental laws and regulations concerning, among other matters, solid waste disposal, wastewater effluent and air emissions. Although the costs of compliance have not been significant due to the nature of the materials and processes used in manufacturing operations, such laws also make generators of hazardous wastes and their legal successors financially responsible for the cleanup of sites contaminated by those wastes. The Company has been named a potentially responsible party at several environmentally contaminated sites, both owned and not owned by the Company. These regulatory actions and a small number of private party lawsuits are believed to represent the Company’s largest potential environmental liabilities. The Company has accrued $70.5 million (including $67.4 million associated with U.S. Mills) at December 31, 2008, compared with $31.1 million at December 31, 2007 (including $29.0 million associated with U.S. Mills), with respect to these sites. See “Other Special Charges, Income Items and Contingencies,” Item 3 – Legal Proceedings, and Note 15 to the Consolidated Financial Statements for more information on environmental matters.
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Results of Operations 2007 versus 2006 Operating Revenue Consolidated net sales for 2007 were $4.04 billion, a $383 million, or 10.5%, increase over 2006. The components of the sales change were:
Prices were higher throughout the Company, with the exceptions of flexible packaging and point-of-purchase and fulfillment operations, as the Company was able to implement price increases to offset the impact of higher costs of labor, energy, freight and materials. Companywide volume, excluding service center revenue, which was on a pass-through basis, decreased approximately 1.0% from 2006 levels driven by decreases in the Tubes and Cores/Paper and Consumer Packaging segments, partially offset by volume increases in point-of-purchase displays. Domestic sales were $2.5 billion, up 7.6% from 2006. International sales were $1.5 billion, up 15.7% over 2006, driven primarily by the impact of acquisitions and currency translation. Costs and Expenses Selling, general and administrative expenses as a percentage of sales increased to 10.1% during the year from 9.8% in 2006, primarily as a result of the previously mentioned $25.2 million U.S. Mills environmental charge. Stock-based compensation expense associated with the issuance of stock-settled stock appreciation rights totaled $4.0 million and $4.1 million in 2007 and 2006, respectively. 2007 results also include the recovery from a third party of $5.5 million in certain benefit costs. In 2007, aggregate pension and postretirement expense decreased $9.9 million to $34.2 million, versus $44.1 million in 2006. This reduction was partially offset by a $3.5 million increase in defined contribution plan costs. The return on assets of U.S.-based defined benefit plans was 8.4% in 2007 and 13.9% in 2006. Operating profits also reflect restructuring and asset impairment charges of $36.2 million and $26.0 million in 2007 and 2006, respectively. These items are discussed in more detail in the section above titled, “Restructuring Charges, Unusual Items and Other Activities.” Research and development costs, all of which were charged to expense, totaled $15.6 million and $12.7 million in 2007 and 2006, respectively. Net interest expense totaled $52.3 million for the year ended December 31, 2007, compared with $45.3 million in 2006. The increase was due primarily to higher average debt levels resulting from acquisitions and stock buybacks. The 2007 effective tax rate was 21.6%, compared with 34.0% in 2006. The year-over-year decrease in the effective tax rate, which added approximately $32 million to reported net income, was due primarily to the release of tax reserves on expiration of statutory assessment periods, foreign tax rate reductions and improved international results. Included in the effective tax rate for 2006 was the impact of a $5.3 million benefit associated with entering into favorable tax agreements with state tax authorities and closing state tax examinations for amounts less than originally anticipated. The 2006 benefits were partially offset by a $4.9 million impact resulting from restructuring charges for which a tax benefit could not be recognized. Reportable Segments Consolidated operating profits, also referred to as “Income before income taxes” on the Consolidated Statements of Income, are comprised of the following:
Consumer Packaging
Sales in this segment increased due to the impact of acquisitions, increased selling prices of composite cans and closures and favorable exchange rates, as the dollar weakened against foreign currencies. These favorable impacts were partially offset by lower volume in composite cans along with lower volume and lower selling prices in flexible packaging. Overall volumes, excluding the impact of acquisitions, were down 1% in the segment. Domestic sales were approximately $1,027 million, up 11.0% from 2006, and international sales were approximately $411 million, up 8.3% from 2006. Segment operating profits decreased primarily due to price and volume declines in flexible packaging, along with volume declines in composite cans. These unfavorable factors exceeded the impact of productivity and purchasing initiatives and acquisitions. While the Company was able to increase selling prices in all operations except for flexible packaging, it was unable to offset increased costs of energy, freight, material and labor. High startup costs at the Company’s rigid plastics container plants in Wisconsin and Ohio also dampened operating profits in the segment, as did operational issues at the metal ends plant in Brazil. Both the Wisconsin and Brazil plants were closed by the end of the first quarter of 2008.
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Significant capital spending included increasing rigid plastic production capacity in the United States and productivity projects throughout the segment. Tubes and Cores/Paper
The increase in sales was due to increased selling prices throughout the segment, the impact of acquisitions and the effect of favorable exchange rates. Lower domestic tube and core volume was partially offset by increased volume in the Company’s European operations. Excluding the impact of acquisitions, overall volume in the segment decreased by approximately 2%. Domestic sales increased approximately $52 million, or 6.8%, to approximately $825 million and international sales increased approximately $134 million, or 17.8% to approximately $887 million. International sales increased primarily as a result of the late 2006 acquisition of the remaining 75% interest in Demolli Industria Cartaria S.p.A, an Italy-based manufacturer of tubes, cores and paperboard. Segment operating profits were unfavorably impacted by a charge of $25.2 million related to an increase in the environmental reserve at a Company subsidiary’s paper operations in Wisconsin (see “Other Special Charges, Income Items and Contingencies” above for a discussion of this claim). In addition, lower volume and increases in the costs of energy, freight, material and labor had a negative impact on segment profitability. Partially offsetting these items were productivity and purchasing initiatives and higher selling prices, along with the impact of acquisitions. Significant capital spending included the modification of several paper machines, primarily in the United States, Mexico and Europe, and building of new tube and core plants in Asia. Packaging Services
Sales increased due to higher volumes throughout the segment, which more than offset lower selling prices in point-of-purchase and fulfillment operations related to competitive bidding activity. Domestic sales increased to approximately $374 million, an 8.5% increase, while international sales increased to approximately $144 million, up 29.1%, primarily as a result of increased service center volume in Poland. The increase in segment operating profits is attributable to volume increases in point-of-purchase and fulfillment operations along with productivity and purchasing initiatives. The service centers’ sales increase had very little impact on profits, as these sales were on a pass-through basis with no significant additional gross margin. Partially offsetting these favorable factors were the selling price declines discussed above. Capital spending included numerous productivity and customer development projects in the United States and Europe. All Other Sonoco
