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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 COMMISSION FILE NUMBER 1-15399
PACKAGING CORPORATION OF AMERICA
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 36-4277050
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1900 WEST FIELD COURT, LAKE FOREST, ILLINOIS 60045
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (847) 482-3000
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
COMMON STOCK, $0.01 PAR VALUE NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
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/
At February 2, 2000, the aggregate market value of the Registrant's voting
stock held by nonaffiliates was approximately $632,198,520. The calculation of
such market value has been made for the purposes of this report only and should
not be considered as an admission or conclusion by the Registrant that any
person is in fact an affiliate of the Registrant.
On February 2, 2000, there were 105,850,000 shares of Common Stock
outstanding.
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PACKAGING CORPORATION OF AMERICA
INDEX
PAGE
PART I --------
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 12
Item 3. Legal Proceedings........................................... 13
Item 4. Submission of Matters to a Vote of Security Holders......... 13
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder
Matters................................................... 13
Item 6. Selected Financial Data..................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 17
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 25
Item 8. Financial Statements and Supplementary Data................. 25
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures................................. 26
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 26
Item 11. Executive Compensation...................................... 28
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 34
Item 13. Certain Relationships and Related Transactions.............. 35
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K.................................................. 38
SIGNATURES.................................................................... 41
INDEX TO FINANCIAL STATEMENTS................................................. F-1
2
PART I
ITEM 1. BUSINESS
GENERAL
PCA is the sixth largest producer of containerboard and corrugated products
in the United States, based on production capacity as reported in the Pulp &
Paper 1999-2000 North American Fact Book. With 1999 net sales of $1.7 billion,
PCA produced 2.2 million tons of containerboard and shipped about 27 billion
square feet of corrugated products.
In 1999, we produced over 1.4 million tons of kraft linerboard at our mills
located in Counce, Tennessee and Valdosta, Georgia. We also produced 0.8 million
tons of semi-chemical corrugating medium at our mills located in Tomahawk,
Wisconsin and Filer City, Michigan. About 15% of our 1999 total fiber
requirements were met with wood from our owned or leased timberland, which are
generally located within 100 miles of our mills.
Our converting operations produce a wide variety of corrugated packaging
products, including conventional shipping containers used to protect and
transport manufactured goods. We also produce multi-color boxes and displays
with strong visual appeal that help to merchandise the packaged product in
retail locations. Finally, we are a large producer of meat boxes and wax-coated
boxes for the agricultural industry.
THE TRANSACTIONS
On April 12, 1999, Pactiv Corporation, formerly known as Tenneco Packaging,
Inc., sold its containerboard and corrugated products business to PCA, an entity
formed by Madison Dearborn Partners, LLC, a private equity investment firm, in
January 1999, for $2.2 billion, consisting of $246.5 million in cash, the
assumption of $1.76 billion of debt incurred by Pactiv immediately prior to the
contribution, and a 45% common equity interest in PCA valued at $193.5 million.
PCA Holdings LLC, an entity organized and controlled by Madison Dearborn,
acquired the remaining 55% common equity interest in PCA for $236.5 million in
cash, which was used to finance in part the transactions.
The financing of the transactions consisted of (1) borrowings under a new
$1.46 billion senior credit facility for which J.P. Morgan Securities Inc. and
BT Alex. Brown Incorporated (the predecessor to Deutsche Banc Alex. Brown) were
co-lead arrangers, (2) the offering of $550 million of 9 5/8% senior
subordinated notes due 2009 and $100 million of 12 3/8% senior exchangeable
preferred stock due 2010, (3) a cash equity investment of $236.5 million by PCA
Holdings and (4) an equity investment by Pactiv valued at $193.5 million. As
required by their terms, the $550 million of senior subordinated notes and
$100 million of senior exchangeable preferred stock issued in the April 12, 1999
transactions were exchanged for publicly registered securities in the same
amounts in a registered exchange offer completed in October 1999.
On February 2, 2000, PCA completed an initial public offering of its common
stock. In connection with that offering, PCA sold 11,250,000 new shares of
common stock and used the net proceeds to redeem all of the outstanding senior
exchangeable preferred stock on March 3, 2000.
The senior credit facility was entered into to finance in part the
transactions and to pay related fees and expenses and to provide future
borrowings to PCA for general corporate purposes, including working capital. The
senior credit facility initially consisted of three term loan facilities in an
original aggregate principal amount of $1.21 billion and a revolving credit
facility with up to $250 million in availability. PCA's total borrowings under
the senior credit facility as of December 31, 1999 consisted of $779.0 million
of term loans. No amounts were outstanding under the revolving credit facility
as of that date.
3
INDUSTRY OVERVIEW
CORRUGATED PRODUCTS
According to the Fibre Box Association, the value of industry shipments of
corrugated products was over $21 billion in 1999. Using reported volumes from
this source, corrugated products volume has grown at a compound annual rate of
3.1% since 1975. Demand for corrugated products has increased in all but four
years during this 24-year period. At no time during this period did demand for
corrugated products decrease in consecutive years.
Most converting plants are either corrugator plants or sheet plants. There
are approximately 612 corrugator plants in the United States. Corrugator plants
have equipment on-site that flutes the corrugating medium and combines it with
linerboard to create corrugated sheets. These sheets are then converted into
corrugated products.
There are approximately 860 sheet plants in the United States. Sheet plants
purchase corrugated sheets from corrugator plants and convert these sheets into
finished corrugated products. According to the Fibre Box Association, corrugator
plants account for 84% of the industry's corrugated products shipments, while
sheet plants contribute the remaining 16%.
The primary end-use markets for corrugated products are shown below:
Food, beverages and agricultural products................... 39.2%
Paper and fiber products.................................... 22.6%
Petroleum, plastic, synthetic and rubber products........... 10.3%
Glass, pottery, fabricated metal and metal containers....... 6.8%
Electrical and electronic machinery and appliances.......... 3.7%
High-volume, national account customers typically seek suppliers with
multiple plant locations that can provide broad geographic coverage, an array of
manufacturing capabilities and flexibility to provide products in critical
situations. Local accounts tend to place a greater emphasis on local sales and
customer service support, quick order turnaround and specialized services.
Corrugated products are generally delivered by truck. Compared to many other
products, the amount of corrugated products that can fit into a truckload weighs
much less. This, coupled with the relatively low price per ton of corrugated
products, make shipping costs account for a relatively high portion of total
costs. As a result, converting plants tend to be located in close proximity to
customers to minimize freight costs.
The corrugated products industry consists of an estimated 702 companies in
the United States. The top five U.S. integrated corrugated manufacturers produce
approximately 65% of total U.S. industry production. Integrated producers
accounted for approximately three-quarters of total corrugated products
shipments.
CONTAINERBOARD
Containerboard, which includes both linerboard and corrugating medium, is
the principal raw material used to manufacture corrugated products. Linerboard
is used as the inner and outer facings, or liners, of corrugated products.
Corrugating medium is fluted and laminated to linerboard in corrugator plants to
produce corrugated sheets. The sheets are subsequently printed, cut, folded and
glued in corrugator plants or sheet plants to produce corrugated products.
Containerboard may be manufactured from both softwood and hardwood fibers,
as well as from recycled fibers from used corrugated and waste from converting
operations. Kraft linerboard is made predominantly from softwoods like pine.
Semi-chemical corrugating medium is made from hardwoods
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such as oak. Wood may be brought to the mill as logs to be chipped, or as
already-chipped wood. The chips are chemically treated and cooked to
form virgin fiber, also known as wood pulp. This pulp can be processed alone or
blended with some percentage of recycled fiber on paper machines. The pulp is
mixed with water and flows onto a moving wire screen, which allows the water to
drain and concentrates the fibers. What remains is a paper mat that is
compressed by a series of presses and then dried. The paper is wound into large
rolls, which are slit to size as required by converters, and shipped to them.
Linerboard is made in a range of grades or basis weights. The most common
basis weight for linerboard is 42 lb., although linerboard is produced in
weights that vary from under 26 lb. to over 90 lb. Basis weight represents the
weight in pounds per thousand square feet of linerboard. Producers also market
linerboard by performance characteristics, appearance and color. The following
table describes different product weight, performance and color characteristics:
CATEGORY PRODUCTS DESCRIPTION
- -------- -------- -----------
Weights (lb./1,000 sq. ft.)....... 26 - 38 lb. Lightweights
41 - 56 Middleweights
61 - 90 Heavyweights
>90 Super heavyweights
Performance....................... High ring crush stacking or compression
strength
Tare weight minimal variations in basis
weight
Wet strength strength while wet
Color............................. Mottled white bleached pulp applied to
unbleached sheet; mottled
appearance
White top even, white surface appearance
Full bleached solid white throughout
The market demand for high performance grades, lightweights and white
linerboard continue to grow at a faster rate because customers are seeking
better strength characteristics at a lower cost as well as improved appearance.
Recycled linerboard production has also grown rapidly in recent years due to
favorable economics, customer demand for recycled packaging, and improved
quality and performance characteristics. Recycled linerboard accounted for
approximately 17% of total estimated U.S. linerboard production in 1999. A
recycled linerboard mill is typically smaller and less capital-intensive than
kraft linerboard mills. These mills are likely to be located near a major urban
area where the supply of recycled material is abundant and converter operations
are more geographically concentrated.
U.S. linerboard producers export nearly 20% of their production. The top
three markets are Europe, Asia and Latin America, which together consumed about
90% of the U.S. linerboard exports during 1998. Linerboard exports have grown at
an average rate of 6% a year during the last 15 years, reaching a record
4.6 million tons in 1997. Due to the strong U.S. dollar and weak Asian markets,
exports of linerboard were significantly lower in 1998 and 1999 at 3.7 million
tons and 3.2 million tons, respectively. The market for exported corrugating
medium is considerably smaller than for linerboard. About 2.5% of the
corrugating medium produced in the United States is exported.
Despite recent consolidation activity, the containerboard industry remains
relatively fragmented, with the top five producers accounting for 57% of
production capacity and the top ten accounting for 76%.
Containerboard is a commodity-like product whose price tends to be highly
cyclical. Historically, pricing for containerboard has reflected changes in
containerboard supply that resulted from capacity additions and reductions, as
well as changes in inventory levels and demand. The supply/demand balance
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improved throughout 1999 and the average price of linerboard increased about 25%
during 1999. In 1999, several major containerboard manufacturers announced
production curtailments and mill shutdowns. These reductions represent nearly
2 million tons or 5% of North American capacity. Only minimal capacity additions
have been publicly announced through 2002 according to the American Forest &
Paper Association.
COMPETITIVE STRENGTHS
- LOW-COST PRODUCER. Based on two studies performed in 1998 by
Jacobs-Sirrine, an industry consulting firm, PCA's two largest containerboard
mills were ranked in the lowest quartile for cash manufacturing costs in the
industry. One of these studies was a single-client study that we paid
Jacobs-Sirrine to perform in February 1998. The other was a multi-client study
issued by Jacobs-Sirrine in the fourth quarter of 1998 that was available for
purchase by the general public. The Counce and Tomahawk mills represent
two-thirds of PCA's production capacity. Counce produces linerboard and Tomahawk
makes semi-chemical corrugating medium. The industry uses cash manufacturing
cost per ton as a measure of operating cost effectiveness for containerboard
mill production. Cash manufacturing costs are the out-of-pocket costs associated
with producing containerboard, which include costs for fiber, chemicals, energy,
other materials and consumables, hourly labor and salaried supervision.
Valdosta, our second kraft linerboard mill, uses only virgin fiber. In
February 1998, Jacobs-Sirrine also ranked it as a low cost, or first quartile,
mill. In the fourth quarter 1998 study, Valdosta's ranking fell to below average
cost, or third quartile. This was due primarily to a decline in recycled fiber
prices. This decline improved the relative cost position of recycled mills.
Recycled fiber costs have increased recently to nearly the same level as in
February 1998. This recycled fiber cost increase has improved Valdosta's cost
position, returning it to the lowest cost quartile.
Filer City, our smallest mill, produces semi-chemical corrugating medium.
Filer City ranks as an average cost mill in both of the Jacobs-Sirrine studies.
Fiber represents the single largest cost element in manufacturing
containerboard. Our mills are located near abundant supplies of wood fiber.
Additionally, our ability to vary the percentage of softwood, hardwood and
recycled fiber enables us to react to changes in fiber prices and minimize fiber
costs. Overall, our fiber costs are among the lowest in the industry.
In recent years, we have also made significant productivity and efficiency
gains. These include labor savings, higher machine speeds, reduced waste and
lower chemical and energy costs.
- INTEGRATED OPERATIONS. Our level of containerboard integration with our
converting operations is approximately 80%. This high level of integration
provides a stable and predictable demand for our containerboard mill production.
The remaining 20% of production is sold externally, with about two-thirds going
to domestic corrugated converters and one-third to the export market.
Containerboard pricing behaves much as a commodity and is dependent on the
relative balance of containerboard supply and demand. Corrugated products demand
has been fairly stable over the past 20 years.
- FOCUS ON VALUE-ADDED PRODUCTS AND SERVICES. We provide our customers with
value-added products, enhanced graphics and superior customer service. Since
1995, we have acquired nine converting operations. Four of these acquisitions
significantly increased our graphics capabilities, while five sheet plant
acquisitions improved our ability to provide shorter production runs and faster
turnaround times in those markets. We have also established five geographically
dispersed graphics design centers that use sophisticated computer design
software to create visually appealing customized corrugated products.
6
OPERATIONS AND PRODUCTS
MILLS
Our two linerboard mills can manufacture a broad range of linerboard grades
ranging from 26 lb. to 96 lb. Our two semi-chemical corrugating medium mills can
manufacture grades ranging in weight from 21 lb. to 47 lb. All four of our mills
have completed an extensive independent review process to become ISO 9002
certified. ISO 9002 is an international quality certification that verifies a
facility maintains and follows stringent procedures for manufacturing, sales and
customer service.
COUNCE. Our Counce, Tennessee mill is one of the five largest linerboard
mills in the United States out of approximately 70 linerboard mills. Its
production capacity is approximately 1,003,000 tons per year. In 1999, we
produced approximately 948,800 tons of kraft linerboard on two paper machines at
Counce. We produced a broad range of basis weights from 31 lb. to 96 lb. Our
Counce mill machines also produce a variety of performance and specialty grades
of linerboard including high-ring crush and wet strength. In 1998 we developed
the capability to produce linerboard grades with a mottled white printing
surface. Mottled white has a marble-like coloration and is typically priced from
$130 to $175 per ton higher than kraft linerboard, but is more expensive to
produce.
VALDOSTA. Our Valdosta, Georgia mill is a kraft linerboard mill and has a
production capacity of approximately 457,000 tons per year. In 1999, our single
paper machine at Valdosta produced approximately 433,800 tons of linerboard.
Valdosta primarily produces middleweight linerboard ranging from 42 lb. to
56 lb., and heavyweight/super heavyweight linerboard ranging from 61 lb. to
96 lb.
TOMAHAWK. Our Tomahawk, Wisconsin mill is the second largest corrugating
medium mill in the United States out of 69 corrugating medium mills. Its
production capacity is 548,000 tons per year. In 1999, we produced approximately
525,300 tons of semi-chemical corrugating medium at Tomahawk using three paper
machines, one of which is the third largest corrugating medium machine in the
United States. These machines produce a broad range of basis weights from
23 lb. to 47 lb. Our Tomahawk mill also produces a variety of performance and
specialty grades of corrugating medium. This includes high ring crush, wet
strength, tare weight and super heavyweight.
FILER CITY. Our Filer City, Michigan mill is a semi-chemical corrugating
medium mill. In 1999, Filer City produced approximately 272,100 tons of
corrugating medium on two paper machines. In July 1998, we shut down one machine
at Filer City. Mill production capacity at Filer City is 367,000 tons a year if
we run all three paper machines. Filer City produces a range of corrugating
medium grades in basis weights from 21 lb. to 40 lb.
CORRUGATED PRODUCTS
We operate 39 corrugator plants, 29 sheet/specialty plants and five graphic
design centers. The 39 corrugator plants have a corrugator on site and
manufacture both combined sheets and finished products. Twenty-seven sheet
plants purchase combined sheets and create finished products. Two other small
specialty facilities include a collating and distribution packaging center, as
well as a machine rebuild facility. The five graphic design centers are located
in Westmont, Illinois; Cincinnati, Ohio; Dallas, Texas; North Brunswick, New
Jersey; and Southgate, California.
These graphic design centers were established in response to customers'
increasing need for sophisticated, high impact graphics on their corrugated
products. Customers are increasingly using special in-store corrugated displays
to market their products and are requiring more intricate packaging designs. In
response, our graphic design centers offer state-of-the-art computers and
equipment that are capable of 24-hour design turnaround and reduced product
delivery times.
Our converting operations are spread throughout the United States. Each
corrugator plant serves a market radius that typically averages 150 miles. Our
sheet plants are generally located in close proximity to
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our larger corrugator plants which enables us to offer additional services and
converting capabilities such as small volume and quick turnaround items.
We produce a wide variety of products ranging from basic corrugated shipping
containers to specialized packaging such as wax-coated boxes for the agriculture
industry. We also have multi-color printing capabilities to make high-impact
graphics boxes and displays that offer customers more attractive packaging.