Sales for All Other Sonoco increased slightly as price increases, the impact of acquisitions and the effect of favorable exchange rates were nearly offset by lower volumes in molded plastics and wire and cable reels. Domestic sales were approximately $294 million, down 2.2% from 2006, and international sales were approximately $77 million, an increase of 11.9%. Operating profits in All Other Sonoco increased due primarily to manufacturing productivity and purchasing initiatives, although they were partially offset by the impact of the volume declines. Through higher selling prices, the Company was able to recover increases in raw material costs but not higher costs of energy, freight and labor. Capital spending included investing in productivity and customer development projects in the United States and Asia for molded and extruded plastics, protective packaging and wire and cable reels. Critical Accounting Policies and Estimates Management’s discussion and analysis of the Company’s financial condition and results of operations are based upon the Company’s Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States (US GAAP). The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. The Company evaluates these estimates and assumptions on an ongoing basis, including but not limited to those related to inventories, bad debts, derivatives, income taxes, intangible assets, restructuring, pension and other postretirement benefits, environmental liabilities and contingencies and litigation. Estimates and assumptions are based on historical and other factors believed to be reasonable under the circumstances. The results of these estimates may form the basis of the carrying value of certain assets and liabilities and may not be readily apparent from other sources. Actual results, under conditions and circumstances different from those assumed, may differ from estimates. The impact of and any associated risks related to
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estimates, assumptions and accounting policies are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as in the Notes to the Consolidated Financial Statements, if applicable, where such estimates, assumptions and accounting policies affect the Company’s reported and expected financial results. The Company believes the accounting policies discussed in the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K are critical to understanding the results of its operations. The following discussion represents those policies that involve the more significant judgments and estimates used in the preparation of the Company’s Consolidated Financial Statements. Impairment of Long-lived, Intangible and Other Assets Assumptions and estimates used in the evaluation of potential impairment can result in adjustments affecting the carrying values of long-lived, intangible and other assets and the recognition of impairment expense in the Company’s Consolidated Financial Statements. The Company evaluates its long-lived assets (property, plant and equipment), definite-lived intangible assets and other assets (including notes receivable and equity investments) for impairment whenever indicators of impairment exist, or when it commits to sell the asset. If the sum of the undiscounted expected future cash flows from a long-lived asset or definite-lived intangible asset is less than the carrying value of that asset, an asset impairment charge is recognized. Key assumptions and estimates used in the cash flow model generally include price levels, sales growth, profit margins and asset life. The amount of an impairment charge, if any, is calculated as the excess of the asset’s carrying value over its fair value, generally represented by the discounted future cash flows from that asset or, in the case of assets the Company evaluates for sale, at estimated proceeds less costs to sell. The Company takes into consideration historical data and experience together with all other relevant information available when estimating the fair values of its assets. However, fair values that could be realized in actual transactions may differ from the estimates used to evaluate impairment. In addition, changes in the assumptions and estimates may result in a different conclusion regarding impairment. Impairment of Goodwill In accordance with Statement of Financial Accounting Standards No. 142, ‘Goodwill and Other Intangible Assets’ (FAS 142), the Company evaluates its goodwill for impairment annually and whenever events happen or circumstances change that would make it more likely than not that an impairment may have occurred. Under FAS 142, if the carrying value of a reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment charge is recognized for the excess. The Company’s reporting units are one level below its operating segments, as determined in accordance with Statement of Financial Accounting Standards No. 131, ‘Disclosures about Segments of an Enterprise and Related Information.’ The Company uses a discounted cash flow model to estimate the fair value of its reporting units. The Company’s model discounts future cash flows, forecasted over a five-year period, with an estimated residual growth rate. In order to project and discount the future cash flows associated with each reporting unit, the Company must make a number of assumptions and estimates. In addition to the assumed discount and residual growth rates, these assumptions and estimates include market size and market share, sales volumes and prices, costs to produce, working capital changes, capital spending requirements and the impact of currency exchange rates. The Company’s analysis takes into consideration historical data and experience together with all other relevant information available when estimating the fair values of its reporting units. However, because the analysis is an estimate, fair values that could be realized in actual transactions may differ from those used to evaluate the impairment of goodwill. In addition, changes in the underlying assumptions and estimates may result in a different conclusion regarding impairment. In the annual evaluation of goodwill impairment that was completed during the third quarter of 2008, the estimated fair value of each of the Company’s reporting units exceeded its respective carrying value and, as a result, no potential goodwill impairment was indicated. In addition, at December 31, 2008, the Company considered whether any events and/or changes in circumstances that occurred subsequent to the annual review had resulted in the likelihood that the goodwill of any of its reporting units had been impaired. It was management’s conclusion that no such events or circumstances had arisen. At the time of the annual review, the estimated future cash flows of two of the Company’s reporting units, Matrix Packaging and Sonoco CorrFlex (CorrFlex), reflected management expectations for notable improvements in the results of operations. The risk related to realizing these improvements to the full extent or in the timeframes projected increases the probability that an impairment of goodwill may arise in future periods. Matrix Packaging manufactures blow-molded plastic containers primarily for use in nonfood applications. Matrix Packaging was acquired in May 2007 to be a growth platform for the Company and to expand the Company’s operations into the health and beauty market. Since that time, the Company has continued to invest significantly in the organic growth of the business. In 2008, Matrix opened a plant in Hazelwood (St. Louis), Missouri, to support new business with a major customer that is expected to double in 2009. Other growth is expected to be driven by recent awards across a number of customers and management’s five-year plan anticipates opening as many as five additional production plants representing a doubling of capacity. In the annual evaluation of goodwill impairment, the estimated fair value of Matrix Packaging exceeded its carrying value by approximately $30 million, or 11%. Goodwill for Matrix Packaging was $120.2 million at December 31, 2008. If the actual performance of Matrix Packaging falls short of the projected results, or the assessment of the relevant facts and circumstances changes, it is reasonably possible that a noncash impairment charge would be required. CorrFlex designs, manufactures, packs and distributes point-of-purchase displays and provides contract packaging and fulfillment services. In the annual goodwill impairment review, cash flows were projected to show significant growth over the five-year forecast period. However, 2008 actual results for CorrFlex fell considerably below those expectations for various reasons, including the
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impact of the recession. CorrFlex has booked a number of new business wins for 2009 that management believes, together with on-going cost reduction initiatives, justify its positive outlook for the business. However, should the actual performance of CorrFlex fall significantly short of expected results, or if the assessment of the relevant facts and circumstances changes, it is reasonably possible that a noncash impairment charge would be required. Goodwill for CorrFlex was $149.6 million at December 31, 2008. Income Taxes The Company records an income tax valuation allowance when the realization of any deferred tax assets, net operating losses and capital loss carryforwards is not likely. Deferred tax assets generally represent expenses recognized for financial reporting purposes, which will result in tax deductions over varying future periods. Certain judgments, assumptions and estimates may affect the amounts of the valuation allowance and deferred income tax expense in the Company’s Consolidated Financial Statements. For those tax positions where it is more likely than not that a tax benefit will be sustained, the Company has recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. For those positions not meeting the more-likely-than-not standard, no tax benefit has been recognized in the financial statements. Where applicable, associated interest has also been recognized. Stock Compensation Plans The Company utilizes share-based compensation in the form of stock options, stock appreciation rights, restricted stock units and other share-based awards. Certain awards are in the form of contingent stock units where both the ultimate number of units and the vesting period are performance based. The amount and timing of compensation expense associated with these performance-based awards are based on estimates regarding future performance using measures defined in the plans. In 2008, the performance measures consisted of Earnings per Share and Return on Net Assets Employed. Changes in estimates regarding the future achievement of these performance measures may result in significant fluctuations from period to period in the amount of compensation expense reflected in the Company’s Consolidated Financial Statements. The Company uses a binomial option-pricing model to determine the grant date fair value of its stock options and stock appreciation rights. The binomial option-pricing model requires the input of subjective assumptions. Management routinely assesses the assumptions and methodologies used to calculate estimated fair value of share-based compensation. Circumstances may change and additional data may become available over time that result in changes to these assumptions and methodologies, which could materially impact fair value determinations. Pension and Postretirement Benefit Plans The Company has significant pension and postretirement benefit costs that are developed from actuarial valuations. The actuarial valuations employ key assumptions, which are particularly important when determining the Company’s projected liabilities for pension and other postretirement benefits. The key actuarial assumptions used at December 31, 2008, in determining the projected benefit obligation and the accumulated benefit obligation for U.S. retirement and retiree health and life insurance plans include: a discount rate of 6.10%, 6.26% and 6.19% for the qualified retirement plan, non-qualified retirement plans, and retiree health and life insurance plan, respectively; an expected long-term rate of return on plan assets of 8.5%; and a rate of compensation increase ranging from 4.46% to 6.21%. Discount rates of 6.40%, 6.27% and 6.11% were used to determine net periodic benefit cost for 2008 for the qualified retirement plan, non-qualified retirement plans, and retiree health and life insurance plan, respectively. The Company adjusts its discount rates at the end of each fiscal year based on yield curves of high-quality debt instruments over durations that match the expected benefit payouts of each plan. The expected rate of return assumption is derived by taking into consideration the targeted plan asset allocation, projected future returns by asset class and active investment management. A third party asset return model was used to develop an expected range of returns on plan investments over a 12 to 15 year period, with the expected rate of return selected from a best estimate range within the total range of projected results. The Company periodically rebalances its plan asset portfolio in order to maintain the targeted allocation levels. The rate of compensation increase assumption is generally based on salary and incentive increases. A key assumption for the U.S. retiree health and life insurance plan is a medical trend rate beginning at 10.3% for post-age 65 participants and trending down to an ultimate rate of 6.0% in 2014. The ultimate trend rate of 6.0% represents the Company’s best estimate of the long-term average annual medical cost increase over the duration of the plan’s liabilities. It provides for real growth in medical costs in excess of the overall inflation level. During 2008, the Company incurred total pension and postretirement benefit expenses of approximately $26.3 million, compared with $34.2 million during 2007. The 2008 amount is net of $91.7 million of expected returns on plan assets at the assumed rate of 8.5%, and includes interest cost of $78.3 million at a weighted-average discount rate of 6.28%. The 2007 amount is net of $91.3 million of expected returns on plan assets at the assumed rate of 8.5%, and includes interest cost of $75.4 million at a discount rate of 5.63%. During 2008, the Company made contributions to pension plans of $17.2 million and postretirement plans of approximately $1.5 million. The contribution amount varies from year to year depending on factors including asset market values and interest rates. Although these contributions reduced cash flows from operations during the year, under Statement of Financial Accounting Standards No. 87, ‘Employers’ Accounting for Pensions’ (FAS 87), they did not have an immediate significant impact on pension expense. Cumulative net actuarial losses were approximately $602 million at December 31, 2008, and are primarily the result of poor asset performance in 2008 and from 2000 through 2002. The amortization period for losses/gains is approximately 11 years for the portion outside the 10% corridor as defined by FAS 87, except for curtailments, which may result in accelerated income or expense.
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Other assumptions and estimates impacting the projected liabilities of these plans include inflation, participant withdrawal and mortality rates and retirement ages. The Company annually reevaluates assumptions used in projecting the pension and postretirement liabilities and associated expense. These judgments, assumptions and estimates may affect the carrying value of pension and postretirement plan net assets and liabilities and pension and postretirement plan expenses in the Company’s Consolidated Financial Statements. The sensitivity to changes in the critical assumptions for the Company’s U.S. plans as of December 31, 2008 is as follows:
See Note 13 to the Consolidated Financial Statements for additional information on the Company’s pension and postretirement plans.
Recent Accounting Pronouncements Information regarding recent accounting pronouncements is provided in Note 19 of the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Information regarding market risk is provided in this Annual Report on Form 10-K under the following items and captions: “Conditions in foreign countries where the Company operates may reduce earnings” and “Foreign exchange rate fluctuations may reduce the Company’s earnings” in Item 1A – Risk Factors; “Risk Management” in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations; and in Note 9 to the Consolidated Financial Statements in Item 8 – Financial Statements and Supplementary Data. Item 8. Financial Statements and Supplementary Data The Consolidated Financial Statements and Notes to the Consolidated Financial Statements are provided on pages F-1 through F-28 of this report. Selected quarterly financial data is provided in Note 20 to the Consolidated Financial Statements included in this Annual Report on Form 10-K.
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Table of Contentsn REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Directors of Sonoco Products Company: In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Sonoco Products Company and its subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these 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 Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. 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. 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 (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) 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 (iii) 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.
Table of Contentsn CONSOLIDATED BALANCE SHEETS Sonoco Products Company
The Notes beginning on page F-6 are an integral part of these financial statements.
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Table of Contentsn CONSOLIDATED STATEMENTS OF INCOME Sonoco Products Company and consolidated subsidiaries
The Notes beginning on page F-6 are an integral part of these financial statements.
Table of Contentsn CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY Sonoco Products Company
The Notes beginning on page F-6 are an integral part of these financial statements.
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Table of Contentsn CONSOLIDATED STATEMENTS OF CASH FLOWS Sonoco Products Company
Prior year data has been reclassified to conform to the current presentation. The Notes beginning on page F-6 are an integral part of these financial statements.