TIMBERLAND
We currently own, lease, manage or have cutting rights to approximately
540,000 acres of timberland located near our Counce and Valdosta mills. The
acreage we control includes 390,000 acres of owned land and another 150,000
acres of long term leases. Virtually all of these leases have terms over
20 years.
Over 95% of our owned or leased timberland is located within 100 miles of
our mills, which results in lower wood transportation costs and provides a
secure source of wood fiber. After giving effect to the timberland sold in 1999,
approximately 15% of our total fiber requirements were supplied by wood from
timberland owned or leased by us.
In addition to the timberland we manage ourselves, we have initiated a
Forest Management Assistance Program. Through this program we provide
professional forestry assistance to private timberland owners to improve harvest
yields and to optimize their harvest schedule. We have managed the regeneration
of over 97,000 acres by supplying pine seedlings. In exchange for our expertise,
we are given the right of first refusal over timber sales from those lands.
These private lands include over 200,000 acres of timberland. We expect to
harvest over 150,000 cords of wood from these forests annually.
We also participate in the Sustainable Forestry Initiative, which is
organized by the American Forest and Paper Association. This initiative is aimed
at ensuring the long-term health and conservation of America's forestry
resources. Activities include limiting tree harvest sizes, replanting harvest
acreage, and participating in flora and fauna research and protecting water
streams.
We believe that the wood supply markets near our Valdosta, Filer City and
Tomahawk mills are very good and will remain so for the foreseeable future. We
do not own or lease any timberland near our Filer City mill, and as a result of
our recent sale of 405,000 acres of timberland, we do not own or lease any
timberland near our Tomahawk mill and we own or lease significantly less
timberland near our Valdosta mill. We have entered into supply agreements
covering 329,000 acres of the 405,000 acres of timberland sold near our Tomahawk
and Valdosta mills. We currently believe that we will be able to purchase our
wood requirements at competitive prices.
SOLID WOOD AND RECYCLING FACILITIES
We own three sawmills located in Ackerman, Mississippi; Selmer, Tennessee;
and Fulton, Mississippi. These three sawmills produce approximately 155 million
board feet annually of lumber used to make furniture and building products. We
also have an air-dry yard operation in Burnsville, Mississippi that holds newly
cut lumber while it dries. Finally, we have a 50% interest in a wood chipping
joint venture in Fulton, Mississippi. The solid wood products group enables us
to maximize the value of our timber through lumber sales, when appropriate, and
also provides us with a supply of wood chips.
We also operate three paper recycling centers, one in Jackson, Tennessee and
two in Nashville, Tennessee. These recycling centers collect old corrugated
containers, newspapers and other paper and provide a source of recycled fiber to
our nearby Counce mill.
8
PERSONNEL
An on-site mill manager oversees each of our mills. The mill manager's
operating staff includes personnel who support mill operations and woodlands, as
well as support groups for scheduling and shipping, technical services and
process control, maintenance and reliability, and engineering and technology.
Our administrative support groups include accounting, information systems,
payroll and human resources. All of the groups mentioned above report to each
respective mill manager. Headquarters corporate support, located in Lake Forest,
Illinois includes the containerboard sales group and the production scheduling
group, which processes customer orders. We also maintain a corporate mill
engineering staff that provides engineering, procurement, construction and
start-up services for the four mills.
Each of our converting operations is managed by a team, which usually
includes a general manager, a sales manager, a production manager, a controller
and a customer service manager. We also have a centralized technical support
group comprised of packaging engineers and technicians. This group provides
services to our 68 converting operations that include testing, engineering,
manufacturing and technical support. Our technical support group also works with
our customers on location to assure that our customers' quality and performance
standards are consistently met. Our converting operations are grouped into seven
geographic areas, each managed by an area general manager.
SALES AND MARKETING
Our containerboard sales group is responsible for the sale of linerboard and
corrugating medium to our own corrugator plants, to other domestic customers and
to the export market. This group handles order processing for all shipments of
containerboard from our own mills to our own corrugator plants. These personnel
also coordinate and execute all containerboard trade agreements with other
containerboard manufacturers.
Our corrugated products are sold through a direct sales and marketing
organization. Sales representatives and a sales manager at each converting
operations facility serve local and regional accounts. Corporate account
managers serve large national accounts at multiple customer locations.
Additionally, our graphic design centers maintain an on-site dedicated graphics
sales force. General marketing support is located at our corporate headquarters.
In addition to direct sales and marketing personnel, we utilize support
personnel that are new product development engineers and product graphics and
design specialists. These individuals are located at both the corrugator plants
as well as the graphic design centers.
DISTRIBUTION
Containerboard produced in our mills is shipped by rail or truck. Our
individual mills do not own or maintain outside warehousing facilities. We do
use several third-party warehouses for short-term storage.
Our corrugated products are usually delivered by truck due to our large
number of customers and their demand for timely service. Shipping costs
represent a relatively high percentage of our total costs due to the high bulk
of corrugated products. As a result, our converting operations typically service
customers within a 150 miles radius.
CUSTOMERS
CONTAINERBOARD. Our converting operations, either directly or through trade
agreements, consume approximately 80% of our mills' containerboard production.
These trade agreements allow us to swap containerboard produced in our mills for
containerboard produced at other companies' locations. Trades, which are common
in the industry, reduce the distance the rolls of containerboard have to be
shipped, and, in turn, overall freight costs. Trades also encourage more
efficient production for the industry, since
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companies can trade for containerboard grades they cannot manufacture as
efficiently on their own equipment.
The containerboard that we do not consume directly or through trades is sold
to independent domestic converters and export customers. We also sell
containerboard to manufacturers of fiber drums, air bags, protective packaging
and other specialty products.
CORRUGATED PRODUCTS. About three-quarters of our corrugated products
customers are regional and local accounts, and they are broadly diversified
across industries and geographic locations. Based on an internal customer survey
conducted in 1998, we estimate that nearly 40% of our customers have purchased
from us for over five years.
RAW MATERIALS
FIBER SUPPLY. Fiber is the single largest cost in the manufacture of
containerboard. To reduce our fiber costs we have invested in processes and
equipment to ensure a high degree of fiber flexibility. Our mills have the
capability to shift a portion of their fiber consumption between softwood,
hardwood and recycled sources. With the exception of our Valdosta mill, all of
our mills can utilize some recycled fiber in their containerboard production.
Our ability to use various types of virgin and recycled fiber helps mitigate the
impact of changes in the prices of various fibers.
ENERGY SUPPLY. Energy at the mills is obtained through purchased
electricity or through various fuels which are then converted to steam or
electricity on-site. Fuel sources include coal, natural gas, oil, bark and
byproducts of the containerboard manufacturing and pulping process. These fuels
are burned in boilers to produce steam. Steam turbine generators are used to
produce electricity.
Our two kraft linerboard mills at Counce and Valdosta generate approximately
60% to 70% of their energy requirements from their own byproducts. Presently,
50% of our electricity consumption for the four mills is generated on-site.
COMPETITION
CONTAINERBOARD. Containerboard is generally considered a commodity-type
product and can be purchased from numerous suppliers. Approximately 59 companies
currently produce containerboard and the top five represent 57% of total
industry shipments. PCA's primary competition for our external sales of
containerboard are a number of large, diversified paper companies, including
Georgia-Pacific Corporation, International Paper Company, Smurfit-Stone
Container Corporation, Temple-Inland Inc., Weyerhaeuser Company and Willamette
Industries, Inc., as well as other regional manufacturers.
CORRUGATED PRODUCTS. Corrugated products are produced by more than 700 U.S.
companies operating nearly 1,500 plants. Most corrugated products are custom
manufactured to the customer's specifications. Corrugated producers generally
sell within a 150-mile radius of their plants and compete with other corrugated
producers in their local market. In fact, the Fibre Box Association tracks
industry data by 47 distinct market regions.
The larger, multi-plant integrated companies may also solicit larger,
multi-plant customers who purchase for all of their facilities on a consolidated
basis. These customers are often referred to as national or corporate accounts.
Corrugated products businesses seek to differentiate themselves through
pricing, quality, service, design and product innovation. We compete for both
local and national account business and we compete against producers of other
types of packaging products. On a national level, our competitors include
Four M Corporation, Gaylord Container Corporation, Georgia-Pacific Corporation,
International Paper
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Company, Smurfit-Stone Container Corporation, Temple-Inland Inc., Weyerhaeuser
Company and Willamette Industries, Inc. However, with our strategic focus on
local and regional accounts, we believe we compete as much with the smaller,
independent converters as with the larger, integrated producers.
EMPLOYEES
As of December 31, 1999, we had approximately 7,800 employees. Approximately
2,100 of these employees were salaried and approximately 5,700 were hourly.
Approximately 75% of our hourly employees are represented by unions. Our
unionized employees are represented primarily by the Paper, Allied Industrial,
Chemical, Energy Workers International Union, the Graphic Communications
International Union and the United Steel Workers of America.
Contracts for our unionized mill employees expire between October 2000 and
September 2003. Contracts for unionized converting plant employees expire
between May 2000 and February 2006. We are currently in negotiations to renew or
extend any union contracts expiring in the near future.
There have been no instances of significant work stoppages in the past
15 years. We believe we have satisfactory relations with our employees.
ENVIRONMENTAL MATTERS
Compliance with environmental requirements is a significant factor in our
business operations. We commit substantial resources to maintaining
environmental compliance and managing environmental risk. We are subject to, and
must comply with, a variety of federal, state and local environmental laws,
particularly those relating to air and water quality, waste disposal and the
cleanup of contaminated soil and groundwater. We believe that we are currently
in material compliance with all applicable environmental rules and regulations.
Because environmental regulations are constantly evolving, we have incurred, and
will continue to incur, costs to maintain compliance with those laws. We work
diligently to anticipate and budget for the impact of applicable environmental
regulations and do not currently expect that future environmental compliance
obligations will materially affect our business or financial condition.
In April 1998, the United States Environmental Protection Agency finalized
the Cluster Rules, which govern all pulp and paper mill operations, including
those at our mills. Over the next several years, the Cluster Rules will affect
our allowable discharges of air and water pollutants. As a result, PCA and its
competitors are required to incur costs to ensure compliance with these new
rules. Our current spending projections to complete Cluster Rule compliance
implementation at our four mills is about $47.9 million from 2000 to 2005. From
1997 through 1999, we spent approximately $7.1 million on Cluster Rule
compliance. Total capital costs for environmental matters, including Cluster
Rule compliance, were $11.0 million for 1999 and we currently estimate that they
will be $25.6 million for 2000.
As is the case with any industrial operation, we have in the past incurred
costs associated with the remediation of soil or groundwater contamination. From
January 1994 through December 1999, remediation costs at our mills and
converting plants totaled about $2.5 million. We do not believe that any
on-going remedial projects are material in nature. As of December 31, 1999, we
maintained a reserve of $0.1 million for environmental remediation liability as
well as a general overall environmental reserve of $3.6 million, which includes
funds relating to onsite landfill and surface impoundments as well as on-going
and anticipated remedial projects. We believe these reserves are adequate.
We could also incur environmental liabilities as a result of claims by third
parties for civil damages, including liability for personal injury or property
damage, arising from releases of hazardous substances or contamination. We are
not aware of any material claims of this type currently pending against us.
In the transactions, Pactiv agreed to retain all liability for all former
facilities and all sites associated with pre-closing offsite waste disposal.
Pactiv also retained environmental liability for a closed landfill located near
the Filer City mill.
11
ITEM 2. PROPERTIES
MILLS. The table below provides a summary of our containerboard mills, the
principal products produced and each mill's capacity.
LOCATION FUNCTION CAPACITY (TONS)
- -------- ---------------------- ---------------
Counce, TN..................................... Kraft linerboard mill 1,003,000
Filer City, MI................................. Semi-chemical
medium mill 367,000*
Tomahawk, WI................................... Semi-chemical
medium mill 548,000
Valdosta, GA................................... Kraft linerboard mill 457,000
----------
Total...................................... 2,375,000
==========
- ------------------------
* We operated only two of our three paper machines at Filer City in 1999,
reducing the total productive capacity by 70,000 tons to 297,000 tons.
Each of the mills is currently subject to a mortgage held by Morgan Guaranty
Trust Company of New York on behalf of the lenders under the senior credit
facility.
OTHER FACILITIES. In addition to our mills, we own 37 corrugator plants and
seven sheet/specialty plants. We also own three sawmills, an air-drying yard,
one recycling facility, one warehouse and miscellaneous other property, which
includes sales offices and woodlands forest management offices. These sales
offices and woodlands forest management offices generally have one to four
employees and serve as administrative offices. We lease two corrugator plants,
22 sheet/specialty plants, five regional design centers, two recycling
facilities and numerous other distribution centers, warehouses and facilities.
PCA has no owned or leased properties outside of the continental United States.
All of our owned real property is subject to a first priority mortgage held by
Morgan Guaranty Trust Company of New York on behalf of the lenders under the
senior credit facility.
TIMBERLAND. We own or lease approximately 540,000 acres of timberland as
shown below:
OWN LEASE TOTAL
-------- -------- --------
Counce, TN....................................... 300,000 56,000 356,000
Tomahawk, WI..................................... 1,000 -- 1,000
Valdosta, GA..................................... 89,000 94,000 183,000
------- ------- -------
Total Acres.................................... 390,000 150,000 540,000
======= ======= =======
All of our owned timberland is subject to a mortgage held by Morgan Guaranty
Trust Company of New York on behalf of the lenders under the senior credit
facility. Lease agreements are generally for 35 to 66 years and offer fiber
harvest rights on the leased properties.
HEADQUARTERS. We currently lease our executive and administrative offices
in Lake Forest, Illinois from Pactiv under a lease expiring in January 2003.
We currently believe that our facilities and properties are sufficient to
meet our operating requirements for the foreseeable future.
12
ITEM 3. LEGAL PROCEEDINGS
In May 1999, we were served with a complaint filed in the United States
District Court for the Eastern District of Pennsylvania (WINOFF INDUSTRIES, INC.
V. STONE CONTAINER CORPORATION, ET AL.) alleging civil violations of Section 1
of the Sherman Act in connection with the pricing and production of linerboard
from October 1, 1993 through November 30, 1995. Plaintiffs purport to represent
a nationwide class of purchasers of corrugated containers, and the complaint
names ten major linerboard manufacturers as defendants. The complaint seeks
treble damages for allegedly unlawful corrugated container price increases, plus
attorneys' fees. We believe the allegations have no merit, are vigorously
defending ourselves, and believe the outcome of this litigation should not have
a material adverse effect on our financial position, results of operations, or
cash flow.
We are also party to various legal actions arising in the ordinary course of
our business. These legal actions cover a broad variety of claims spanning our
entire business. We believe that the resolution of these legal actions will not,
individually or in the aggregate, have a material adverse effect on our
financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 14, 1999, PCA's stockholders acted by written consent to approve
and adopt:
- PCA's 1999 Long-Term Equity Incentive Plan, and
- an Amendment to PCA's Restated Certificate of Incorporation.
The equity incentive plan provides for grants of stock options, stock
appreciation rights, or SAR's, restricted stock and performance awards.
Directors, officers and employees of PCA and its subsidiaries, as well as others
who engage in services for PCA, are eligible for grants under the plan. The
purpose of the plan is to provide these individuals with incentives to maximize
stockholder value and otherwise contribute to the success of PCA and to enable
PCA to attract, retain and reward the best available persons for positions of
responsibility.
The amendment to PCA's Restated Certificate of Incorporation increased the
authorized capitalization of PCA, authorized the board to issue blank check
preferred stock and prohibited the stockholders from taking action by written
consent in lieu of a meeting.
Stockholders holding 91,767,200 shares of common stock, or 96.7% of the
shares then outstanding, consented to the actions taken by written consent. PCA
did not solicit or receive consents from the holders of the remaining shares of
common stock.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
MARKET FOR COMMON STOCK; DIVIDENDS
As a result of PCA's initial public offering completed on February 2, 2000,
PCA's common stock is listed on the New York Stock Exchange under the symbol
"PKG". As of March 1, 2000, there were nine registered holders of record of
PCA's common stock.
PCA has never paid dividends on the common stock. PCA currently has no plans
to pay dividends on the common stock. The payment of any future dividends will
be determined by PCA's board of directors in light of conditions then existing,
including PCA's earnings, financial condition and capital requirements,
restrictions in financing agreements, business conditions and other factors.
Under the terms of the agreements governing our outstanding indebtedness, we are
prohibited or restricted from paying dividends
13
on our common stock. In addition, under Delaware law, we are prohibited from
paying any dividends unless we have "capital surplus" or "net profits" available
for this purpose, as these terms are defined under Delaware law.
USE OF PROCEEDS
PCA used approximately $124.4 million of the net proceeds received by it
from the initial public offering completed on February 2, 2000, to redeem all of
its outstanding 12 3/8% senior exchangeable preferred stock due 2010, on
March 3, 2000. PCA used the remaining net proceeds for general corporate
purposes.
RECENT SALES OF UNREGISTERED SECURITIES
During the year ended December 31, 1999, PCA issued the following securities
without registration under the Securities Act. All share amounts reflect the
October, 1999 220-for-one stock split.