Table of Contentsn NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Sonoco Products Company (Dollars in thousands except per share data)
The following notes are an integral part of the Consolidated Financial Statements. The accounting principles followed by the Company appear in bold type. 1. Basis of Presentation The Consolidated Financial Statements include the accounts of Sonoco Products Company and its majority-owned subsidiaries (the “Company” or “Sonoco”) after elimination of intercompany accounts and transactions. Investments in affiliated companies in which the Company shares control over the financial and operating decisions, but in which the Company is not the primary beneficiary are accounted for as equity investments (“equity investments”). Income applicable to equity investments is reflected in “Equity in earnings of affiliates/minority interest in subsidiaries” in the Consolidated Statements of Income. The aggregate carrying value of equity investments is reported in “Other Assets” in the Company’s Consolidated Balance Sheets and totaled $89,856 and $107,207 at December 31, 2008 and 2007, respectively. Investments in affiliated companies in which the Company is not the primary beneficiary are accounted for by the equity method of accounting and at December 31, 2008, included:
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP) requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In accordance with US GAAP, the Company records revenue when title and risk of ownership pass to the customer, and when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the sales price to the customer is fixed or determinable and when collectibility is reasonably assured. Certain judgments, such as provisions for estimates of sales returns and allowances, are required in the application of the Company’s revenue policy and, therefore, the results of operations in its Consolidated Financial Statements. Shipping and handling expenses are included in “Cost of sales,” and freight charged to customers is included in “Net sales” in the Company’s Consolidated Statements of Income. The Company’s trade accounts receivable are non-interest bearing and are recorded at the invoiced amounts. The allowance for doubtful accounts represents the Company’s best estimate of the amount of probable credit losses in existing accounts receivable. Provisions are made to the allowance for doubtful accounts at such time that collection of all or part of a trade account receivable is in question. The allowance for doubtful accounts is monitored on a regular basis and adjustments are made as needed to ensure that the account properly reflects the Company’s best estimate of uncollectible trade accounts receivable. Trade accounts receivable balances that are more than 180 days past due are generally 100% provided for in the allowance for doubtful accounts. Account balances are charged off against the allowance for doubtful accounts when the Company determines that the receivable will not be recovered. One of the Company’s customers represented approximately 12% and 10% of the consolidated trade accounts receivable at December 31, 2008 and 2007, respectively. Sales to this customer accounted for approximately 12% of the Company’s consolidated revenues in 2008, 2007 and 2006, and were primarily reported in the Consumer Packaging and Packaging Services segments. No other single customer comprised more than 5% of the Company’s consolidated revenues in 2008, 2007 or 2006. The Company identifies its reportable segments in accordance with Statement of Financial Accounting Standards No. 131, ‘Disclosures about Segments of an Enterprise and Related Information’, based on the level of detail reviewed by the chief operating decision maker, gross profit margins, nature of products sold, nature of the production processes, type and class of customer, methods used to distribute products and nature of the regulatory environment. Of these factors, the Company believes that the most significant are the nature of its products and the type of customers served. Research and development costs are charged to expense as incurred and include salaries and other directly related expenses. Research and development costs totaling $15,888 in 2008, $15,614 in 2007 and $12,735 in 2006, are included in “Selling, general and administrative expenses” in the Company’s Consolidated Statements of Income. 2. Acquisitions The Company completed two acquisitions during 2008 at an aggregate cost of $5,535 in cash. These acquisitions consisted of Amtex Packaging, Inc., a packaging fulfillment company included in the Packaging Services segment, and VoidForm International Ltd., a Canada-based construction tube business included in the Tubes and Cores/Paper segment. The acquisition of these businesses is expected to generate annual sales of approximately $6,000. In conjunction with these acquisitions, the Company recorded identifiable intangibles of $4,890, goodwill of $179, and other net tangible assets of $466. The Company has accounted for these acquisitions as purchases and, accordingly, has included their results of operations in consolidated net income from the respective dates of acquisition. Pro forma results have not been provided, as the acquisitions were not material to the Company’s financial statements individually or in the aggregate. The Company completed four acquisitions during 2007, and purchased the remaining 51.1% interest of its AT-Spiral Oy joint ven-
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ture, a European manufacturer of tubes and cores, at an aggregate cost of $236,263, all of which was paid in cash. In connection with these acquisitions, the Company recorded fair value of identified intangibles totaling $49,565, goodwill of $126,856 (none of which is expected to be tax deductible) and other net tangible assets of $59,842. Acquisitions in the Consumer Packaging segment included Matrix Packaging, Inc., a manufacturer of custom-designed blow molded rigid plastic containers and injection molded products with operations in the United States and Canada, and the fiber and plastic container business of Caraustar Industries, Inc. in the United States. Additional acquisitions in 2007 consisted of a small tube and core business in Mexico, which is included in the Tubes and Cores/Paper segment, and a small protective packaging business in the United States, which is included in All Other Sonoco. As these acquisitions were not material to the Company’s financial statements individually or in the aggregate, pro forma results have not been provided. The Company completed six acquisitions during 2006, and purchased the remaining 35.5% minority interest in Sonoco-Alcore S.a.r.l. (Sonoco-Alcore), a European tube, core and coreboard joint venture formed in 2004, at an aggregate cost of $227,304, all of which was paid in cash. In connection with these acquisitions, the Company recorded fair value of identified intangibles of approximately $27,800, goodwill of approximately $83,400 (of which approximately $23,500 is expected to be tax deductible), and other net tangible assets of approximately $116,100. Acquisitions in the Company’s Tubes and Cores/Paper segment included the remaining 75% interest in Demolli Industria Cartaria S.p.A, an Italy-based manufacturer of tubes, cores and paperboard and a small tube and core manufacturer in Canada. Acquisitions in the Consumer Packaging segment included a rotogravure printed flexible packaging manufacturer in Texas; a rigid paperboard composite container manufacturer in Ohio; and Clear Pack Company, a manufacturer of thermoformed and extruded plastic materials and containers in Illinois. The Company also acquired a small packaging fulfillment business in Illinois, which is included in the Packaging Services segment. 3. Restructuring and Asset Impairment The Company accounts for restructuring charges in accordance with Statement of Financial Accounting Standards No. 146, ‘Accounting for Costs Associated with Exit or Disposal Activities’ (FAS 146), whereby exit costs are recognized when the liability is incurred. If assets become impaired as a result of a restructuring action, the assets are written down to fair value, less estimated costs to sell, if applicable. A number of significant estimates and assumptions are involved in the determination of fair value. The Company considers historical experience and all available information at the time the estimates are made; however, the amounts that are ultimately realized upon the sale of divested assets may differ from the estimated fair values reflected in the Company’s Consolidated Financial Statements. The Company has engaged in a number of restructuring actions over the past several years. Actions initiated in 2008 and 2007 are reported as “Other 2008 Actions” and “Other 2007 Actions,” respectively. The Company has two formal restructuring plans that are still active, although both were substantially complete at December 31, 2008. These are the 2006 Plan and the 2003 Plan. Following are the total restructuring and asset impairment charges, net of adjustments, recognized by the Company during the periods presented:
Restructuring and asset impairment charges are included in “Restructuring/Asset impairment charges” in the Consolidated Statements of Income, except for restructuring charges applicable to equity method investments, which are included in “Equity in earnings of affiliates/minority interest in subsidiaries, net of tax.” The Company expects to recognize future additional costs totaling approximately $11,000 in connection with previously announced restructuring actions. The Company believes that the majority of these charges will be incurred and paid by the end of 2009. Additional disclosures concerning other 2008 and other 2007 restructuring and asset impairment charges, and the 2006 and 2003 restructuring plans, is provided below. Other 2008 Actions During 2008, the Company initiated the following closures in its Tubes and Cores/Paper segment: ten tube and core plants, three in the United States, three in Canada, two in the United Kingdom, one in Spain, and one in China; two paper mills, one in the United States and one in Canada; and a specialty paper machine in the United States. In addition, closures were initiated of four rigid packaging plants in the United States (part of the Consumer Packaging segment) and two fulfillment centers in the United States (part of the Packaging Services segment). The Company also realigned its fixed cost structure resulting in the permanent elimination of approximately 125 salaried positions. Communication to most of the affected employees took place
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prior to the end of 2008; accordingly, the vast majority of the costs of severance and termination benefits were recognized in 2008. All remaining severance costs will be recognized in the first half of 2009. Below is a summary of the Other 2008 Actions and related expenses by type incurred and estimated to be incurred through the end of the restructuring initiative.
The following table sets forth the activity in the Other 2008 Actions restructuring accrual included in “Accrued expenses and other” on the Company’s Consolidated Balance Sheets:
Other Costs in the Tubes and Cores/Paper segment include curtailment and settlement charges of $3,927 related to a defined benefit pension plan maintained for the hourly union employees of the Canadian paper mill. The Company also recorded noncash, after-tax offsets in the amount of $1,131 to reflect a minority interest holder’s portion of restructuring costs that were charged to expense in 2008. The Company expects to pay the majority of the remaining Other 2008 Actions restructuring costs by the end of 2009 using cash generated from operations.
Other 2007 Actions In 2007, the Company initiated the closures of the following operations: a metal ends plant in Brazil (Consumer Packaging segment), a rigid packaging plant in the United States (Consumer Packaging segment), a paper mill in China (Tubes and Cores/Paper segment), a molded plastics plant in Turkey (All Other Sonoco), and a point-of-purchase display manufacturing plant in the United States (Packaging Services segment). Below is a summary of the Other 2007 Actions and related expenses by type incurred, and estimated to be incurred, through the end of the restructuring initiative.
The net charges for 2008 relate primarily to severance and other termination benefits that became recognizable upon communication to the affected employees throughout the first half of the year. Asset impairment charges in the Consumer Packaging segment totaling $5,181 resulted from noncash impairments of property, plant and equipment at the Company’s metal ends plant in Brazil and rigid packaging plant in the United States, while a net gain of $845 was recognized in the Tubes and Cores/Paper segment as sales proceeds for the Company’s former paper mill in China in excess of the carrying value of the underlying assets were realized at the end of the year. Other costs relate primarily to the dismantling of machinery and equipment and other miscellaneous exit costs. During the year ended December 31, 2008, the Company also recorded noncash, after-tax offsets in the amounts of $2,971 to reflect a minority interest holder’s portion of restructuring costs that were charged to expense.
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The following table sets forth the activity in the Other 2007 Actions restructuring accrual included in “Accrued expenses and other” on the Company’s Consolidated Balance Sheets:
As a result of plant closures associated with Other 2007 Actions, the Company recognized pre-tax asset impairment charges totaling $10,067 in 2008. These noncash charges were primarily the result of additional impairment losses on property, plant and equipment at the Company’s metal ends plant in Brazil and additional reserves on accounts receivable at the Company’s paper mill in China. In each case, the assets were determined to be impaired directly as a result of the closure of the facilities. Sales proceeds, net of commissions, of $14,671 were recognized in December 2008 for the sale of the Company’s paper mill in China. Accordingly, the remaining net book value of property, plant and equipment of $4,763, and the remaining net book value of land use rights, an intangible asset, of $4,178, was written off in 2008. The net gain of $5,730 is reflected in “Adjustments” in the table above. Under the terms of the sales agreement for this paper mill, additional sales proceeds of approximately $10,000 are due in 2009. The Company is following the cost recovery method of Statement of Financial Accounting Standards No. 66, ‘Accounting for Sales of Real Estate,’ in recognizing the net gain on this transaction. Accordingly, gains on the sale have been recognized only to the extent that cash has been received. Upon receipt of the additional proceeds, the Company expects to recognize a net gain of approximately $3,700 after taxes and minority interest. The Company expects to pay the majority of the remaining Other 2007 Actions restructuring costs during 2009 using cash generated from operations.
The 2006 Plan The 2006 Plan included the closure of 12 plant locations and the reduction of approximately 540 positions worldwide. The majority of the restructuring program focused on improving the cost effectiveness of international operations, principally in Europe. These measures began in the fourth quarter of 2006 and are substantially complete. Significant operations affected in the Tubes and Cores/Paper segment included a paper mill in France, two tube and core plants in Canada, and one in the United States. Operations affected in the Consumer Packaging segment included a rigid packaging plant in Germany, rigid packaging production lines in the United Kingdom, and a flexible packaging plant in Canada. Operations affected in All Other Sonoco included a molded plastics plant and a wooden reels facility, both located in the United States. In addition, the 2006 Plan included downsizing actions in the Company’s European tube and core/paper operations. Below is a summary of the 2006 Plan and related expenses by type incurred, and estimated to be incurred, through the end of the restructuring initiative.
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The following table sets forth the activity in the 2006 Plan restructuring accrual included in “Accrued expenses and other” on the Company’s Consolidated Balance Sheets:
Other Costs in the Tubes and Cores/Paper segment include settlement charges of $495 related to a defined benefit pension plan maintained for the hourly union employees of the Canadian tube and core plants. During the year ended December 31, 2007, the Company recorded noncash, after-tax offsets in the amount of $64, in order to reflect a minority interest holder’s portion of restructuring costs that were charged to expense. The Company expects to pay the majority of the remaining 2006 Plan restructuring costs, with the exception of certain building lease termination expenses, by the end of 2009, using cash generated from operations. The 2003 Plan In August 2003, the Company announced general plans to reduce its overall cost structure by $54,000 pretax by realigning and centralizing a number of staff functions and eliminating excess plant capacity. Pursuant to these plans, the Company completed 22 plant closings and reduced its workforce by approximately 1,120 employees. As of December 31, 2008, the Company had incurred cumulative pre-tax charges, net of adjustments, of $103,114 associated with these activities. The 2003 Plan is substantially complete. At December 31, 2008, the remaining restructuring accrual for the 2003 Plan totaled $1,049. The accrual, included in “Accrued expenses and other” on the Company’s Consolidated Balance Sheet, relates primarily to a building lease termination. The Company expects to recognize future pre-tax charges of approximately $150 associated with the 2003 Plan, primarily related to this building lease termination. The Company expects both the liability and the future costs to be fully paid at the end of 2012, using cash generated from operations.
4. Financial Asset Impairment As a result of the 2003 sale of the High Density Film business, the Company received a preferred equity interest in the buyer and a subordinated note receivable due in 2013 as a portion of the selling price. The Company’s year-end 2007 financial review of the buyer indicated that collectibility was probable. However, based on updated information provided by the buyer late in the first quarter of 2008, the Company concluded that neither the collection of its subordinated note receivable nor redemption of its preferred equity interest was probable, and that their value was likely zero. Accordingly, the Company fully reserved these items in the first quarter of 2008, recording a charge totaling $42,651 pretax ($30,981 after tax). This financial asset impairment charge is included in “Restructuring/Asset impairment charges” in the Company’s Consolidated Statements of Income. Both the preferred equity interest and the subordinated note receivable had been included in “Other Assets” in the Company’s Consolidated Balance Sheets. On May 6, 2008, the buyer filed a petition for relief under Chapter 11 with the United States Bankruptcy Court for the District of Delaware that included a plan of reorganization, which was subsequently approved by the court June 26, 2008. As part of the plan of reorganization, the Company’s preferred equity interest and its subordinated note receivable were extinguished. 5. Cash and Cash Equivalents Cash equivalents are composed of highly liquid investments with an original maturity of three months or less. Cash equivalents are recorded at cost, which approximates market. At December 31, 2008 and 2007, outstanding checks totaling $23,781 and $12,469, respectively, were included in “Payable to suppliers” on the Company’s Consolidated Balance Sheets. In addition, outstanding payroll checks of $1,229 and $686 as of December 31, 2008 and 2007, respectively, were included in “Accrued wages and other compensation” on the Company’s Consolidated Balance Sheets. The Company uses a notional pooling arrangement with an international bank to help manage global liquidity requirements. Under this pooling arrangement, the Company and its participating subsidiaries may maintain either cash deposit or borrowing positions through local currency accounts with the bank, so long as the aggregate position of the global pool is a notionally calculated net cash deposit. Because it maintains a security interest in the cash deposits, and has the right to offset the cash deposits against the borrowings, the bank provides the Company and its participating subsidiaries favorable interest terms on both. The Company’s Consolidated Balance Sheets reflect a net cash deposit under this pooling arrangement of $1,753 and $200 as of December 31, 2008 and 2007, respectively. 6. Inventories Inventories are stated at the lower of cost or market. The last-in, first-out (LIFO) method is used for the valuation of certain of the Company’s domestic inventories, primarily metal, internally manufactured paper and paper purchased from third parties. The
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LIFO method of accounting was used to determine the costs of approximately 23% and 18% of total inventories at December 31, 2008 and 2007, respectively. The remaining inventories are determined on the first-in, first-out (FIFO) method. If the FIFO method of accounting had been used for all inventories, total inventory would have been higher by $17,667 and $16,404 at December 31, 2008 and 2007, respectively. 7. Property, Plant and Equipment Plant assets represent the original cost of land, buildings and equipment, less depreciation, computed under the straight-line method over the estimated useful lives of the assets, and are reviewed for impairment whenever events indicate the carrying value may not be recoverable. Equipment lives generally range from three to 11 years, and buildings from 15 to 40 years. Timber resources are stated at cost. Depletion is charged to operations based on the estimated number of units of timber cut during the year. Details at December 31 are as follows:
Estimated costs for completion of capital additions under construction totaled approximately $62,000 at December 31, 2008. Depreciation and depletion expense amounted to $170,032 in 2008, $170,013 in 2007 and $157,000 in 2006. The Company has certain properties and equipment that are leased under noncancelable operating leases. Future minimum rentals under noncancelable operating leases with terms of more than one year are as follows: 2009 – $34,100; 2010 – $26,100; 2011 – $19,700; 2012– $15,500; 2013 – $11,000 and thereafter – $20,900. Total rental expense under operating leases was approximately $52,900 in 2008, $46,800 in 2007 and $42,200 in 2006.