On April 12, 1999, in transactions exempt from registration under
Section 4(2) of the Securities Act, PCA issued:
- an aggregate of 52,030,000 shares of common stock to PCA Holdings LLC for
an aggregate of $236.5 million;
- an aggregate of 42,570,000 shares of common stock valued at
$193.5 million to Pactiv in partial consideration for the contribution of
its containerboard and corrugated products business to PCA;
- an aggregate of 55 shares, liquidation preference $1.00 per share, of
junior preferred stock to PCA Holdings for nominal consideration; and
- an aggregate of 45 shares, liquidation preference $1.00 per share, of
junior preferred stock to Pactiv for nominal consideration.
PCA used the net proceeds from these issuances to fund the transactions.
On April 12, 1999, in a transaction exempt from registration under
Section 4(2) of the Securities Act, PCA sold to J.P. Morgan Securities Inc. and
BT Alex. Brown Incorporated, pursuant to a Purchase Agreement dated as of
March 30, 1999:
- an aggregate of $550 million aggregate principal amount of 9 5/8% senior
subordinated notes due 2009 for an aggregate consideration of
$550 million less underwriting discounts and commissions of $16.5 million;
and
- an aggregate of $100 million aggregate liquidation preference of 12 3/8%
senior exchangeable preferred stock due 2010 for an aggregate
consideration of $100 million less underwriting discounts and commissions
of $3.5 million.
The notes and preferred stock were immediately resold by the initial
purchasers in transactions not involving a public offering.
PCA used the net proceeds of these issuances to fund the transactions.
In June 1999, in transactions exempt from registration under Rule 701 of the
Securities Act, PCA sold an aggregate of 3,132,800 shares of common stock to
employees of PCA for an aggregate of $14.2 million in cash. The proceeds were
used to redeem 1,723,040 shares from PCA Holdings and 1,409,760 shares from
Pactiv. PCA also issued options to management employees to purchase 6,576,460
shares of common stock, of which 7,260 have been canceled.
14
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth the selected historical financial and other
data of PCA and the containerboard and corrugated products business of Pactiv
Corporation (the "Group"). The selected historical financial and other data as
of and for the years ended December 31, 1996, 1997 and 1998, and for the period
from January 1, 1999 to April 11, 1999, was derived from the audited combined
financial statements of the Group and the related notes thereto included
elsewhere in this report. The selected historical financial and other data as of
and for the year ended December 31, 1995 was derived from the unaudited combined
financial statements of the Group. The historical financial data as of
December 31, 1999 and for the period from April 12, 1999 to December 31, 1999
has been derived from the audited consolidated financial statements of PCA
included elsewhere in this report. The information contained in the following
table also should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations," the historical
combined financial statements of the Group including the notes thereto and the
historical consolidated financial statements of PCA including the notes thereto,
contained elsewhere in this report.
GROUP PCA(1)
---------------------------------------------------------------------- --------------
YEAR ENDED DECEMBER 31, JAN. 1, 1999 APRIL 12, 1999
----------------------------------------------------- THROUGH THROUGH
1995 1996 1997 1998 APRIL 11, 1999 DEC. 31, 1999
----------- ----------- ----------- ----------- -------------- --------------
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
STATEMENT OF INCOME DATA:
Net sales................. $ 1,844,708 $ 1,582,222 $ 1,411,405 $ 1,571,019 $ 433,182 $1,262,285
=========== =========== =========== =========== ========== ==========
Income (loss) before
extraordinary item...... $ 224,121 $ 90,366 $ 27,390 $ 71,439 $ (128,599) $ 47,397
Extraordinary Item........ -- -- -- -- (6,327) (6,897)
----------- ----------- ----------- ----------- ---------- ----------
Net income (loss)......... 224,121 90,366 27,390 71,439 (134,926) 40,500
Preferred dividends and
accretion of preferred
stock issuance costs.... -- -- -- -- -- (9,296)
----------- ----------- ----------- ----------- ---------- ----------
Net income (loss)
available to common
stockholders............ $ 224,121 $ 90,366 $ 27,390 $ 71,439 $ (134,926) $ 31,204
=========== =========== =========== =========== ========== ==========
Basic earnings per
share(3):
Income (loss) before
extraordinary item.... $ 2.37 $ .96 $ .29 $ .76 $ (1.36) $ .41
Extraordinary item...... -- -- -- -- (.07) (.07)
----------- ----------- ----------- ----------- ---------- ----------
Net income (loss) per
common share.......... $ 2.37 $ .96 $ .29 $ .76 $ (1.43) $ .34
=========== =========== =========== =========== ========== ==========
Diluted earnings per
share(3):
Income (loss) before
extraordinary item.... $ 2.37 $ .96 $ .29 $ .76 $ (1.36) $ .39
Extraordinary item...... -- -- -- -- (.07) (.07)
----------- ----------- ----------- ----------- ---------- ----------
Net income (loss) per
common share.......... $ 2.37 $ .96 $ .29 $ .76 $ (1.43) $ .32
=========== =========== =========== =========== ========== ==========
Weighted average common
shares outstanding...... 94,600 94,600 94,600 94,600 94,600 92,108
15
GROUP PCA(1)
---------------------------------------------------------------------- --------------
YEAR ENDED DECEMBER 31, JAN. 1, 1999 APRIL 12, 1999
----------------------------------------------------- THROUGH THROUGH
1995 1996 1997 1998 APRIL 11, 1999 DEC. 31, 1999
----------- ----------- ----------- ----------- -------------- --------------
(IN THOUSANDS)
BALANCE SHEET DATA:
Total assets.............. $ 1,202,536 $ 1,261,051 $ 1,317,263 $ 1,367,403 $2,391,089 $2,153,208
Total long-term
obligations(2).......... 21,739 20,316 27,864 17,552 1,760,466 1,432,553
- ------------------------
1) There was no activity for PCA from January 25, 1999, its date of inception,
through April 11, 1999.
2) Total long-term obligations include long-term debt, the current maturities
of long-term debt and redeemable preferred stock. The amount excludes
amounts due to Pactiv or other Tenneco affiliates as part of the Group's
interdivision account or other financing arrangement.
3) Earnings per share through April 11, 1999 has been calculated using the
historical earnings of the Group and the number of common shares resulting
from the closing of the acquisition on April 12, 1999 (94,600,000 common
shares after giving effect to the 220-for-one stock split). For the PCA
historical period from April 12, 1999 to December 31, 1999, earnings
available to common stockholders includes a reduction for $9,296 of
preferred stock dividends. PCA did not declare any dividends on its common
shares in 1999.
For all periods presented through April 11, 1999, basic and diluted earnings
per share are the same because there are no potentially dilutive other
securities. For the PCA historical period from April 12, 1999 to
December 31, 1999, diluted earnings per share includes the dilutive effect
of the 6,569,200 options granted in June 1999. This dilutive effect is
calculated using the treasury stock method and the initial public offering
price of $12 per share.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of historical results of operations and financial
condition should be read in conjunction with the audited financial statements
and the notes thereto which appear elsewhere in this report.
OVERVIEW
In connection with the transactions, PCA acquired The Containerboard Group
of Pactiv Corporation, which consisted of its containerboard and corrugated
products business and which we refer to in this report as the Group. From its
formation in January 1999 and through the closing of the acquisition on
April 12, 1999, PCA did not have any significant operations. Accordingly, the
historical financial results for periods prior to April 12, 1999 described below
are those of the Group.
The Group has historically operated as a division of Pactiv, and has not
historically operated as a separate, stand-alone entity. As a result, the
historical financial information included in this report does not necessarily
reflect what the Group's financial position and results of operations would have
been had the Group been operated as a separate, stand-alone entity during the
periods presented.
The acquisition was accounted for using historical values for the
contributed assets. Purchase accounting was not applied because, under the
applicable accounting guidance, a change of control was deemed not to have
occurred as a result of the participating veto rights held by Pactiv after the
closing of the transactions under the terms of the stockholders agreement
entered into in connection with the transactions.
GENERAL
The market for containerboard is highly cyclical. Historically, prices for
containerboard have reflected changes in containerboard supply that result from
capacity additions and reductions, as well as changes in inventory levels.
Containerboard demand is dependent upon both domestic demand for corrugated
products and linerboard export activity. Domestic demand for corrugated products
is the more stable factor. It generally corresponds to changes in the rate of
growth in the U.S. economy. Exports represent about 20% of total linerboard
shipments.
From 1994 to 1996, capacity additions outpaced both domestic and export
demand for containerboard. This excess supply led to lower industry operating
rates and declining prices from late-1995 until mid-1997. Although prices
generally improved from mid-1997 through mid-1998, the containerboard market was
adversely affected by weaker containerboard exports. This weakness was most
apparent in shipments to Asia in the second half of 1998, which resulted in
lower prices.
While export shipments in 1999 continued to be lower than in 1998, the
supply/demand balance improved throughout 1999, and the average price of
linerboard increased approximately 25% during 1999. However, industry oversupply
conditions could return or economic conditions could deteriorate in the future.
During 1999, several major containerboard manufacturers announced production
curtailments and mill shutdowns, and only minimal capacity additions have been
publicly announced through 2002 according to the American Forest & Paper
Association.
According to Pulp & Paper Week, after giving effect to the price increases
in 1999, average prices in December 1999 for linerboard and corrugating medium
were 25% and 46% higher, respectively, than December 1998 prices.
17
Pulp & Paper Week, in its February 21, 2000 publication, reported that
prices for linerboard and corrugating medium increased $50 per ton and $60 per
ton, respectively, compared to January 2000 levels.
RESULTS OF OPERATIONS
The historical results of operations of the Group and PCA are set forth
below:
GROUP PCA
------------------------------------- -------------------------------
FOR THE FOR THE
FOR THE PERIOD FROM PRO FORMA
FOR THE YEAR ENDED PERIOD FROM APRIL 12, 1999 YEAR
DECEMBER 31, JANUARY 1, 1999 THROUGH ENDED
------------------- THROUGH DECEMBER 31, DECEMBER 31,
1997 1998 APRIL 11, 1999 1999 1999
-------- -------- --------------- -------------- --------------
(IN MILLIONS)
Net Sales................... $1,411.4 $1,571.0 $ 433.2 $1,262.3 $1,695.5
======== ======== ======= ======== ========
Operating Income (Loss)..... $ 49.8 $ 121.7 $(212.1) $ 192.2 $ 218.1
Interest Expense............ (3.7) (2.8) (0.2) (107.6) (151.7)
Income (Loss) Before Taxes
and Extraordinary Item.... 46.1 118.9 (212.3) 84.6 66.4
Provision for Income
Taxes..................... (18.7) (47.5) 83.7 (37.2) (30.1)
-------- -------- ------- -------- --------
Income (Loss) Before
Extraordinary Item........ $ 27.4 $ 71.4 $(128.6) $ 47.4 $ 36.3
-------- -------- ------- -------- --------
Extraordinary Item.......... -- -- (6.3) (6.9) (6.9)
-------- -------- ------- -------- --------
Net Income (Loss)........... $ 27.4 $ 71.4 $(134.9) $ 40.5 $ 29.4
======== ======== ======= ======== ========
PRO FORMA YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
NET SALES
Net sales increased by $124.4 million, or 7.9%, for the pro forma year ended
December 31, 1999 from the comparable period in 1998. The increase was the
result of increased sales volume of both corrugated products and containerboard
and the increased sales prices of corrugated products and containerboard to
third parties.
Average prices of corrugated products increased by 1.0% for the pro forma
year ended December 31, 1999 from the comparable period of 1998, while
corrugated products volume increased by 7.1% in 1999, from 25.0 billion square
feet in 1998 to 26.7 billion square feet in 1999.
Average containerboard prices for third party sales increased by 8.2% in the
pro forma year of 1999 from the comparable period in 1998, while volume to
external domestic and export customers increased 8.5% to 571,749 tons in 1999
from 527,041 tons in 1998.
According to Pulp & Paper Week, average linerboard and semi-chemical medium
prices for 42 lb. Liner-East and 26 lb. Medium-East, which are representative
benchmark grades, were $401 and $361, respectively, per ton in 1999. This
compares to $373 and $315, respectively, per ton in 1998. Acccording to the
Fibre Box Association, average sale prices for corrugated products increased by
5.0% in 1999 from 1998.
INCOME BEFORE INTEREST EXPENSE AND INCOME TAXES (OPERATING INCOME)
Operating income increased by $87.1 million or 73.2% for the pro forma year
ended December 31, 1999 compared to 1998. This increase excludes a
$12.2 million gain on a 1999 fourth quarter timberlands
18
sale and for the comparable period in 1998 a $16.9 million gain on the sale of
non-strategic woodlands, a $15.1 million gain on the sale of a 20% interest in a
recycled paperboard joint venture, a $14.4 million restructuring charge, and a
$14.8 million charge for factored receivables financing. The increase was the
result of increased sales volume of both corrugated products and containerboard,
the increased sales prices of corrugated products and containerboard to third
parties and reduced corporate overhead expenses.
Gross profit increased $77.2 million, or 27.4% for the pro forma year ended
December 31, 1999 from the comparable period in 1998. Gross profit as a
percentage of sales improved from 17.9% of sales in 1998 to 21.1% of sales in
the current year primarily due to the sales price and volume increases described
above.
Selling and administrative expenses were unchanged at $109.0 million for the
pro forma year ended December 31, 1999 from the comparable period in 1998.
Corporate overhead for the pro forma year ended December 31, 1999, decreased
by $20.5 million, or 32.4% from the comparable period in 1998. The reduction
primarily reflects the difference in cost between the overhead charged to the
Group by Tenneco and Pactiv and overhead expenses incurred by PCA as a
stand-alone entity. Corporate overhead for the pro forma year ended
December 31, 1999 included three and one-half months of corporate overhead
charged by Tenneco and Pactiv and eight and one-half months of corporate
overhead expenses incurred by PCA as a stand-alone entity. Corporate overhead
for the comparable period in 1998 consisted exclusively of corporate overhead
charged by Tenneco and Pactiv.
INTEREST EXPENSE AND INCOME TAXES
Interest expense increased by $148.9 million, or 5,353.3%, for the pro forma
year ended December 31, 1999 from the comparable period in 1998, primarily due
to borrowings under the senior credit facility and the issuance of $550 million
of the senior subordinated notes. This indebtedness was incurred to finance the
transactions.
PCA's effective tax rate was 43.9% for the pro forma year ended
December 31, 1999 and 40.0% for the comparable period in 1998. The tax rate is
higher than the federal statutory rate of 35.0% due to state income taxes.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
NET SALES
Net sales increased by $159.6 million, or 11.3%, from 1997 to 1998. The
increase was primarily the result of increases in prices for both corrugated
products and containerboard and, to a lesser extent, increases in shipments of
corrugated products.
Average prices for corrugated products increased by 7.0% in 1998 from 1997,
while corrugated volume increased by 4.6% in 1998, from 23.9 billion square feet
in 1997 to 25.0 billion square feet in 1998.
Average containerboard prices for external third party sales increased by
11.7% in 1998 from 1997, while volume to external domestic and export customers
decreased 8.4%, to 527,000 tons in 1998 from 575,000 tons in 1997.
According to Pulp & Paper Week, an industry publication, average linerboard
and semi-chemical medium prices for 42 lb. Liner-East and 26 lb. Medium-East,
which are representative benchmark grades, were $373 and $315, respectively, per
ton in 1998. This compares to $333 and $268, respectively, per ton in 1997.
According to the Fibre Box Association, average sale prices for corrugated
products increased by 4.0% in 1998 from 1997.
19
INCOME BEFORE INTEREST EXPENSE AND INCOME TAXES (OPERATING INCOME)
Operating income increased by $96.4 million, or 1,251.9%, from 1997 to 1998,
excluding a $16.9 million gain on the sale of non-strategic woodlands, a
$15.1 million gain on the sale of a 20% interest in a recycled paperboard joint
venture and a $14.4 million restructuring charge in 1998. Operating income in
1997 excludes a net gain of $37.7 million related to mill lease refinancing and
a $4.4 million gain on the sale of non-strategic woodlands. This increase was
primarily the result of both higher sales prices and sales volumes, which
primarily contributed to the gross margin improvement of $112.0 million, or
66.1%.
Gross margins improved from 12.0% of sales in 1997 to 17.9% of sales in
1998, primarily due to the price increases described above. These price
increases were partially offset by a higher level of depreciation attributable
to the Group's capital expenditure program and to higher costs incurred as a
result of changes in product mix.
Selling and administrative expenses increased by $6.1 million, or 5.9%, from
1997 to 1998, primarily as a result of costs incurred to support the increased
focus on graphics design and other value added product services in corrugated
products.
Corporate allocations increased by $1.8 million, or 2.9%, primarily as a
result of the Group's increased use of the Tenneco shared services center
located in The Woodlands, Texas.
INTEREST EXPENSE AND INCOME TAXES
The Group's interest expense for 1998 and 1997 primarily related to the cost
of debt incurred to finance a boiler at the Counce mill. The interest expense
declined by approximately $1.0 million, or 25.6%, in 1998, as a portion of this
debt was retired during the year.
The Group's effective tax rate was 40.0% in 1998 and 40.6% in 1997. The tax
rate is higher than the federal statutory rate of 35.0% due to state income
taxes.