8. Goodwill and Other Intangible Assets Goodwill The Company accounts for goodwill in accordance with Statement of Financial Accounting Standards No. 142 ‘Goodwill and Other Intangible Assets’ (FAS 142). Under FAS 142, purchased goodwill and intangible assets with indefinite lives are not amortized. The Company evaluates its goodwill for impairment at least annually, and more frequently if indicators of impairment are present. In performing the impairment test, the Company uses discounted future cash flows to estimate the fair value of each reporting unit. If the fair value of the reporting unit exceeds the carrying value of the reporting unit’s assets, including goodwill, there is no impairment. Otherwise, if the carrying value of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment charge is recognized for the excess. The Company completed its annual goodwill impairment testing during the third quarters of 2008, 2007 and 2006. Based on the results of these evaluations, the Company concluded that there was no impairment of goodwill for any of its reporting units. The 2008 evaluation used forward-looking projections and included significant expected improvements in the future cash flows of two of the Company’s reporting units, Matrix Packaging and Sonoco CorrFlex (CorrFlex). The annual evaluation indicated that the estimated fair value of Matrix Packaging exceeded its carrying value by approximately $30,000, or 11%. If the Company’s assessment of the relevant facts and circumstances changes or if actual performance in these reporting units falls short of the projected results, noncash impairment charges may be required. Total goodwill associated with Matrix Packaging and CorrFlex at December 31, 2008, was approximately $120,000 and $150,000, respectively. The changes in the carrying amount of goodwill for the year ended December 31, 2008, are as follows:
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Adjustments to goodwill totaled $1,630 in 2008. Of this total, $1,420 was in connection with the closures of two plants and an injection molding operation that were part of the fourth quarter 2007 acquisition of the fiber and plastic container business of Caraustar Industries, Inc. The remaining adjustments consisted of minor tax adjustments associated with the second quarter 2007 acquisition of Matrix Packaging, LLC, impairment charges and other purchase price adjustments relating to 2007 acquisitions. Other Intangible Assets Intangible assets are amortized, usually on a straight-line basis, over their respective useful lives, which generally range from three to 20 years. The Company evaluates its intangible assets for impairment whenever indicators of impairment exist. The Company has no intangibles with indefinite lives.
The Company recorded $4,890 of identifiable intangibles in connection with 2008 business acquisitions, all of which related to customer lists that will be amortized over a period of 15 years. An additional $160 of identifiable intangibles was recorded in connection with new contracts. This intangible is related to a customer list and will be amortized over a period of five years. In addition, the Company acquired various patents during 2008 for a total cost of $170. During 2008, the Company wrote off $4,178 of land use rights in conjunction with the sale of its paper mill in China. In addition, noncash impairment charges totaling $595 were recorded on customer lists within the Consumer Packaging segment in 2008. Aggregate amortization expense on intangible assets was $13,002, $11,326 and $7,863 for the years ended December 31, 2008, 2007 and 2006, respectively. Amortization expense on intangible assets is expected to approximate $12,700 in 2009, $12,500 in 2010, $12,100 in 2011, $11,600 in 2012 and $11,400 in 2013.
9. Debt Debt at December 31 was as follows:
The Company operates a $500,000 commercial paper program that provides a flexible source of domestic liquidity. The program is supported by the Company’s five-year committed bank credit facility of an equal amount established May 3, 2006, with a syndicate of lenders that is committed until May 2011. The commercial paper program has continued to operate efficiently during the recent disruption of global credit markets. In the event that the disruption of global credit markets were to become so severe that the Company was unable to issue commercial paper, it has the contractual right to draw funds directly on the underlying bank credit facility. Based on the information currently available to it, the Company believes that the lenders continue to have the ability to meet their obligations under the facility. At the Company’s discretion, the borrowing rate for such loans could be based on either the agent bank’s prime rate, or a pre-established spread over LIBOR. Outstanding commercial paper, a component of the Company’s long-term debt, totaled $95,000 at December 31, 2008. During the latter part of 2008, the Internal Revenue Service issued a temporary rule extending to 60 days the period that U.S. corporations may borrow funds from foreign subsidiaries without unfavorable tax consequences. The Company utilized this rule during the final two months of the year to access approximately $72 million of
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offshore cash on hand, which was used to reduce commercial paper outstanding. These short-term lending arrangements were subsequently settled in 2009, resulting in equivalent increases in commercial paper outstanding and cash on hand. Depending on its immediate offshore cash needs, the Company may choose to access such funds again in the future as allowed by this temporary rule. In addition, at December 31, 2008, the Company had approximately $184,000 available under unused short-term lines of credit. These short-term lines of credit are for general Company purposes, with interest at mutually agreed-upon rates. Certain of the Company’s debt agreements impose restrictions with respect to the maintenance of financial ratios and the disposition of assets. The most restrictive covenant currently requires the Company to maintain a minimum level of net worth, as defined. As of December 31, 2008, the Company’s defined net worth was approximately $420,000 above the minimum level required under this covenant. The 6.0% and the 6.125% IRBs were prepaid during 2008 with commercial paper. These IRBs had been collateralized by property, plant and equipment at several locations. The approximate principal requirements of debt maturing in the next five years are: 2009 – $32,978; 2010 – $104,665; 2011 – $96,790; 2012 – $8,338 and 2013 – $250,935. 10. Financial Instruments and Derivatives The following table sets forth the carrying amounts and fair values of the Company’s significant financial instruments where the carrying amount differs from the fair value.