LIQUIDITY AND CAPITAL RESOURCES
PRIOR TO THE TRANSACTIONS
As a division of Pactiv, the Group did not maintain separate cash accounts
other than for petty cash. The Group's disbursements for payroll, capital
projects, operating supplies and expenses were processed and funded by Pactiv
through centrally managed accounts. In addition, cash receipts from the
collection of accounts receivable and the sales of assets were remitted directly
to bank accounts controlled by Pactiv.
Because of Pactiv's centrally managed cash system, in which the cash
receipts and disbursements of Pactiv's various divisions were commingled, it was
not feasible to segregate cash received from Pactiv, such as financing for the
business, from cash transmitted to Pactiv, such as a distribution. Accordingly,
the net effect of these cash transactions with Pactiv is represented as a single
line item within the financing section of the statement of cash flows.
Similarly, the activity of the interdivision account presents the net transfer
of funds and charges between Pactiv and the Group as a single line item.
Effective April 12, 1999, PCA maintains its own cash accounts.
OPERATING ACTIVITIES
Cash flow provided by operating activities increased $83.1 million, or
42.5%, for the pro forma year ended December 31, 1999 from the comparable period
in 1998. The increase was primarily due to the replacement of leased assets with
owned, depreciable assets in connection with the April 12, 1999 transactions and
a reduction in working capital.
Cash flow provided by operating activities increased by $88.2 million, or
82.3%, from 1997 to 1998. The increase was due primarily to higher net income of
$44.0 million, collection of a higher level of receivables and increased
non-cash charges for restructuring and depreciation.
20
INVESTING ACTIVITIES
Net cash used for investing activities decreased $328.1 million, or 184.6%,
for the pro forma year ended December 31, 1999 from the comparable period in
1998, primarily attributable to a prepaid lease payment made in December 1998 to
acquire timberland as part of a lease buy-out and timberlands sale proceeds
received in the fourth quarter of 1999.
Cash used for investing activities increased by $65.8 million, or 58.9%,
from 1997 to 1998. The increase was primarily attributable to the prepaid lease
payment previously discussed. Proceeds from assets sales were $15.8 million
higher in 1998, due to the 1998 timberland sale transaction previously
described. During 1997 and 1998, additions to property, plant and equipment
totaled $110.2 million and $103.4 million, respectively.
As of December 31, 1999, PCA had commitments for capital expenditures of
$66.3 million. PCA believes operating cash flow from continuing operations will
be sufficient to fund these commitments.
FINANCING ACTIVITIES
Cash used for financing activities increased $409.8 million, or 2,319.2%,
for the pro forma year ended December 31, 1999 from the comparable period in
1998. The increase was primarily attributable to the voluntary prepayments PCA
has made on its three term loans under the senior credit facility.
Cash provided by financing activities decreased by $21.4 million, or 584.6%,
from 1997 to 1998, primarily reflecting the change in the net transfer of funds
between the Group and Pactiv. The Group also retired $10.3 million of debt
during 1998, which related to the financing of a boiler at the Counce mill.
AFTER THE TRANSACTIONS
Following the transactions, PCA's primary sources of liquidity are cash flow
from operations and borrowings under PCA's new revolving credit facility. PCA's
primary uses of cash are for debt service and capital expenditures. PCA expects
to be able to fund its debt service and capital expenditures from these sources.
PCA incurred substantial indebtedness in connection with the transactions.
On April 12, 1999, PCA had approximately $1.77 billion of indebtedness
outstanding. PCA's significant debt service obligations following the
transactions could have material consequences to PCA's securityholders,
including holders of common stock.
Concurrently with the transactions, PCA issued the notes and preferred stock
and entered into the senior credit facility. The senior credit facility
initially provided for three term loans in an aggregate amount of $1.21 billion
and a revolving credit facility with up to $250.0 million in availability. Upon
the closing of the acquisition, PCA borrowed the full amount available under the
term loans and $9.0 million under the revolving credit facility. The following
table provides the interest rate as of December 31, 1999 for each of the term
loans and the revolving credit facility:
BORROWING ARRANGEMENT INTEREST RATE
- --------------------- -------------
Term Loan A................................................. 8.7036%
Term Loan B................................................. 9.2035%
Term Loan C................................................. 9.4536%
Revolver
Revolver--Eurodollar...................................... N.A.
Revolver--Base Rate....................................... N.A.
The borrowings under the revolving credit facility are available to fund
PCA's working capital requirements, capital expenditures and other general
corporate purposes. The Term Loan A must be repaid in quarterly installments
from December 2001 through 2005. The Term Loan B must be repaid in
21
quarterly installments from December 2001 through 2007. The Term Loan C must be
repaid in quarterly installments from December 2001 through 2008. The revolving
credit facility will terminate in 2005. See "Description of Certain
Indebtedness--Description of Senior Credit Facility."
Effective December 14, 1999, PCA elected to reduce its availability under
the revolving credit facility from $250.0 million to $150.0 million.
PCA made voluntary prepayments using timberland proceeds or excess cash to
permanently reduce its borrowings under the term loans on the following dates in
the following amounts:
- May 18, 1999--$75.0 million;
- July 15, 1999--$10.0 million;
- September 16, 1999--$1.3 million;
- September 30, 1999--$13.7 million;
- October 1, 1999--$194.6 million;
- October 14, 1999--$27.5 million;
- October 29, 1999--$10.9 million;
- November 15, 1999--$10.0 million;
- November 19, 1999--$12.5 million;
- November 22, 1999--$43.7 million;
- November 30, 1999--$23.8 million;
- December 30, 1999--$8.0 million; and
- January 19, 2000--$0.7 million.
In addition, PCA repaid the $9.0 million drawn on the revolver using excess
cash.
The instruments governing PCA's indebtedness and the preferred stock,
including the senior credit facility, the indenture governing the notes and the
certificate of designation governing the preferred stock, contain financial and
other covenants that restrict, among other things, the ability of PCA and its
subsidiaries to:
- incur additional indebtedness,
- pay dividends or make certain other restricted payments,
- consummate certain asset sales,
- incur liens,
- enter into certain transactions with affiliates, or
- merge or consolidate with any other person or sell or otherwise dispose of
all or substantially all of the assets of PCA.
These limitations, together with the highly leveraged nature of PCA, could
limit corporate and operating activities.
PCA estimates that it will make approximately $135 million in capital
expenditures in 2000. These expenditures will be used primarily for cost
reduction, business growth, maintenance and environmental compliance.
In August 1999, PCA signed purchase and sales agreements with various buyers
to sell 405,000 acres of its 800,000 acres of owned timberland. PCA completed
these sales in the fourth quarter of 1999 and received total proceeds of $263
million. These proceeds were used to pay down debt.
In addition, PCA is permitted under the terms of the senior credit facility
and the indenture governing the notes to use net proceeds in excess of
$500.0 million, if any, to redeem up to $100.0 million of the notes, or to pay a
dividend on or repurchase its equity interests. Under the terms of the notes
indenture, PCA may use the net proceeds of a timberland sale to redeem not more
than 35% of the aggregate principal amount of notes issued and outstanding under
the notes indenture, excluding notes held by PCA and its subsidiaries. PCA must
make the redemption within 60 days of the timberland sale and must pay a
22
redemption price equal to 109.625% of the principal amount of notes to be
redeemed plus accrued and unpaid interest and liquidated damages, if any, to the
date of redemption.
PCA may only use the net proceeds of a timberland sale to pay a dividend or
repurchase its equity interests if PCA's debt to cash flow ratio at the time of
payment or repurchase, after giving effect to the payment or repurchase, the
application of the proceeds of the timberland sale, and any increase in fiber,
stumpage or similar costs as a result of the timberland sale, would be no
greater than 4.5:1 and PCA's debt and preferred stock to cash flow ratio no
greater than 5.0:1. The senior credit facility imposes similar restrictions on
the ability of PCA to use the net proceeds of a timberland sale to make these
payments or repurchases.
On February 2, 2000, PCA completed an initial public offering of its common
stock. On March 3, 2000, PCA used the net proceeds from the offering to redeem
all of its outstanding shares of 12.375% senior exchangeable preferred stock due
2010. See note 18 to PCA's financial statements.
PCA believes that cash generated from operations will be adequate to meet
its anticipated debt service requirements, capital expenditures and working
capital needs for the next 12 months, and that cash generated from operations
and amounts available under the revolving credit facility will be adequate to
meet its anticipated debt service requirements, capital expenditures and working
capital needs for the foreseeable future. There can be no assurance, however,
that PCA's business will generate sufficient cash flow from operations or that
future borrowings will be available under the senior credit facility or
otherwise to enable it to service its indebtedness, including the senior credit
facility and the notes, to retire or redeem the notes when required or to make
anticipated capital expenditures. PCA's future operating performance and its
ability to service or refinance the notes and to service, extend or refinance
the senior credit facility will be subject to future economic conditions and to
financial, business and other factors, many of which are beyond PCA's control.
ENVIRONMENTAL MATTERS
We are subject to, and must comply with, a variety of federal, state and
local environmental laws, particularly those relating to air and water quality,
waste disposal and the cleanup of contaminated soil and groundwater. Because
environmental regulations are constantly evolving, we have incurred, and will
continue to incur, costs to maintain compliance with those laws. In particular,
the United States Environmental Protection Agency recently finalized the Cluster
Rules which govern pulp and paper mill operations, including those at the
Counce, Filer City, Valdosta and Tomahawk mills. Over the next several years,
the Cluster Rules will affect our allowable discharges of air and water
pollutants, and require us to spend money to ensure compliance with those new
rules.
As is the case with any industrial operation, we have, in the past, incurred
costs associated with the remediation of soil or groundwater contamination, as
required by the federal Comprehensive Environmental Response, Compensation and
Liability Act, commonly known as the federal "Superfund" law, and analogous
state laws. Cleanup requirements arise with respect to properties we currently
own or operate, former facilities and off-site facilities where we have disposed
of hazardous substances. Because liability under these laws is strict, meaning
that liability is imposed without fault, joint and several, meaning that
liability is imposed on each party without regard to contribution, and
retroactive, we could receive notifications of cleanup liability in the future
and this liability could be material. Under the terms of the contribution
agreement, Pactiv has agreed to retain all liability for all former facilities
and all sites associated with pre-closing off-site waste disposal. Pactiv has
also retained environmentally impaired real property in Filer City, Michigan
unrelated to current mill operations.
Because liability for remediation costs under environmental laws is strict,
meaning that liability is imposed without fault, joint and several, meaning that
liability is imposed on each party without regard to contribution, and
retroactive, we could receive notifications of cleanup liability in the future
and this liability could be material. From January 1994 through December 1999,
remediation costs at our mills and converting plants totaled about $2.5 million.
As of December 31, 1999, we maintained a reserve of $0.1
23
million for environmental remediation liability as well as a general overall
environmental reserve of $3.6 million, which includes funds relating to onsite
landfills and surface impoundments as well as on-going and anticipated remedial
projects. Total capital costs for environmental matters, including Cluster Rule
compliance, was $11.0 million for 1999 and we currently estimate that they will
be $25.6 million for 2000.
YEAR 2000 ISSUE
YEAR 2000 ISSUE. Year 2000 issues address the ability of electronic
processing equipment to process date sensitive information and recognize the
last two digits of a date as occurring in or after the Year 2000. Many of our
computer software and hardware systems, and some of our non-information
technology infrastructure and manufacturing equipment, that utilize
date-sensitive data, were structured to use a two-digit data field. As a result,
these IT and non-IT systems would not, as originally structured, be able to
properly recognize dates in or after the Year 2000. We believe we have completed
the remediation or replacement of critical IT and non-IT systems, and as of
March 1, 2000, Year 2000 issues have not had and are not expected to have a
material adverse effect on our results of operations.
YEAR 2000 PROGRAM. Our predecessor, Pactiv, created a Year 2000 management
team in June of 1998 to address the Year 2000 issue. The Year 2000 program,
started by Pactiv and continued by PCA, involved three primary phases:
- identifying and testing all information technology systems and all
non-information technology infrastructure and equipment that have a
potential Year 2000 issue;
- remediating or replacing all non-compliant systems and equipment; and
- testing all remediated or replaced systems and equipment.
In addition, our Year 2000 efforts have involved assessing and monitoring
the Year 2000 readiness of our major suppliers and vendors, responding to
customer inquiries regarding our state of readiness, tracking Year 2000 related
expenditures and developing contingency or continuity plans.
STATE OF READINESS. PCA has completed all phases of its Year 2000 program.
As of March 1, 2000 all critical functions were operating in the Year 2000 with
no apparent Year 2000 issues. None of PCA's products are date-sensitive. In
addition, we have reasonable assurance that as an outcome of our testing/
certification process, we will continue to remain in normal "operations and
maintenance" mode with no Year 2000 issues materially affecting our business.
In addition, we have developed and implemented a standard purchasing,
accounts payable and maintenance tracking system for our mills. In conjunction
with our Year 2000 project we have also implemented new order entry, corrugator
scheduling, converting scheduling, shop floor manufacturing, shipping, inventory
management and invoicing systems as part of an overall modernization project for
our corrugated products plants.
YEAR 2000 COSTS. As of December 31, 1999, we incurred costs of
approximately $4.5 million to address Year 2000 issues. We do not expect to
incur any significant additional costs to address Year 2000 issues. We have
expensed these costs as they have been incurred, except in instances where we
determined that replacing existing computer systems or equipment was more
effective and efficient, particularly where additional functionality was
available.
YEAR 2000 RISKS. At this time, we believe we have resolved all material
Year 2000 issues. However, it is possible that latent Year 2000 issues could
arise in the future. If this happens, we will implement our contingency plans in
an effort to minimize the impact of the problem.
IMPACT OF INFLATION
PCA does not believe that inflation has had a material impact on its
financial position or results of operations during the past three years.
24
NEW ACCOUNTING STANDARDS
For a description of changes in accounting principles affecting PCA, see
Note 2 to PCA's audited consolidated financial statements included elsewhere in
this report.
ITEM 7A. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Historically, PCA has not had any material market risk due to the fact that
its debt financing and risk management activities were conducted by Pactiv or
Tenneco. As a result of the transactions, PCA is exposed to the impact of
interest rate changes and changes in the market value of its financial
instruments. PCA periodically enters into derivatives in order to minimize these
risks, but not for trading purposes.
On March 5, 1999, PCA entered into an interest rate protection agreement
with J.P. Morgan Securities Inc. to lock in then current interest rates on
10-year U.S. Treasury notes. PCA entered into this agreement to protect it
against increases in the 10-year U.S. Treasury note rate, which served as a
reference in determining the interest rate applicable to the notes, which have a
comparable term. The agreement had a notional amount of $450.0 million and a
10-year U.S. Treasury note reference rate of 5.41%. As a result of a decrease in
the interest rate on 10-year U.S. Treasury notes, PCA was obligated to make a
single payment of approximately $8.4 million to J.P. Morgan Securities Inc. upon
settlement of the agreement which was made on the date of the closing of the
notes offering.
Under the terms of the senior credit facility, PCA is required to maintain
for at least two years after the closing of the transactions interest rate
protection agreements establishing a fixed maximum interest rate with respect to
at least 50% of the outstanding term loans under the senior credit facility.
As a result, PCA has entered into three interest rate collar agreements
which protect against rising interest rates and simultaneously guarantee a
minimum interest rate. The notional amount of these collars was $720 million. As
PCA has made debt prepayments, the required notional amount of these collars has
continued to decrease. Accordingly, on November 30, 1999 PCA sold an interest
rate collar which reduced the notional amount of the remaining two collars to
$510 million. The weighted average floor of the interest rate collar agreements
is 4.96% and the weighted average ceiling of the interest rate collar agreements
is 6.75%. The interest rate on approximately 65% of PCA's term loan obligations
at December 31, 1999 are capped. PCA receives payments under the collar
agreements if the LIBOR rate exceeds the ceiling. Correspondingly, PCA makes
payments under the collar agreements if the LIBOR rate goes below the floor. In
both cases, the amount received or paid is based on the notional amount and the
difference between the actual LIBOR rate and the ceiling or floor rate. The
weighted average duration of the interest rate collar agreements is
approximately three and one half years.
PCA's earnings are affected by changes in short-term interest rates as a
result of borrowings under the term loans. If LIBOR interest rates for these
borrowings increase one percent, PCA's interest expense would increase, and
income before income taxes would decrease, by approximately $7.8 million
annually until the LIBOR rate exceeds the ceiling rate. At that point, only 35%
of the debt would result in additional interest rate expense. As of
December 31, 1999, the interest rate on the term loans was based on a weighted
average LIBOR rate of 5.9%. The effect of the interest rate change to the fair
market value of the outstanding debt is insignificant. This analysis does not
consider any other impacts on fair value that could exist in such an interest
rate environment. In the event of a change in interest rates, management could
take actions to further mitigate its exposure to the change. However, due to the
uncertainty of the specific actions that would be taken and their possible
effects, the sensitivity analysis assumes no changes in PCA's financial
structure.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is included in a separate section of this report
on page F-1.