The carrying value of cash and cash equivalents, short-term debt and long-term variable-rate debt approximates fair value. The fair value of long-term debt is based on quoted market prices or is determined by discounting future cash flows using interest rates available to the Company for issues with similar terms and average maturities. At December 31, 2007, the fair value of the Hilex note receivable and equity instrument was based on discounted future cash flows using observable market interest rates for issues with similar terms, maturities and risks. These instruments became impaired during 2008 resulting in a charge to earnings of $42,651 before tax. See additional information regarding this financial asset impairment in Note 4 to the Consolidated Financial Statements. The Company records its derivatives in accordance with Statement of Financial Accounting Standards No. 133, ‘Accounting for Derivative Instruments and Hedging Activities’ (FAS 133), and related amendments. This Statement requires that all derivatives be recognized as assets or liabilities on the balance sheet at fair value and provides guidance on accounting for derivatives entered into as a hedge. The Company uses published market prices or estimated values based on current price quotes and a discounted cash flow model to estimate the fair market value of derivatives. Changes in the fair value of derivatives are recognized either in net income or in other comprehensive income, depending on the designated purpose of the derivative. It is the Company’s policy not to speculate in derivative instruments. The Company has determined all hedges to be highly effective and as a result no material ineffectiveness has been recorded. The Company uses derivatives to mitigate the effect of fluctuations in some of its raw material and energy costs, foreign currency fluctuations and interest rate movements. The Company purchases commodities such as recovered paper, metal and energy generally at market or fixed prices that are established with the vendor as part of the purchase process for quantities expected to be consumed in the ordinary course of business. The Company may enter into commodity futures or swaps to reduce the effect of price fluctuations. The Company may use foreign currency forward contracts and other risk management instruments to manage exposure to changes in foreign currency cash flows and the translation of monetary assets and liabilities on the Company’s consolidated financial statements. The Company is exposed to interest-rate fluctuations as a result of using debt as a source of financing for its operations. The Company may from time to time use traditional, unleveraged interest rate swaps to adjust its mix of fixed and variable rate debt to manage its exposure to interest rate movements. Cash Flow Hedges At December 31, 2008 and 2007, the Company had derivative financial instruments outstanding to hedge anticipated transactions and certain asset and liability related cash flows. To the extent considered effective, the changes in fair value of these contracts are recorded in other comprehensive income and reclassified to income or expense in the period in which the hedged item impacts earnings. Commodity Cash Flow Hedges The Company has entered into certain derivative contracts to manage the cost of anticipated purchases of natural gas and aluminum. At December 31, 2008, natural gas swaps covering approximately 6.3 million MMBTUs were outstanding. These contracts represent approximately 75%, 57% and 32% of anticipated U.S. and Canadian usage for 2009, 2010 and 2011, respectively. Additionally, the Company had swap contracts covering 7,920 metric tons of aluminum representing approximately 49% of anticipated usage for 2009. The fair value of commodity cash flow hedges was $(20,491) and $(2,588) at December 31, 2008 and 2007, respectively. Foreign Currency Cash Flow Hedges The Company has entered into forward contracts to hedge certain anticipated foreign currency denominated sales and purchases forecasted to occur in 2009. At December 31, 2008, the net position of these contracts was to purchase approximately 55 million Canadian dollars. The fair value of these foreign currency cash flow hedges was $(666) at December 31, 2008. There were no foreign currency derivatives qualifying for hedge accounting treatment outstanding at December 31, 2007.
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Fair Value Hedges Prior to 2007, the Company utilized interest rate swaps that qualified as fair value hedges. These swaps were terminated during 2006 at a time when the fair value of the swaps was a net unfavorable position of $2,137. In accordance with FAS 133, interest expense is being adjusted by amortization of this loss over the remaining lives of the related bonds. The Company did not enter into any new fair value hedges during the years ended December 31, 2008 or 2007. Other Derivatives The Company routinely enters into forward contracts or swaps to economically hedge the currency exposure of intercompany debt and existing foreign currency denominated receivables and payables. The Company does not apply hedge accounting treatment under FAS 133 for these instruments. As such, changes in fair value are recorded directly to income and expense in the periods that they occur. The total notional amount of these hedges, all of which were short-term, was $69,092 and $11,468 at December 31, 2008 and 2007, respectively. On occasion, certain subsidiaries will enter into derivative contracts to hedge various other foreign currency exposures; these contracts were not material for any of the periods presented. The aggregate fair value of all other derivatives was $6,264 and $24 at December 31, 2008 and 2007, respectively. 11. Fair Value Measurements Statement of Financial Accounting Standards No. 157, ‘Fair Value Measurements’ (FAS 157) was issued to increase consistency and comparability in fair value measurements and to expand disclosures about fair value measurements. Applicable provisions of FAS 157 were adopted by the Company effective January 1, 2008, including the disclosures presented below. The following table sets forth information regarding the Company’s financial assets and financial liabilities that are measured at fair value. The Company does not currently have any nonfinancial assets or liabilities that are recognized or disclosed at fair value on a recurring basis.
As discussed in Note 10, the Company uses derivatives to mitigate the effect of raw material and energy cost fluctuations, foreign currency fluctuations and interest rate movements. Fair value measurements for the Company’s derivatives are classified under Level 2 because such measurements are determined using published market prices or estimated based on observable inputs such as interest rates, yield curves, spot and future commodity prices and spot and future exchange rates. Certain deferred compensation plan liabilities are funded and the assets invested in various exchange traded mutual funds. These assets are measured using quoted prices in accessible active markets for identical assets. None of the Company’s financial assets or liabilities currently covered by the disclosure provisions of FAS 157 are measured at fair value using significant unobservable inputs. 12. Stock-based Plans The Company provides share-based compensation to certain of its employees and non-employee directors in the form of stock options, stock appreciation rights, restricted stock units and other share-based awards. Awards issued prior to 2009 were issued pursuant to the 1991 Key Employee Stock Plan (the “1991 Plan”) or the 1996 Non-Employee Directors Stock Plan (the “1996 Plan”). Awards issued after 2008 will be issued pursuant to the Sonoco Products Company 2008 Long-Term Incentive Plan (the “2008 Plan”), which became effective upon approval by the shareholders on April 16, 2008. The maximum number of shares of common stock that may be issued under the 2008 Plan was set at 8,500,000 shares, subject to certain adjustments, which included all awards that were granted, forfeited or expired during 2008 under all previous plans. At December 31, 2008, a total of 7,390,655 shares remain available for future grant under the 2008 Plan. After the effective date of the 2008 Plan, no awards may be granted under any previous plan. The Company issues new shares for stock option and stock appreciation right exercises and stock unit conversions. Although the Company from time to time has repurchased shares to replace its authorized shares issued under its stock compensation plans, there is no specific schedule or policy to do so. The Company’s stock-based awards to non-employee directors have not been material. Accounting for Share-based Compensation For purposes of calculating share-based compensation expense under FAS 123(R) for stock appreciation rights granted to retiree-eligible employees, the service completion date is assumed to be the grant date; therefore, expense associated with share-based compensation to these employees is recognized at that time. Total compensation cost for share-based payment arrangements was $4,177, $11,000 and $11,347, for 2008, 2007 and 2006, respectively. The related tax benefit recognized in net income was $1,550, $3,908 and $3,699, for the same years, respectively. Share-based compensation expense is included in selling, general and administrative expense in the Consolidated Statements of Income. An “excess” tax benefit is created when the tax deduction for an exercised stock option, exercised stock appreciation right or converted stock unit exceeds the compensation cost that has been recognized in income. The excess benefit is not recognized on the income statement, but rather on the balance sheet as additional paid-in capital. The additional net excess tax benefit realized was $709, $9,312 and $10,580 for 2008, 2007 and 2006, respectively.