25
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
There were no changes in or disagreements with PCA's accountants during
1999.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
The names, ages and positions of the persons who are the directors and
executive officers of PCA are provided below:
NAME AGE POSITION
- ---- --- --------
Paul T. Stecko................... 55 Chairman of the Board and Chief Executive Officer
William J. Sweeney............... 59 Executive Vice President--Corrugated Products
Richard B. West.................. 47 Chief Financial Officer, Vice President and Secretary
Mark W. Kowlzan.................. 45 Vice President--Containerboard/Wood Products
Andrea L. Davey.................. 43 Vice President--Human Resources
Samuel M. Mencoff................ 43 Director and Vice President
Justin S. Huscher................ 46 Director and Assistant Secretary
Thomas S. Souleles............... 31 Director and Assistant Secretary
Henry F. Frigon.................. 65 Director
Rayford K. Williamson............ 74 Director
PAUL T. STECKO has served as Chief Executive Officer of PCA since January
1999 and as Chairman of the Board of PCA since March 1999. From November 1998 to
April 1999, Mr. Stecko served as President and Chief Operating Officer of
Tenneco, now known as Tenneco Automotive. From January 1997 to that time,
Mr. Stecko served as Chief Operating Officer of Tenneco. From December 1993
through January 1997, Mr. Stecko served as President and Chief Executive Officer
of Tenneco Packaging, now known as Pactiv. Prior to joining Tenneco Packaging,
Mr. Stecko spent 16 years with International Paper Company. Mr. Stecko is a
member of the board of directors of Pactiv, Tenneco Automotive, State Farm
Mutual Insurance Company and American Forest and Paper Association.
WILLIAM J. SWEENEY has served as Executive Vice President--Corrugated
Products of PCA since April 1999. From May 1997 to April 1999, Mr. Sweeney
served as Executive Vice President--Paperboard Packaging of Tenneco Packaging,
now known as Pactiv. From May 1990 to May 1997, Mr. Sweeney served as Senior
Vice President and General Manager--Containerboard Products of Tenneco
Packaging. From 1983 to that time, Mr. Sweeney served as General Manager and
Vice President of Stone Container Corporation. From 1978 to 1983, Mr. Sweeney
served as Sales Manager, Operations Manager and Division Vice President at
Continental Group and from 1967 to that time, as Sales Manager and General
Manager of Boise Cascade Corporation.
RICHARD B. WEST has served as Chief Financial Officer of PCA since March
1999, as Secretary since April 1999 and also as Vice President since July 1999.
From March 1999 to June 1999, Mr. West also served as Treasurer of PCA.
Mr. West served as Vice President of Finance--Paperboard Packaging of Tenneco
Packaging, now known as Pactiv, from 1995 to April 1999. Prior to joining
Tenneco Packaging, Mr. West spent 20 years with International Paper Company
where he served as an Internal Auditor, Internal Audit Manager and Manufacturing
Controller for the Printing Papers Group and Director/ Business Process
Redesign.
MARK W. KOWLZAN has served as Vice President--Containerboard/Wood Products
of PCA since April 1999. From 1998 to April 1999, Tenneco Packaging, now known
as Pactiv, employed Mr. Kowlzan as Vice President and General
Manager--Containerboard/Wood Products and from May 1996 to 1998, as
26
Operations Manager and Mill Manager of the Counce mill. Prior to joining Tenneco
Packaging, Mr. Kowlzan spent 15 years at International Paper Company, where he
held a series of operational positions within its mill organization.
ANDREA L. DAVEY has served as Vice President--Human Resources of PCA since
April 1999. From 1994 to April 1999, Ms. Davey was employed principally by
Tenneco Packaging, now known as Pactiv, where she held the positions of Director
of Field Employee Relations, Director of Training and Development, Director of
Compensation and Benefits, and Project Manager of HRIS project and also served
in the capacity of Vice President--Human Resources, Paperboard Packaging from
May 1997 to April 1999. From 1992 until joining Tenneco Packaging in 1994,
Ms. Davey served as Director of Human Resources for the Bakery division of Sara
Lee Corporation. From 1989 to that time, she served as Human Resource Manager
for the Converting Group of International Paper Company. Prior to that time,
Ms. Davey spent five years with ITT Corporation, where she served in several
human resources positions.
SAMUEL M. MENCOFF has served as a director and Vice President of PCA since
January 1999. Mr. Mencoff has been employed principally by Madison Dearborn
Partners, Inc. since 1993 and currently serves as a Managing Director. From 1987
until 1993, Mr. Mencoff served as Vice President of First Chicago Venture
Capital. Mr. Mencoff is a member of the operating committee of the general
partner of Golden Oak Mining Company, L.P. and a member of the board of
directors of Bay State Paper Holding Company, Buckeye Technologies, Inc. and
Riverwood Holding, Inc.
JUSTIN S. HUSCHER has served as a director of PCA since March 1999 and also
as an Assistant Secretary of PCA since April 1999. Mr. Huscher has been employed
principally by Madison Dearborn Partners, Inc. since 1993 and currently serves
as a Managing Director. From 1990 until 1993, Mr. Huscher served as Senior
Investment Manager of First Chicago Venture Capital. Mr. Huscher is a member of
the operating committee of the general partner of Golden Oak Mining Company,
L.P. and a member of the board of directors of Bay State Paper Holding Company.
THOMAS S. SOULELES has served as a director of PCA since March 1999 and also
as an Assistant Secretary of PCA since April 1999. From January 1999 to
April 1999, Mr. Souleles served as a Vice President and Secretary of PCA.
Mr. Souleles has been employed principally by Madison Dearborn Partners, Inc.
since 1995 and currently serves as a Director. Prior to joining Madison Dearborn
Partners, Inc., Mr. Souleles attended Harvard Law School and Harvard Graduate
School of Business Administration where he received a J.D. and an M.B.A.
Mr. Souleles is a member of the board of directors of Bay State Paper Holding
Company.
HENRY F. FRIGON has served as a director of PCA since February 2000. Mr.
Frigon is currently Chairman, President and Chief Executive Officer of Carstar,
Inc., a provider of collision repair services. Since 1994, he has been a private
investor and business consultant. Mr. Frigon served as Executive Vice
President--Corporate Development and Strategy and Chief Financial Officer of
Hallmark Cards, Inc. from 1990 through 1994. He retired as President and Chief
Executive Officer of BATUS, Inc. in March 1990 after serving with the company
for over 10 years. Mr. Frigon currently serves as a director of H&R Block, Inc.,
Buckeye Technologies, Inc., Dimon, Inc. and Sypress Solutions, Inc.
RAYFORD K. WILLIAMSON has served as a director of PCA since February 2000.
Prior to his retirement in 1998, Mr. Williamson served as Senior Vice President
of B E & K, Inc., a construction and engineering consulting firm, from 1995 to
1998. Prior to that time, Mr. Williamson was President of B E & K Engineering
Company from 1989 to 1995 and Vice President of B E & K Engineering Company from
1985 to 1989. From 1951 to 1985, Mr. Williamson was employed by International
Paper. His most recent position with International Paper was Vice President and
Project Manager of the Georgetown, South Carolina mill reconfiguration project
from 1982 to 1985. Mr. Williamson's responsibilities included engineering,
construction and mill operations. Mr. Williamson currently serves as Director
Emeritus of B E & K, Inc.
27
BOARD COMMITTEES
PCA has two committees--an audit committee and a compensation committee.
Each of these committees consists of a majority of nonmanagement directors.
The audit committee will review and recommend to the board internal
accounting and financial controls for PCA and accounting principles and auditing
practices and procedures to be used in the preparation of PCA's financial
statements. The audit committee will also make recommendations to the board
concerning the engagement of independent public accountants and the scope of
their audits. The audit committee consists of Henry F. Frigon, chairman, and
Rayford K. Williamson.
The compensation committee will administer PCA's benefit plans and make
recommendations concerning the compensation of employees. The compensation
committee consists of Samuel M. Mencoff, chairman, and Thomas S. Souleles.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF EXECUTIVE OFFICERS
None of the executive officers of PCA received compensation from PCA prior
to the closing of the transactions on April 12, 1999. Before the closing of the
transactions, PCA's chief executive officer and its four other most highly
compensated executive officers, Mr. Stecko, Mr. Sweeney, Mr. West, Mr. Kowlzan
and Ms. Davey, were employed by, and received compensation from, Tenneco or its
affiliates.
Under the terms of letter agreements entered into with Mr. Stecko on
January 25, 1999 and May 19, 1999, PCA pays Mr. Stecko a base salary of $600,000
per annum, subject to increases approved by the Board, and has agreed to pay
Mr. Stecko an annual bonus of not less than $500,000 with respect to each of the
fiscal years 1999, 2000 and 2001, and an annual perquisite allowance of not less
than $60,000 payable in cash. In addition, PCA paid Mr. Stecko a signing bonus
payment of $1 million, the net proceeds of which, under the terms of the letter
agreements, were invested in common stock of PCA. If PCA terminates Mr. Stecko
without cause, he is entitled to receive an amount equal to three times the sum
of his base salary plus the amount of the highest annual bonus paid to him
during the previous three year period.
Under the terms of a memorandum from PCA to Mr. Sweeney, dated April 16,
1999, PCA agreed to pay Mr. Sweeney a bonus in the amount of $500,000 if either
PCA terminates Mr. Sweeney before April 12, 2002 for any reason other than for
cause or he is still employed by PCA on April 12, 2002. If Mr. Sweeney dies
before April 12, 2002, the bonus will be paid to his beneficiaries on a pro rata
basis. Mr. Sweeney agreed to use the after-tax proceeds of this bonus to pay off
the outstanding balance, if any, of the loan he received from Morgan Guaranty
Trust Company of New York to purchase equity of PCA during the June 1999
management equity issuance.
28
SUMMARY COMPENSATION TABLE. The following table sets forth compensation
information for the period from April 12, 1999 through December 31, 1999 for
PCA's chief executive officer and the four other most highly compensated
executive officers of PCA for the period ended December 31, 1999.
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
-------------------------------------- -------------
NAME AND OTHER ANNUAL OPTIONS ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION GRANTED (#) COMPENSATION (4)
- ---------------------------------------- -------- -------- -------- ------------- ------------- ----------------
Paul T. Stecko.......................... 1999 $434,545(1) $750,000(2) $57,684(3) 1,386,000 $1,008,289
Chief Executive Officer
William J. Sweeney...................... 1999 255,943(1) $250,000(2) --(3) 587,400 39,914
Executive Vice President-Corrugated
Products
Richard B. West......................... 1999 143,142(1) $150,000(2) --(3) 215,600 54,055
Chief Financial Officer, Vice
President and Secretary
Mark W. Kowlzan......................... 1999 140,941(1) $175,000(2) --(3) 350,900 1,379
Vice President-Containerboard/Wood
Products
Andrea L. Davey......................... 1999 108,859(1) $ 85,000(2) --(3) 140,580 9,795
Vice President-Human Resources
- ------------------------------
(1) Represents salary paid by PCA from April 12, 1999, the date of the closing
of the transactions, through December 31, 1999.
(2) Represents annual bonuses earned during the period from January 1, 1999 to
December 31, 1999 that were paid in January 2000.
(3) In the case of Mr. Stecko, represents amounts paid by PCA for tax and
financial planning assistance in connection with the transactions. None of
the other named executive officers received perquisites and other benefits
exceeding the lesser of $50,000 or 10% of his or her total annual salary and
bonus.
(4) Includes the dollar value of life insurance premiums paid by PCA on behalf
of the named executive officers, amounts contributed to supplemental
executive retirement accounts for the benefit of the named executive
officers and, in the case of Mr. Stecko, a $1 million signing bonus paid by
PCA and, in the case of Mr. West, a one-time bonus paid by PCA for
successful completion of the transactions.
OPTION GRANT TABLE. The following table shows all grants of options to
acquire shares of PCA common stock made to the named executive officers under
the management equity agreements during 1999.
OPTION GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZABLE VALUE
AT ASSUMED ANNUAL RATES
NUMBER OF OF STOCK PRICE
SECURITIES PERCENTAGE OF TOTAL APPRECIATION
UNDERLYING OPTIONS GRANTED EXERCISE FOR OPTION TERM (1)
OPTIONS TO EMPLOYEES PRICE EXPIRATION --------------------------
NAME GRANTED IN FISCAL YEAR PER SHARE DATE 5% 10%
- ---- ----------- ------------------- --------- ---------- ----------- ------------
Paul T. Stecko......... 1,386,000 21.1% $4.55 6/1/09 $3,965,998 $10,050,618
William J. Sweeney..... 587,400 8.9 4.55 6/1/09 1,680,828 4,259,548
Richard B. West........ 215,600 3.3 4.55 6/1/09 616,933 1,563,429
Mark W. Kowlzan........ 350,900 5.3 4.55 6/1/09 1,004,090 2,544,561
Andrea L. Davey........ 140,580 2.1 4.55 6/1/09 402,266 1,019,420
- ------------------------
(1) Amounts reflect certain assumed rates of appreciation set forth in the
executive compensation disclosure rules of the SEC. Actual gains, if any, on
stock option exercises depend on future performance of PCA's common stock
and overall stock market conditions. No assurances can be made that the
amounts reflected in these columns will be achieved.
OPTION EXERCISES AND YEAR-END VALUE TABLE. The following table shows
aggregate exercises of options during 1999 by the named executive officers and
the aggregate value of unexercised options held by each named executive officer
as of December 31, 1999.
29
AGGREGATE OPTION EXERCISES IN LAST FISCAL
YEAR AND YEAR-END OPTION VALUES
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT YEAR END(1) AT YEAR END(1)(2)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- -------- ----------- ------------- ----------- -------------
Paul T. Stecko............. 0 0 0 1,386,000 0 $10,325,700
William J. Sweeney......... 0 0 0 587,400 0 4,376,130
Richard B. West............ 0 0 0 215,600 0 1,606,220
Mark W. Kowlzan............ 0 0 0 350,900 0 2,614,205
Andrea L. Davey............ 0 0 0 140,580 0 1,047,321
- ------------------------
(1) These options were not exercisable at year end but became exercisable upon
completion of the initial public offering of PCA's common stock on
February 2, 2000.
(2) Based on the initial public offering price of $12.00 per share.
COMPENSATION OF DIRECTORS
PCA does not currently compensate inside directors for serving as a director
or on committees of the board of directors or pay inside directors any fees for
attendance at meetings of the board. PCA compensates outside directors $1,000
per regular meeting attended of the board of directors and $1,000 per meeting
attended of any committee of the board of directors. All directors are
reimbursed for reasonable out-of-pocket expenses incurred in connection with
their attendance at board and committee meetings. In addition, PCA has granted
each of its current outside directors, Messrs. Frigon and Williamson, options to
purchase 7,000 shares of common stock at an exercise price of $10.4375,
representing the fair market value on the date of the grants. These options vest
in four equal annual installments beginning on February 15, 2001.
MANAGEMENT EQUITY AGREEMENTS
PCA entered into management equity agreements in June 1999 with 125 of its
management-level employees, including the named executive officers. Under these
agreements, PCA sold 3,132,800 shares of common stock to 113 of these employees
at approximately $4.55 per share, the same price per share at which PCA Holdings
purchased equity in the transactions. PCA guaranteed bank financing in the
amount of $5,200,000 in the aggregate to enable some of these members of PCA's
management to purchase equity under their respective management equity
agreements. The amount of bank financing guaranteed by PCA with respect to any
employee did not exceed 50% of the purchase price paid by the employee under his
or her management equity agreement.
The management equity agreements also provide for the grant of options to
purchase up to an aggregate of 6,569,200 shares of PCA's common stock at the
same price per share at which PCA Holdings purchased common stock in the
transactions. These options became exercisable upon completion of PCA's initial
public offering. The option shares are subject to contractual restrictions on
transfer for a period of up to 18 months following completion of the offering.
All of the options identified in the option grant table above were issued under
the management equity agreements.
LONG-TERM EQUITY INCENTIVE PLAN
In 1999, PCA adopted the Packaging Corporation of America 1999 Long-Term
Equity Incentive Plan. The equity incentive plan provides for grants of stock
options, stock appreciation rights, or SARs, restricted stock and performance
awards. Directors, officers and employees of PCA and its subsidiaries, as well
as others who engage in services for PCA, are eligible for grants under the
plan. The purpose of the equity incentive plan is to provide these individuals
with incentives to maximize stockholder value and
30
otherwise contribute to the success of PCA and to enable PCA to attract, retain
and reward the best available persons for positions of responsibility.
A total of 4,400,000 shares of our common stock, representing approximately
4% of our currently outstanding common stock on a fully-diluted basis, will be
available for issuance under the equity incentive plan, subject to adjustment in
the event of a reorganization, stock split, merger or similar change in the
corporate structure of PCA or the outstanding shares of common stock. These
shares may be, in whole or in part, authorized and unissued or held as treasury
shares.
The compensation committee of our board of directors will administer the
equity incentive plan. Our board also has the authority to administer the plan
and to take all actions that the compensation committee is otherwise authorized
to take under the plan. Grants will be awarded under the equity incentive plan
entirely in the discretion of the compensation committee. As a result, we are
unable to determine at this time the recipients, amounts and values of future
benefits to be received under the plan.
The following is a summary of the material terms of the equity incentive
plan, but does not include all of the provisions of the plan. For further
information about the plan, we refer you to the equity incentive plan, which is
referenced in the exhibit section of this report.