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Stock Options and Stock Appreciation Rights (SARs) The Company typically grants stock appreciation rights annually on a discretionary basis to its key employees. In prior years, options were granted at market (had an exercise price equal to the closing market price on the date of grant), had 10-year terms and vested over one year, except for the options granted in 2005, which vested immediately. In 2006, the Company began to grant stock appreciation rights (SARs) instead of stock options. SARs are at market, vest over one year, have seven-year terms and can be settled only in stock. Both stock options and SARs are exercisable upon vesting. On February 6, 2008, the Company granted to employees 647,300 stock-settled SARs, net of forfeitures. All SARs were granted at the closing market prices on the dates of grant. As of December 31, 2008, there was $129 of total unrecognized compensation cost related to nonvested SARs. This cost will be recognized over the remaining weighted-average vesting period, which is approximately one month. The weighted-average fair values of options and SARs granted was $4.36, $6.43 and $5.85 per share in 2008, 2007 and 2006, respectively. The Company computed the estimated fair values of all options and SARs using the binomial option-pricing model applying the assumptions set forth in the following table:
The assumptions employed in the calculation of the fair value of stock options and SARs were determined as follows: • Expected dividend yield – the Company’s annual dividend divided by the stock price at the time of grant. • Expected stock price volatility – based on historical volatility of the Company’s common stock measured weekly for a time period equal to the expected life. • Risk-free interest rate – based on U.S. Treasury yields in effect at the time of grant for maturities equal to the expected life. • Expected life – calculated using the simplified method as prescribed in Staff Accounting Bulletin No. 107, where the expected life is equal to the sum of the vesting period and the contractual term divided by two. The following tables summarize information about stock options and SARs outstanding and exercisable at December 31, 2008. At December 31, 2008, the fair market value of the Company’s stock used to calculate intrinsic value was $23.16 per share.
The activity related to the Company’s stock options and SARs is as follows:
The aggregate intrinsic value of options and SARs exercised during the years ended December 31, 2008, 2007 and 2006 was $2,264, $26,631 and $27,827, respectively. Cash received on option exercises was $6,470, $49,698 and $74,413 for the same years, respectively. Performance-based Stock Awards The Company typically grants performance contingent restricted stock units (PCSUs) annually on a discretionary basis to certain of its executives and other members of its management team. Both the ultimate number of PCSUs awarded and the vesting period are dependent upon the degree to which performance targets are achieved for three-year performance periods. Upon vesting, PCSUs are convertible into common shares on a one-for-one basis. These awards vest over five years with accelerated vesting over three years if performance targets are met. For the awards outstanding at December 31, 2008, the ultimate number of PCSUs that could vest ranges from 215,143 to 645,428 and is tied to earnings and capital effectiveness over a three-year period. The 2007 awards are tied to performance targets over the three-year period ending December 31, 2009, and can range from 99,888 to 299,663 units. The 2008 awards are tied to performance targets through fiscal year 2010, and can range from 115,255 to 345,765 units. The three-year performance cycle for the 2006 awards was completed on December 31, 2008. Based on meeting performance goals established at the time of the award, participants to whom awards had been granted earned 202,050 stock units with a vested intrinsic value of $4,679. The Company’s 2005 performance program completed its three-year performance cycle on December 31, 2007. Based on meeting performance goals established at the time of the award, participants earned 198,991 stock units with a vested intrinsic value of $6,503. Noncash stock-based compensation associated with PCSUs totaled $741, $6,619 and $6,654 for 2008, 2007 and 2006, respectively.
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As of December 31, 2008, there was approximately $4,450 of total unrecognized compensation cost related to nonvested PCSUs. This cost is expected to be recognized over a weighted-average period of 36 months. Restricted Stock Awards Since 1994, the Company has from time to time granted awards of restricted stock units to certain of the Company’s executives. These awards normally vest over a five-year period with one-third vesting on each of the third, fourth and fifth anniversaries of the grant. An executive must be actively employed by the Company on the vesting date for shares to be issued. However, in the event of the executive’s death, disability or retirement prior to full vesting, shares will be issued on a pro rata basis up through the time the executive’s employment ceases. Participants can elect to defer receipt. However, once vested these awards do not expire. As of December 31, 2008, a total of 401,213 restricted stock units remained outstanding, 298,843 of which were vested. During 2008, 7,546 restricted stock units vested and 30,000 restricted stock units were granted. Noncash stock-based compensation associated with restricted stock grants totaled $558, $419 and $419 for 2008, 2007 and 2006, respectively. As of December 31, 2008, there was $1,123 of total unrecognized compensation cost related to nonvested restricted stock units. This cost is expected to be recognized over a weighted-average period of 22 months. The activity related to the PCSUs and restricted stock units is as follows:
Deferred Compensation Plans Certain officers of the Company may elect to defer a portion of their compensation in the form of stock units. Units are granted as of the day the cash compensation would have otherwise been paid using the closing price of the Company’s common stock on that day. The units immediately vest and earn dividend equivalents. Units are distributed in the form of common stock upon retirement over a period elected by the employee. Cash compensation totaling $852 was deferred as stock units during 2008, resulting in 27,794 units being granted. Conversions to common stock during 2008 totaled 144 shares. Since 2006, non-employee directors were required to defer a minimum of 50% of their quarterly retainer fees into stock units. Units are granted as of the day the cash compensation would have otherwise been paid using the closing price of the Company’s common stock on that day. The units immediately vest and earn dividend equivalents. Distributions begin after retirement from the board over a period elected by the director. 13. Employee Benefit Plans Retirement Plans and Retiree Health and Life Insurance Plans The Company provides non-contributory defined benefit pension plans for a majority of its employees in the United States, and certain of its employees in Mexico and Belgium. Effective December 31, 2003, the Company froze participation for newly hired salaried and non-union hourly U.S. employees in its traditional defined benefit pension plan. The Company adopted a defined contribution plan, the Sonoco Investment and Retirement Plan, which covers its non-union U.S. employees hired on or after January 1, 2004. The Company also sponsors contributory defined benefit pension plans covering the majority of its employees in the United Kingdom, Canada and the Netherlands. The Company also provides postretirement healthcare and life insurance benefits to the majority of its retirees and their eligible dependents in the United States and Canada. In the fourth quarter of 2005, the Company announced changes in eligibility for retiree medical benefits effective January 1, 2006, for its U.S. plan. These changes included the elimination of a Company subsidy toward the cost of retiree medical benefits if certain age and service criteria were not met, as well as the elimination of Company-provided prescription drug benefits for the majority of its current retirees and all future retirees. The components of net periodic benefit cost include the following:
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The following tables set forth the Plans’ obligations and assets at December 31:
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