TERMS OF THE EQUITY INCENTIVE PLAN
ELIGIBILITY. Directors, officers and employees of PCA and its subsidiaries,
as well as other individuals performing significant services for us, or to whom
we have extended an offer of employment, will be eligible to receive grants
under the equity incentive plan. However, only employees may receive grants of
incentive stock options. In each case, the compensation committee will select
the actual grantees. As of March 1, 2000, there were approximately 350 employees
expected to be eligible to participate in the equity incentive plan.
STOCK OPTIONS. Under the equity incentive plan, the compensation committee
may award grants of incentive stock options conforming to the provisions of
Section 422 of the Internal Revenue Code and other, non-qualified stock options.
The compensation committee may not, however, award to any one person in any
calendar year options to purchase common stock equal to more than 20% of the
total number of shares authorized under the plan. The compensation committee
also may not grant incentive stock options first exercisable in any calendar
year for shares of common stock with a fair market value greater than $100,000,
determined at the time of grant.
The compensation committee will determine the exercise price of any option
in its discretion. However, the exercise price of an incentive option may not be
less than 100% of the fair market value of a share of common stock on the date
of grant, and the exercise price of an incentive option awarded to a person who
owns stock constituting more than 10% of PCA's voting power may not be less than
110% of the fair market value on the date of grant.
Unless the compensation committee determines otherwise, the exercise price
of any option may be paid in any of the following ways:
- in cash,
- by delivery of shares of common stock with a fair market value equal to
the exercise price,
- by simultaneous sale through a broker of shares of common stock acquired
upon exercise, and/or
- by having PCA withhold shares of common stock otherwise issuable upon
exercise.
If a participant elects to deliver or withhold shares of common stock in
payment of any part of an option's exercise price, the compensation committee
may in its discretion grant the participant a "reload option." The reload option
entitles its holder to purchase a number of shares of common stock equal to the
number so delivered or withheld. The reload option may also include, if the
compensation committee chooses, the right to purchase a number of shares of
common stock equal to the number delivered or withheld in satisfaction of any of
PCA's tax withholding requirements in connection with the exercise of the
31
original option. The terms of each reload option will be the same as those of
the original exercised option, except that the grant date will be the date of
exercise of the original option, and the exercise price will generally be the
fair market value of the common stock on the date of grant of the reload option.
The compensation committee will determine the term of each option in its
discretion. However, no term may exceed ten years from the date of grant or, in
the case of an incentive stock option granted to a person who owns stock
constituting more than 10% of the voting power of PCA, five years from the date
of grant. In addition, all options under the equity incentive plan, whether or
not then exercisable, generally cease vesting when a grantee ceases to be a
director, officer or employee of, or to otherwise perform services for, PCA or
its subsidiaries. Options generally expire 90 days after the date of cessation
of service, provided that the grantee does not compete with PCA during this
90-day period.
There are, however, exceptions depending upon the circumstances of
cessation. In the case of a grantee's death or disability, all options will
become fully vested and exercisable and remain so for up to 180 days after the
date of death or disability. In the event of retirement, a grantee's vested
options will remain exercisable for up to 90 days after the date of retirement,
while his or her unvested options may become fully vested and exercisable in the
discretion of the compensation committee. Upon termination for cause, all
options will terminate immediately. If there is a change in control of PCA and a
grantee is terminated from service with PCA and its subsidiaries within one year
thereafter, all options will become fully vested and exercisable and remain so
for up to one year after the date of termination. In addition, the compensation
committee has the authority to grant options that will become fully vested and
exercisable automatically upon a change in control of PCA, whether or not the
grantee is subsequently terminated.
SARS. The compensation committee may grant SARs under the equity incentive
plan alone or in tandem with stock options. SARs will be subject to the terms
and conditions determined by the compensation committee in its discretion. SARs
granted in tandem with options become exercisable only when, to the extent and
on the conditions that the related options are exercisable, and they expire at
the same time the related options expire. The exercise of an option results in
the immediate forfeiture of any related SAR to the extent the option is
exercised, and the exercise of an SAR results in the immediate forfeiture of any
related option to the extent the SAR is exercised.
Upon exercise of an SAR, the grantee will receive an amount in cash and/or
shares of common stock or other PCA securities equal to the difference between
the fair market value of a share of common stock on the date of exercise and the
exercise price of the SAR or, in the case of an SAR granted in tandem with
options, of the option to which the SAR relates, multiplied by the number of
shares as to which the SAR is exercised.
RESTRICTED STOCK. Under the equity incentive plan, the compensation
committee may award restricted stock to eligible participants. Restricted Stock
will be subject to the conditions and restrictions determined by the
compensation committee in its discretion, and will be restricted for the
duration determined by the committee, which will generally be at least six
months. A grantee will be required to pay PCA at least the aggregate par value
of any shares of restricted stock within ten days of the date of grant, unless
the shares are treasury shares. Unless the compensation committee determines
otherwise, all restrictions on a grantee's restricted stock will lapse when the
grantee ceases to be a director, officer or employee of, or to otherwise perform
services for, PCA and its subsidiaries, if the cessation occurs due to a
termination within one year after a change in control of PCA or due to death,
disability or, in the discretion of the compensation committee, retirement. If
termination of employment or service occurs for any other reason, all of a
grantee's restricted stock as to which the applicable restrictions have not
lapsed will be forfeited immediately.
PERFORMANCE AWARDS. Under the equity incentive plan, the compensation
committee may grant performance awards contingent upon achievement by the
grantee, PCA and/or its subsidiaries or divisions of set goals and objectives
regarding specified performance criteria, such as return on equity, over a
specified performance cycle, as designated by the compensation committee.
Performance awards may include:
- specific dollar-value target awards;
32
- performance units, the value of which is established by the compensation
committee at the time of grant; and/or
- performance shares, the value of which is equal to the fair market value
of a share of common stock on the date of grant. The value of a
performance award may be fixed or fluctuate on the basis of specified
performance criteria. A performance award may be paid out in cash and/or
shares of common stock or other PCA securities.
Unless the compensation committee determines otherwise, if a grantee ceases
to be a director, officer or employee of, or to otherwise perform services for,
PCA and its subsidiaries prior to completion of a performance cycle, and the
reason for that cessation is because of termination within one year after a
change in control of PCA or due to death, disability or retirement, the grantee
will receive the portion of the performance award payable to him or her based on
achievement of the applicable performance criteria over the elapsed portion of
the performance cycle. If termination of employment or service occurs for any
other reason prior to completion of a performance cycle, the grantee will become
ineligible to receive any portion of a performance award.
VESTING, WITHHOLDING TAXES AND TRANSFERABILITY OF ALL AWARDS. The terms and
conditions of each award made under the equity incentive plan, including vesting
requirements, will be set forth consistent with the plan in a written notice to
the grantee. Except in limited circumstances, no award under the equity
incentive plan may vest and become exercisable within six months of the date of
grant, unless the compensation committee determines otherwise.
Unless the compensation committee determines otherwise, a participant may
elect to deliver shares of common stock, or to have PCA withhold shares of
common stock otherwise issuable upon exercise of an option or SAR or upon grant
or vesting of restricted stock, in order to satisfy PCA's required withholding
obligations in connection with any such exercise, grant or vesting.
Unless the compensation committee determines otherwise, no award made under
the equity incentive plan will be transferable other than by will or the laws of
descent and distribution or to a grantee's family member by gift, and each award
may be exercised only by the grantee, his or her qualified family member
transferee, or any of their respective executors, administrators, guardians or
legal representatives.
AMENDMENT AND TERMINATION OF THE EQUITY INCENTIVE PLAN. The board may amend
or terminate the equity incentive plan in its discretion, except that no
amendment will become effective without prior approval of PCA's stockholders if
such approval is necessary for continued compliance with any stock exchange
listing requirements. Furthermore, any termination may not materially and
adversely affect any outstanding rights or obligations under the equity
incentive plan without the affected participant's consent. If not previously
terminated by the board, the equity incentive plan will terminate on the tenth
anniversary of its adoption.
ONE MILLION DOLLAR COMPENSATION LIMIT
The Revenue Reconciliation Act of 1993 limits the annual deduction a
publicly held company may take for compensation paid to its chief executive
officer or any of its four other highest compensated officers in excess of
$1,000,000 per year, excluding for this purpose compensation that is
"performance-based" within the meaning of Code Section 162(m).
Compensation paid under the equity incentive plan will not qualify as
performance-based except to the extent paid pursuant to grants made under the
plan following approval of the plan by PCA's stockholders in accordance with
Code Section 162(m)(4)(c) and the related Treasury Regulations, and except to
the extent certain other requirements are satisfied. However, based on a special
rule contained in regulations issued under Section 162(m), the $1 million
deduction limitation described above should not apply to any options, SARs or
restricted stock granted, or cash-based compensation paid, prior to PCA's annual
meeting of stockholders in 2003, to the extent such grants or payments are made
under the equity incentive plan.
33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information with respect to the beneficial
ownership of PCA's common stock as of March 1, 2000 by (1) each person or group
of affiliated persons who is known by PCA to own beneficially more than 5% of
the common stock, (2) each of PCA's directors, (3) each of PCA's executive
officers and (4) all directors and executive officers of PCA as a group. Except
as otherwise noted and subject to community property laws, the persons or
entities in this table have sole voting and investment power with respect to all
the shares of common stock owned by them.
NAME NUMBER(1) PERCENT
- ---- --------- -------
PCA Holdings LLC (2) ....................................... 50,306,960 47.5%
c/o Madison Dearborn Partners, LLC
Three First National Plaza
Chicago, IL 60602
Pactiv Corporation.......................................... 6,160,240 5.8%
1900 West Field Court
Lake Forest, IL 60045
Paul T. Stecko (3).......................................... 2,090,000 1.9%
William J. Sweeney (4)...................................... 868,780 *
Richard B. West (5)......................................... 314,820 *
Mark W. Kowlzan (6)......................................... 513,700 *
Andrea L. Davey (7)......................................... 206,580 *
Samuel M. Mencoff (8)....................................... 44,131,010 41.7%
Justin S. Huscher (9)....................................... 44,131,010 41.7%
Thomas S. Souleles (10)..................................... 44,131,010 41.7%
Henry F. Frigon............................................. 4,000 *
Rayford K. Williamson....................................... -- --
All directors and executive officers as a group (10 persons)
(11)...................................................... 48,124,890 44.3%
- ------------------------
* Denotes ownership of less than one percent.
(1) Includes the number of shares and percentage ownership represented by the
shares determined to be beneficially owned by a person in accordance with
the rules of the Securities and Exchange Commission. The number of shares
beneficially owned by a person includes shares of common stock that are
subject to options held by that person that are currently exercisable or
exercisable within 60 days of March 1, 2000. These shares are deemed
outstanding for the purpose of computing the percentage of outstanding
shares owned by that person. These shares are not deemed outstanding,
however, for the purposes of computing the percentage ownership of any
other person.
(2) The members of PCA Holdings include Madison Dearborn Capital Partners III,
L.P. ("MDCP III"), two funds affiliated with MDCP III, J.P. Morgan Capital
Corporation ("J.P. Morgan Capital"), an affiliated fund of J.P. Morgan
Capital and BT Capital Investors, L.P. ("BT Capital"). MDCP III and its
affiliated funds may be deemed to have beneficial ownership of 44,131,010
shares of common stock of PCA held by PCA Holdings, J.P. Morgan Capital and
its affiliated fund may be deemed to have beneficial ownership of 4,888,950
shares of common stock of PCA and BT Capital may be deemed to have
beneficial ownership of 880,000 shares of common stock of PCA. Shares
beneficially owned by MDCP III and its affiliated funds may be deemed to be
beneficially owned by Madison Dearborn Partners III, L.P., the general
partner or manager, as applicable, of each fund ("MDP III"), by Madison
Dearborn, the general partner of MDP III and by a limited partner committee
of MDP III.
34
(3) Mr. Stecko owns 132,000 shares of common stock of PCA and the Paul T.
Stecko 1999 Dynastic Trust owns 572,000 shares of common stock of PCA. Mr.
Stecko may be deemed to have beneficial ownership of the shares of common
stock of PCA owned by the Paul T. Stecko 1999 Dynastic Trust. Mr. Stecko
also has an exercisable option to acquire 1,386,000 shares of common stock
of PCA.
(4) Mr. Sweeney may be deemed to have beneficial ownership of the 281,380
shares of common stock of PCA owned by the William J. Sweeney 1999
Irrevocable Trust. Mr. Sweeney also has an exercisable option to acquire
587,400 shares of common stock of PCA.
(5) Mr. West has an exercisable option to acquire 215,600 shares of common
stock of PCA.
(6) Mr. Kowlzan has an exercisable option to acquire 350,900 shares of common
stock of PCA.
(7) Ms. Davey may be deemed to have beneficial ownership of the 66,000 shares
of common stock of PCA owned by the Andrea Lora Davey Trust dated February
19, 1994. Ms. Davey also has an exercisable option to acquire 140,580
shares of common stock of PCA.
(8) Mr. Mencoff is a Managing Director of Madison Dearborn and may therefore be
deemed to share beneficial ownership of the shares owned by Madison
Dearborn. Mr. Mencoff expressly disclaims beneficial ownership of the
shares owned by Madison Dearborn.
(9) Mr. Huscher is a Managing Director of Madison Dearborn and may therefore be
deemed to share beneficial ownership of the shares owned by Madison
Dearborn. Mr. Huscher expressly disclaims beneficial ownership of the
shares owned by Madison Dearborn.
(10) Mr. Souleles is a Director of Madison Dearborn and may therefore be deemed
to share beneficial ownership of the shares owned by Madison Dearborn.
Mr. Souleles expressly disclaims beneficial ownership of the shares owned
by Madison Dearborn.
(11) Includes 2,680,480 shares issuable upon exercise of currently exercisable
stock options.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CONTRIBUTION AGREEMENT
Pactiv, PCA Holdings and PCA entered into a contribution agreement governing
the sale of the containerboard and corrugated products business to PCA. PCA
Holdings owns approximately 48% of the outstanding common stock of PCA and
Pactiv owns approximately 6% of the outstanding common stock of PCA. Under the
terms of the contribution agreement, the following occurred:
- PCA paid to Madison Dearborn, the entity that controls PCA Holdings, a
transaction fee of $15.0 million and reimbursed Madison Dearborn for
out-of-pocket expenses.
- PCA paid $2.0 million of the legal and accounting fees and expenses of
Pactiv incurred in connection with the transactions.
- Pactiv agreed to indemnify PCA, PCA Holdings and their affiliates for any
breaches of representations, warranties and covenants it made in the
contribution agreement relating to the condition of the business as of the
closing of the transactions and liabilities of the containerboard and
corrugated products business which it agreed to retain. Pactiv's
indemnification obligation in respect of breaches of its representations
and warranties generally survives for 18 months from the closing and
generally is subject to a $12.5 million deductible and a $150.0 million
cap.
- PCA agreed to indemnify Pactiv and its affiliates against those
liabilities it agreed to assume. PCA generally agreed to assume all
liabilities relating to the business. PCA did not generally assume,
however, liabilities relating to tax and employee benefit matters arising
before the closing or with respect to assets not conveyed to PCA. These
liabilities were retained by Pactiv. Pactiv also retained
35
all environmental liability for all former facilities, sites associated
with pre-closing waste disposal and a closed landfill located near the
Filer City mill.
- Pactiv agreed that, for a period of five years from the closing, it would
not engage in the business conducted by PCA as of the closing anywhere in
the U.S. or induce any customer of PCA to terminate its relationship with
PCA.
REGISTRATION RIGHTS AGREEMENT
PCA, PCA Holdings and Pactiv entered into a registration rights agreement
under which Pactiv, PCA Holdings and their affiliates and transferees have
"demand" registration rights, which entitle them to cause PCA to register their
securities of PCA under the Securities Act. In addition, Pactiv, PCA Holdings
and their affiliates and transferees have "piggyback" registration rights, which
entitle them to cause PCA to include their securities in a registration in which
PCA proposes to register any of its securities under the Securities Act. Pactiv
and its affiliates, on the one hand, and PCA Holdings and its affiliates, on the
other hand, are each entitled to demand:
(1) three "long form" registrations on Form S-1, or a similar long form, in
which PCA will pay the registration expenses, other than underwriting
discounts and commissions,
(2) an unlimited number of "short form" registrations on Form S-2 or S-3, or
a similar short form, in which PCA will pay the registration expenses,
other than underwriting discounts and commissions, and
(3) an unlimited number of "long form" registrations on Form S-1, or a
similar long form, in which the requesting holders will pay the
registration expenses.
Pactiv and PCA Holdings also agreed in the registration rights agreement
that Pactiv and its affiliates will have first priority to participate in any
registration of PCA's securities during the 14-month period following the
closing of the transactions. After that time, PCA Holdings, Pactiv and their
affiliates will have equal priority, before any other holders of PCA's
securities, to participate in the registrations. Pactiv exercised one of its
"demand" registration rights under this agreement in order to effect the
registration of its shares of common stock for sale in the public offering of
PCA's common stock completed on February 2, 2000.
MANAGEMENT EQUITY AGREEMENTS
Each of PCA's executive officers entered into management equity agreements
with PCA in June 1999 under which the executive officers, or their respective
designees, purchased PCA common stock at approximately $4.55 per share as
follows:
- Paul T. Stecko--704,000 shares;
- William J. Sweeney--281,380 shares;
- Richard B. West--99,220 shares;
- Mark W. Kowlzan--162,800 shares; and
- Andrea L. Davey--66,000 shares.
The executive officers, or their respective designees, borrowed funds from
Morgan Guaranty Trust Company of New York, an affiliate of J.P. Morgan
Securities Inc., to finance up to 50% of the cost of purchasing the shares. PCA
guaranteed repayment of each of these loans. PCA has not been required to make
any payments with respect to these guarantees.
36
SERVICES AGREEMENT
PCA entered into a holding company support agreement with PCA Holdings under
which PCA agreed to reimburse PCA Holdings for all fees, costs and expenses, up
to an aggregate amount of $250,000 per year, related to PCA Holdings' investment
in PCA. These expenses include PCA Holdings' general operating expenses,
franchise tax obligations, accounting, legal, corporate reporting and
administrative expenses, and any other expenses incurred by PCA Holdings as a
result of its investment in PCA.
PURCHASE/SUPPLY AGREEMENTS
PCA entered into separate purchase/supply agreements with the following
parties: Pactiv; Tenneco Automotive Inc.; and Tenneco Packaging Specialty and
Consumer Products Inc., an affiliate of Pactiv. Under the purchase/supply
agreements, each Pactiv entity agreed to purchase a substantial percentage of
its requirements for containerboard and corrugated products from PCA at the
prices charged by PCA to Pactiv and its affiliates as of the closing. As a
result of these agreements, Pactiv and Tenneco Automotive represent 4.6% and
0.7%, respectively, of our total net sales for 1999. For the year ended
December 31, 1999, Pactiv accounted for $78.8 million of our sales of all
products and $64.7 million, of our sales of corrugated products. For the year
ended December 31, 1999, Tenneco Automotive accounted for $12.7 million of our
sales of corrugated products.
TRANSITION AGREEMENTS
PCA and Pactiv entered into a facility use agreement which provides for
PCA's use of a designated portion of Pactiv's headquarters located in Lake
Forest, Illinois for a period of up to four years following the closing of the
transactions. Under the facility use agreement, PCA is required to pay Pactiv
rent plus additional charges for the provision of building and business
services. The rent is calculated based on PCA's proportionate square footage
usage of the property.
PCA also entered into a transition services agreement with Pactiv which
provides for the performance of transitional services by Pactiv and its
affiliates to PCA that PCA currently requires to operate the containerboard and
corrugated products business. Pactiv charges PCA an amount substantially equal
to its actual cost of providing the services, which cost includes Pactiv's
overhead expenses, but does not include Tenneco's overhead expenses. The exact
charge to PCA is the lesser of (1) Pactiv's actual cost and (2) 105% of the cost
as forecasted by Pactiv with respect to providing services within the following
categories: payroll, general accounting, tax support, treasury/cash management,
insurance/risk management, procurement and, human resources and
telecommunication and information services. The initial term of the transition
services agreement is for one year, but may be extended by PCA for an additional
six month term for a cost increase of 15% per year. PCA has exercised this
extension for some of the services covered by this agreement. PCA may terminate
any of the provided services on 90 days notice to Pactiv. In addition, Pactiv
agreed in the transition services agreement to reimburse PCA for up to
$5.4 million in expenditures incurred by PCA relating to system enhancement and
Year 2000 compliance for which $5.4 million was paid by Pactiv in 1999. PCA
agreed to provide administrative and transitional services to Pactiv's former
folding carton business under the terms of the transition services agreement
through 1999.
PCA, Tenneco and Pactiv entered into a human resources agreement under which
Pactiv transferred the employment of all of its active employees engaged in the
containerboard and corrugated products business to PCA as of the closing at the
same rate of pay. Under the human resources agreement, the employees are
entitled to continue their participation in Pactiv and Tenneco welfare and
pension plans for a period of up to five years following the closing of the
transactions depending on the plan. PCA has agreed to reimburse Tenneco for
associated costs. In addition, PCA has agreed to pay Tenneco an annualized fee
of at least $5.2 million for continued participation. PCA assumed all of the
existing collective bargaining agreements with respect to containerboard and
corrugated products business employees as of the closing. PCA is in the process
of adopting compensation and benefit plans with respect to its employees as
contemplated under the terms of the transactions.
37
PART IV
ITEM. 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) THE FOLLOWING DOCUMENTS ARE FILED AS A PART OF THIS REPORT:
(1) THE FINANCIAL STATEMENTS LISTED IN THE "INDEX TO FINANCIAL STATEMENTS."
(2) FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedules of the Group for
the three years ended December 31, 1998 and for the period from January 1, 1999
through April 11, 1999 are included in this report.
Schedule II - Packaging Corporation of America - Valuation and Qualifying
Accounts.
ALLOWANCE FOR DOUBTFUL ACCOUNTS BALANCE PROVISION ADDITIONS/DEDUCTIONS TRANSLATION BALANCE END
RECEIVABLE BEGINNING OF YEAR (BENEFIT) FROM RESERVES * ADJUSTMENTS OF YEAR
- ---------- ----------------- --------- -------------------- ----------- -----------
January 1, 1999 through
April 11, 1999.................. 5,220 (412) (861) -- 3,947
1998.............................. 5,023 2,710 (2,513) -- 5,220
1997.............................. 5,010 611 (598) -- 5,023
1996.............................. 5,239 1,018 (1,247) -- 5,010
- ------------------------
* Consists primarily of write-offs and recoveries of bad debts.
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions, are inapplicable or not material, or the information
called for thereby is otherwise included in the financial statements and
therefore has been omitted.
We have audited in accordance with generally accepted auditing standards the
financial statements of The Containerboard Group (a division of Tenneco
Packaging Inc., which is a Delaware corporation and a wholly owned subsidiary of
Tenneco Inc.), included in this report and have issued our report on the
December 31, 1998, 1997 and 1996 financial statements dated February 26, 1999
and our report on the April 11, 1999 financial statements dated July 16, 1999.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule listed above is the responsibility of
the company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois
August 26, 1999
38
(2) FINANCIAL STATEMENT SCHEDULES (CONTINUED)
The following consolidated financial statement schedule of PCA for the
period from April 12, 1999 through December 31, 1999 is included in this report.
Schedule II - Packaging Corporation of America - Valuation and Qualifying
Accounts.
ALLOWANCE FOR DOUBTFUL ACCOUNTS BALANCE PROVISION ADDITIONS/DEDUCTIONS TRANSLATION BALANCE END
RECEIVABLE BEGINNING OF YEAR (BENEFIT) FROM RESERVES * ADJUSTMENTS OF YEAR
- ---------- ----------------- --------- -------------------- ----------- -----------
April 12, 1999 through
December 31, 1999............... 3,947 1,833 (1,099) -- 4,681
- ------------------------
* Consists primarily of write-offs and recoveries of bad debts.
All other schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions, are inapplicable or not material, or the information
called for thereby is otherwise included in the financial statements and
therefore has been omitted.
(b) REPORTS ON FORM 8-K
During the last quarter of the period covered by this report, PCA filed a
Current Report on Form 8-K dated October 25, 1999 with the Securities and
Exchange Commission in connection with the postponement of its proposed initial
public offering of common stock and, as a result, its decision not to redeem its
12 3/8% Senior Exchangeable Preferred Stock due 2010 at that time.
(c) EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- --------------------- -----------
2.1 Contribution Agreement, dated as of January 25, 1999, among
Pactiv Corporation (formerly known as Tenneco
Packaging Inc.) ("Pactiv"), PCA Holdings LLC ("PCA
Holdings") and Packaging Corporation of America ("PCA").(2)
2.2 Letter Agreement Amending the Contribution Agreement, dated
as of April 12, 1999, among Pactiv, PCA Holdings and PCA.(2)
3.1 Restated Certificate of Incorporation of PCA.(2)
3.2 Form of Certificate of Amendment to Restated Certificate of
Incorporation of PCA.(1)
3.3 Form of Second Amended and Restated By-laws of PCA.(1)
4.1 Indenture, dated as of April 12, 1999, by and among PCA,
Dahlonega Packaging Corporation ("Dahlonega"), Dixie
Container Corporation ("Dixie"), PCA Hydro Inc. ("PCA
Hydro"), PCA Tomahawk Corporation ("PCA Tomahawk"), PCA
Valdosta Corporation ("PCA Valdosta") and United States
Trust Company of New York.(2)
4.2 Certificate of Designations, Preferences and Relative,
Participating, Optional and Other Special Rights of
Preferred Stock and Qualifications, Limitations and
Restrictions Thereof of 12 3/8% Senior Exchangeable
Preferred Stock due 2010 and 12 3/8% Series B Senior
Exchangeable Preferred Stock due 2010 of PCA.(2)
4.3 Exchange Indenture, dated as of April 12, 1999, by and among
PCA and U.S. Trust Company of Texas, N.A.(2)
4.4 Intentionally omitted.
4.5 Preferred Stock Registration Rights Agreement, dated as of
April 12, 1999, by and among PCA, J.P. Morgan and BT.(2)
4.6 Form of Rule 144A Global Note and Subsidiary Guarantee.(2)
4.7 Intentionally omitted.
4.8 Form of Rule 144A Global Certificate.(2)
4.9 Form of certificate representing shares of common stock.(1)
10.1 Purchase Agreement, dated as of March 30, 1999, by and among
PCA, Dahlonega, Dixie, PCA Hydro, PCA Tomahawk, PCA
Valdosta, J.P. Morgan and BT.(2)
39
EXHIBIT
NUMBER DESCRIPTION
- --------------------- -----------
10.2 Credit Agreement, dated as of April 12, 1999, among Pactiv,
the lenders party thereto from time to time, J.P. Morgan,
BT, Bankers Trust Company and Morgan Guaranty Trust Company
of New York ("Morgan Guaranty").(2)
10.3 Subsidiaries Guaranty, dated as of April 12, 1999, made by
Dahlonega, Dixie, PCA Hydro, PCA Tomahawk, PCA Valdosta and
Morgan Guaranty.(2)
10.4 Pledge Agreement, dated as of April 12, 1999, among PCA,
Dahlonega, Dixie, PCA Hydro, PCA Tomahawk, PCA Valdosta and
Morgan Guaranty.(2)
10.5 TPI Security Agreement, dated as of April 12, 1999, between
Pactiv and Morgan Guaranty.(2)
10.6 PCA Security Agreement, dated as of April 12, 1999, among
PCA, Dahlonega, Dixie, PCA Hydro, PCA Tomahawk, PCA Valdosta
and Morgan Guaranty.(2)
10.7 Intentionally omitted.
10.8 Registration Rights Agreement, dated as of April 12, 1999,
by and among Pactiv, PCA Holdings and PCA.(2)
10.9 Holding Company Support Agreement, dated as of April 12,
1999, by and between PCA Holdings and PCA.(2)
10.10 Facility Use Agreement, dated as of April 12, 1999, by and
between Pactiv and PCA.(2)
10.11 Human Resources Agreement, dated as of April 12, 1999, by
and among Tenneco Automotive Inc. (formerly known as Tenneco
Inc.), Pactiv and PCA.(2)
10.12 Purchase/Supply Agreement, dated as of April 12, 1999,
between PCA and Tenneco Packaging Speciality and Consumer
Products Inc.(2)
10.13 Purchase/Supply Agreement, dated as of April 12, 1999,
between PCA and Pactiv.(2)
10.14 Purchase/Supply Agreement, dated as of April 12, 1999,
between PCA and Tenneco Automotive Inc.(2)
10.15 Technology, Financial and Administrative Transition Services
Agreement, dated as of April 12, 1999, between Pactiv and
PCA.(2)
10.16 Letter Agreement Regarding Terms of Employment, dated as of
January 25, 1999, between PCA and Paul T. Stecko.*(2)
10.17 Letter Agreement Regarding Terms of Employment, dated as of
May 19, 1999, between PCA and Paul T. Stecko.*(2)
10.18 1999 Long-Term Equity Incentive Plan, effective as of
October 19, 1999.*(1)
10.19 Management Equity Agreement, dated as of June 1, 1999, among
PCA, Paul T. Stecko and the Paul T. Stecko 1999 Dynastic
Trust.*(2)
10.20 Form of Management Equity Agreement, dated as of June 1,
1999, among PCA and the members of management party
thereto.*(2)
10.21 Memorandum Regarding Special Retention Bonus, dated as of
April 16, 1999, from PCA to William J. Sweeney.*(2)
10.22 Amended and Restated 1999 Management Equity Compensation
Plan, effective as of June 2, 1999.*(2)
10.23 First Amendment and Consent, dated as of August 26, 1999,
among PCA, the lenders party thereto, J.P. Morgan, BT,
Bankers Trust Company and Morgan Guaranty.(1)
10.24 Second Amendment and Consent, dated as of January 6, 2000,
among PCA, the lenders party thereto, J.P. Morgan, BT,
Bankers Trust Company and Morgan Guaranty.(1)
21.1 Subsidiaries of the Registrant.(1)
27.1 Financial Data Schedule.
- ------------------------
* Management contract or compensatory plan or arrangement.
(1) Incorporated herein by reference to the same numbered exhibit to PCA's
Registration Statement on Form S-1 (Registration No. 333-86963).
(2) Incorporated herein by reference to the same numbered exhibit to PCA's
Registration Statement on Form S-4 (Registration No. 333-79511).
40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on March 9, 2000.
Packaging Corporation of America
By:
--------------------------------------
Name: Richard B. West
Title: Chief Financial Officer, Vice
President and Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 9, 2000.
SIGNATURE TITLE
--------- -----
- --------------------------------------------
Paul T. Stecko Chairman of the Board and Chief Executive
Officer (Principal Executive Officer)
- --------------------------------------------
Richard B. West Chief Financial Officer, Vice President and
Secretary (Principal Financial and Accounting
Officer)
- --------------------------------------------
Samuel M. Mencoff Director
- --------------------------------------------
Justin S. Huscher Director
- --------------------------------------------
Thomas S. Souleles Director
- --------------------------------------------
Henry F. Frigon Director
- --------------------------------------------
Rayford K. Williamson Director
41
INDEX TO FINANCIAL STATEMENTS
PACKAGING CORPORATION OF AMERICA CONSOLIDATED FINANCIAL
STATEMENTS AS OF DECEMBER 31, 1999
Report of Ernst & Young LLP, independent auditors......... F-2
Consolidated balance sheet as of December 31, 1999........ F-3
Consolidated statement of income for the period
January 25, 1999 (date of incorporation) through
December 31, 1999....................................... F-4
Consolidated statement of changes in stockholders' equity
for the period January 25, 1999 (date of incorporation)
through December 31, 1999............................... F-5
Consolidated statement of cash flows for the period from
January 25, 1999 (date of incorporation) through
December 31, 1999....................................... F-6
Notes to consolidated financial statements................ F-7
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO
PACKAGING, INC.) COMBINED FINANCIAL STATEMENTS AS OF
APRIL 11, 1999
Report of Arthur Andersen LLP, independent public
accountants............................................. F-24
Combined statement of assets, liabilities and
interdivision account as of April 11, 1999.............. F-25
Combined statement of revenues, expenses and interdivision
account for the period January 1, 1999 through
April 11, 1999.......................................... F-26
Combined statement of cash flows for the period
January 1, 1999 through April 11, 1999.................. F-27
Notes to combined financial statements.................... F-28
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO
PACKAGING INC.) COMBINED FINANCIAL STATEMENTS AS OF
DECEMBER 31, 1998, 1997 AND 1996
Report of Arthur Andersen LLP, independent public
accountants............................................. F-44
Combined statements of assets, liabilities and
interdivision account as of December 31, 1998, 1997 and
1996.................................................... F-45
Combined statements of revenues, expenses and
interdivision account for the years ended December 31,
1998, 1997 and 1996..................................... F-46
Combined statements of cash flows for the years ended
December 31, 1998, 1997 and 1996........................ F-47
Notes to combined financial statements.................... F-49
F-1
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of Packaging Corporation of America:
We have audited the accompanying consolidated balance sheet of Packaging
Corporation of America as of December 31, 1999 and the related consolidated
statements of income, changes in stockholders' equity and cash flows for the
period January 25, 1999 (date of incorporation) to December 31, 1999. Our audit
also included the financial statement schedule listed in the index at Item
14(a). These financial statements and schedule are the responsibility of
Packaging Corporation of America management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Packaging
Corporation of America at December 31, 1999, and the consolidated results of its
operations and its cash flows for the period January 25, 1999 to December 31,
1999 in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
Ernst & Young LLP
Chicago, Illinois
January 18, 2000, except for Note 18 dated
February 2, 2000
F-2
PACKAGING CORPORATION OF AMERICA
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 10,300
Accounts receivable, net of allowance for doubtful
accounts of $4,681 as of December 31, 1999.............. 208,356
Notes receivable.......................................... 698
Inventories............................................... 163,858
Prepaid expenses and other current assets................. 11,304
Deferred income taxes..................................... 8,411
----------
TOTAL CURRENT ASSETS.................................. 402,927
Timber and timberlands, at cost, less depletion............. 202,582
Property, plant and equipment, net.......................... 1,460,024
Intangible assets, net of accumulated amortization of $1,154
as of December 31, 1999................................... 1,532
Other long-term assets...................................... 86,143
----------
TOTAL ASSETS.......................................... $2,153,208
==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt......................... $ 829
Accounts payable.......................................... 127,365
Accrued interest.......................................... 13,633
Accrued liabilities....................................... 85,643
----------
TOTAL CURRENT LIABILITIES............................. 227,470
Long-term liabilities:
Long-term debt............................................ 1,329,202
Deferred income taxes..................................... 69,804
Other liabilities......................................... 7,511
----------
TOTAL LONG-TERM LIABILITIES........................... 1,406,517
Mandatorily redeemable preferred stock (liquidation
preference $100 per share, 3,000,000 shares authorized,
1,058,094 shares issued and outstanding).................. 102,522
Stockholders' equity:
Junior preferred stock (liquidation preference $1.00 per
share, 100 shares authorized, issued and outstanding)... --
Common stock (par value $.01 per share, 300,000,000 shares
authorized, 94,600,000 shares issued and outstanding)... 946
Additional paid in capital................................ 384,549
Retained earnings......................................... 31,204
----------
TOTAL STOCKHOLDERS' EQUITY............................ 416,699
----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............ $2,153,208
==========
See notes to consolidated financial statements.
F-3
PACKAGING CORPORATION OF AMERICA
CONSOLIDATED STATEMENT OF INCOME
FOR THE PERIOD JANUARY 25, 1999 (DATE OF INCORPORATION) THROUGH DECEMBER 31,
1999
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net sales................................................... $1,262,285
Cost of sales............................................... (973,525)
----------
Gross profit.............................................. 288,760
Selling and administrative expenses......................... (79,794)
Other income, net........................................... 11,020
Corporate overhead.......................................... (27,756)
----------
Income before interest, taxes and extraordinary item...... 192,230
Interest expense, net....................................... (107,594)
----------
Income before taxes and extraordinary item................ 84,636
Provision for income taxes.................................. (37,239)
----------
Income before extraordinary item.......................... 47,397
Extraordinary item, net of tax.............................. (6,897)
----------
Net income.................................................. 40,500
Preferred dividends and accretion of preferred stock
issuance costs............................................ (9,296)
----------
Net income available to common shareholders................. $ 31,204
==========
Basic earnings per common share:
Income before extraordinary item.......................... $ 0.41
Extraordinary item........................................ (0.07)
----------
Net income per common share............................... $ 0.34
==========
Diluted earnings per common share:
Income before extraordinary item.......................... $ 0.39
Extraordinary item........................................ (0.07)
----------
Net income per common share............................... $ 0.32
==========
See notes to consolidated financial statements.
F-4
PACKAGING CORPORATION OF AMERICA
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE PERIOD JANUARY 25, 1999 (DATE OF INCORPORATION) THROUGH DECEMBER 31,
1999
JUNIOR
PREFERRED STOCK COMMON STOCK ADDITIONAL TOTAL
--------------------- --------------------- PAID IN RETAINED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS EQUITY
-------- ---------- ---------- -------- ---------- -------- -------------
(IN THOUSANDS EXCEPT SHARE DATA)
Balance at January 25, 1999............... -- $ -- -- $ -- $ -- $ -- $ --
Pactiv contribution of assets to PCA.... -- -- 193,500 2 399,323 -- 399,325
Payment to Pactiv....................... -- -- -- -- (246,500) -- (246,500)
Investment by PCA Holdings.............. -- -- 236,500 2 236,500 -- 236,502
Issuance of junior preferred stock...... 100 -- -- -- -- -- --
Non-financing transaction costs......... -- -- -- -- (23,832) -- (23,832)
Post-closing adjustment to contribution
of assets............................. -- -- -- -- 20,000 -- 20,000
220-for-one common stock split.......... -- -- 94,170,000 942 (942) -- --
Net income.............................. -- -- -- -- -- 40,500 40,500
Dividends declared on preferred stock... -- -- -- -- -- (9,084) (9,084)
Accretion of preferred stock costs...... -- -- -- -- -- (212) (212)
---- ---------- ---------- ---- --------- ------- ---------
Balance at December 31, 1999.............. 100 $ -- 94,600,000 $946 $ 384,549 $31,204 $ 416,699
==== ========== ========== ==== ========= ======= =========
See notes to consolidated financial statements.
F-5
PACKAGING CORPORATION OF AMERICA
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD JANUARY 25, 1999 (DATE OF INCORPORATION) THROUGH DECEMBER 31,
1999
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 40,500
---------
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation, depletion and amortization................ 105,935
Amortization of financing costs......................... 6,299
Extraordinary loss--early debt extinguishment........... 6,897
Increase in deferred income taxes....................... 33,228
Undistributed earnings of affiliated companies.......... 597
Gain on sale of timberlands............................. (12,157)
Gain on disposal of property, plant and equipment....... (947)
Other, net.............................................. 1,320
Changes in components of working capital:
Increase in current assets--
Accounts receivable................................... (30,007)
Inventories........................................... (5,625)
Prepaid expenses and other............................ (3,379)
Increase in current liabilities--
Accounts payable...................................... 54,738
Accrued liabilities................................... 57,049
---------
NET CASH PROVIDED BY OPERATING ACTIVITIES........... 254,448
---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment................ (88,938)
Additions to other long term assets....................... (5,302)
Proceeds from disposals of property, plant and
equipment............................................... 1,347
Proceeds from timberlands sales........................... 263,255
Payment to Pactiv for contribution of assets.............. (246,500)
Other, net................................................ (230)
---------
NET CASH USED FOR INVESTING ACTIVITIES.............. (76,368)
---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from preferred stock............................. 96,500
Proceeds from long-term debt issued....................... 9,619
Payments on long-term debt................................ (440,075)
Financing costs........................................... (90,324)
Proceeds from post-closing adjustment..................... 20,000
Proceeds from issuance of common stock to PCA Holdings.... 236,500
---------
NET CASH USED FOR FINANCING ACTIVITIES.............. (167,780)
---------
NET INCREASE IN CASH........................................ 10,300
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. --
---------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $ 10,300
=========
See notes to consolidated financial statements.
F-6
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. BASIS OF PRESENTATION
Packaging Corporation of America ("PCA" or the "Company") was incorporated
on January 25, 1999 pursuant to the General Corporation Law of the State of
Delaware. PCA was formed to acquire the Containerboard Group of Pactiv
Corporation, formerly known as Tenneco Packaging Inc. PCA had no operations from
the date of incorporation on January 25, 1999 to April 11, 1999.
On April 12, 1999, Pactiv Corporation sold its containerboard and
corrugating packaging products business (the "Group") to PCA for $2.2 billion.
The Group is the predecessor to PCA. The $2.2 billion purchase price paid to
Pactiv for the Group consisted of $246.5 million in cash, the assumption of
$1.8 billion of debt incurred by Pactiv immediately prior to closing, and the
issuance of a 45% common equity interest in PCA. PCA Holdings, an entity
organized and controlled by Madison Dearborn Partners, LLC, acquired the
remaining 55% common equity interest in PCA for $236.5 million in cash. These
events are collectively referred to as the "Transactions." As significant veto
rights were retained by Pactiv, the carryover basis of accounting was used and
no goodwill was recognized. Fees of $23.8 million were incurred as part of the
Transactions and have been recorded as a charge to stockholders' equity.
On August 25, 1999, PCA Holdings and Pactiv agreed that the acquisition
consideration should be reduced as a result of a post-closing price adjustment
by $20.0 million. On September 23, 1999, Pactiv paid PCA $20.7 million,
representing the $20.0 million adjustment and $0.7 million of interest through
the date of payment by Pactiv.
The Company is comprised of mills and corrugated products operations. The
mill operations (the "Mills") consist of two Kraft linerboard mills located in
Counce, Tennessee, and Valdosta, Georgia, and two medium mills located in Filer
City, Michigan, and Tomahawk, Wisconsin. The Mills also include two recycling
centers located in Nashville, Tennessee, and Jackson, Tennessee. The Mills also
control and manage approximately 540,000 acres of timberlands. The Mills
transfer the majority of their output to PCA's corrugated products operations
("Corrugated").
PCA's Corrugated operations consist of 39 corrugated combining plants,
28 specialty / sheet plants and five design centers. All plants are located in
North America. Corrugated combines linerboard and medium (primarily from the
Mills) into sheets that are converted into corrugated shipping containers,
point-of-sale graphics packaging, point-of-purchase displays and other
specialized packaging. Corrugated sells to diverse customers primarily in North
America.
2. SUMMARY OF ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The accompanying consolidated financial statements of Packaging Corporation
of America include all majority-owned subsidiaries. The Company has one joint
venture that is carried under the equity method. All significant intercompany
transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
F-7
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include all cash balances and highly liquid
investments with a maturity of three months or less. Cash equivalents are stated
at cost, which approximates market.
INVENTORIES
Raw materials, work in process and finished goods are valued using the lower
of last-in, first-out ("LIFO") cost or market method. Supplies and materials
inventories are valued using a moving average cost. All inventories are stated
at the lower of cost or market. Inventories valued using the LIFO method
comprised 76% of inventories at current cost at December 31, 1999.
At December 31, 1999, inventory by major classification was as follows:
(IN THOUSANDS)
Raw materials............................................... $ 74,881
Work in process............................................. 5,021
Finished goods.............................................. 56,049
Supplies and materials...................................... 49,605
--------
Inventories at FIFO cost.................................... 185,556
Excess of FIFO over LIFO cost............................... (21,698)
--------
Inventory, net........................................ $163,858
========
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment and timber and timberlands are recorded at
cost.
At December 31, 1999, property, plant and equipment by major classification
was as follows:
(IN THOUSANDS)
Land........................................................ $ 69,767
Buildings................................................... 320,418
Machinery and equipment..................................... 1,831,077
Other, including construction in progress................... 81,294
----------
Plant, property and equipment, at cost...................... 2,302,556
Less: Accumulated depreciation.............................. (842,532)
----------
Property, plant and equipment, net.......................... $1,460,024
==========
The amount of interest capitalized related to construction in progress was
approximately $0.1 million for the period April 12, 1999 through December 31,
1999.
F-8
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
Depreciation is computed on the straight-line basis over the estimated
useful lives of the related assets. The following lives are used for the various
categories of assets:
Buildings and land improvements.......................... 5 to 40 years
Machinery and equipment.................................. 3 to 25 years
Trucks and automobiles................................... 3 to 10 years
Furniture and fixtures................................... 3 to 20 years
Computers and hardware................................... 3 to 7 years
Leasehold improvements................................... Period of the lease
Timber depletion is provided on the basis of timber cut during the period
related to the estimated quantity of recoverable timber. Assets under capital
leases are depreciated on the straight-line method over the term of the lease.
Expenditures for repairs and maintenance are expensed as incurred.
INTANGIBLE ASSETS
The Company has capitalized certain intangible assets based on their
estimated fair value at the date of acquisition. Amortization is provided for
these intangible assets on a straight-line basis over periods ranging from three
to ten years. Covenants not to compete are amortized on a straight-line basis
over the terms of the respective agreements.
OTHER LONG-TERM ASSETS
PCA capitalized certain costs related to obtaining its financing at
April 12, 1999. These costs are amortized to interest expense using the
effective interest rate method over the terms of the senior credit facility and
senior subordinated notes, which range from six years to ten years. Deferred
financing costs were $50.6 million as of December 31, 1999.
PCA also capitalizes certain costs related to the purchase and development
of software which is used in its business operations. The costs attributable to
these software systems are amortized over their estimated useful lives based on
various factors such as the effects of obsolescence, technology and other
economic factors.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets to be held and used are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be fully recoverable. In the event that facts and circumstances indicate
that the carrying amount of any long-lived assets may be impaired, an evaluation
of recoverability would be performed. If an evaluation is required, the
estimated future undiscounted cash flows associated with the asset would be
compared to the asset's carrying amount to determine if a write-down to
discounted cash flows is required.
F-9
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
FINANCIAL INSTRUMENTS
The Company uses interest rate collar agreements to manage interest costs
and the risk associated with changing interest rates. As interest rates change,
the differential paid or received is recognized in interest expense of the
period. During 1999, no such amounts were recognized in interest expense as the
interest rates for the period were within the floor and ceiling limits included
in the interest rate collar agreements.
INCOME TAXES
PCA utilizes the liability method of accounting for income taxes whereby it
recognizes deferred tax assets and liabilities for the future tax consequences
of temporary differences between the tax basis of assets and liabilities and
their reported amounts in the financial statements. Deferred tax assets are
reduced by a valuation allowance when, based upon management's estimates, it is
more likely than not that a portion of the deferred tax assets will not be
realized in a future period. The estimates utilized in the recognition of
deferred tax assets are subject to revision in future periods based on new facts
or circumstances.
REVENUE RECOGNITION
The Company recognizes revenue as products are shipped to customers.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred. The amount charged
was $2.5 million for the period April 12, 1999 through December 31, 1999.
FREIGHT TRADES
PCA regularly trades containerboard with other manufacturers primarily to
reduce shipping costs. The freight trade transactions are accounted for
primarily as transactions in the inventory accounts; the impact on income is not
material.
SEGMENT INFORMATION
The Company is primarily engaged in one line of business: the manufacture
and sale of packaging materials, boxes and containers for industrial and
consumer markets. No single customer accounts for more than 10% of total
revenues. PCA has no foreign operations.
NEW ACCOUNTING PRONOUNCEMENTS
In June, 1998, the Financial Accounting Standards Board issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes new accounting and reporting standards requiring that all
derivative instruments (including certain derivative instruments embedded in
other contracts) be recorded on the balance sheet as either an asset or a
liability measured at its fair value. The statement requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's
F-10
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
gains and losses to offset related results on the hedged item in the income
statement and requires that a company must formally document, designate and
assess the effectiveness of transactions that receive hedge accounting. This
statement is effective for all fiscal years beginning after June 15, 2000. The
adoption of this standard is not expected to have a significant effect on PCA's
financial position or results of operations.
3. EARNINGS PER SHARE
All share and per share data included in the accompanying consolidated
financial statements have been adjusted to reflect a 220-for-one-split of the
Company's common stock which became effective on October 19, 1999.
The following table sets forth the computation of basic and diluted income
per common share for the period April 12, 1999 through December 31, 1999:
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Numerator:
Net income available to common stockholders............... $31,204
Denominator:
Basic common shares outstanding........................... 92,108
Effect of dilutive securities:
Stock options............................................. 1,949
Non-vested stock.......................................... 2,492
-------
Dilutive common shares outstanding.......................... 96,549
Basic income per common share............................... $ 0.34
Diluted income per common share............................. $ 0.32
4. ACCRUED LIABILITIES
The components of accrued liabilities as of December 31, 1999 include:
(IN THOUSANDS)
Benefits.................................................... $21,318
Vacation and holiday pay.................................... 11,399
Other....................................................... 52,926
-------
Total..................................................... $85,643
=======
5. PENSION AND OTHER POSTRETIREMENT BENEFITS
In connection with the Transactions, PCA and Pactiv entered into a human
resources agreement which, among other items, granted PCA employees continued
participation in the Pactiv pension and welfare plans for a period of up to five
years following the closing of the Transactions for an agreed upon fee. For
salaried employees, PCA will pay Pactiv $4.0 million in the first and second
years, $6.0 million in the third year, $8.0 million in the fourth year, and
$10.0 million in the fifth year following the closing date
F-11
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
5. PENSION AND OTHER POSTRETIREMENT BENEFITS (CONTINUED)
of the Transactions. For hourly employees, PCA will pay Pactiv $1.2 million per
year until December 31, 2000. These amounts can be adjusted if there are
material increases in the pension costs to Pactiv. The fees paid to Pactiv are
expensed ratably throughout the year. PCA intends to adopt its own compensation
and benefit plans with respect to its employees sometime in the future.
PCA also provides certain medical and life insurance benefits for retired
and terminated employees. For salaried employees, the plan covers employees
retiring from PCA on or after attaining age 55 who have had at least 10 years
service with PCA after attaining age 45. For hourly employees, the
postretirement benefit plan generally covers employees who retire according to
one of PCA's hourly employee retirement plans. Per the human resources agreement
referred to above, Pactiv retained the liability relating to retiree medical and
life benefits for PCA employees who had retired on or before the closing date of
the Transactions or who will retire within two years of that date. Any
postretirement liability recorded on PCA's balance sheet relates to active
employees only.
A summary of the change in benefit obligation, the change in plan assets,
the development of net amount recognized, and the amounts recognized in the
statement of financial position for the postretirement benefit plans follows:
(IN THOUSANDS)
Change in benefit obligation:
Benefit obligation at April 12, 1999...................... $ 4,007
Service cost.............................................. 441
Interest cost............................................. 210
Actuarial loss (gain)..................................... (614)
-------
Benefit obligation at September 30, 1999.................. $ 4,044
=======
Plan assets at fair value at September 30, 1999............. $ --
=======
Development of net amount recognized:
Funded status at September 30, 1999....................... $(4,044)
Unrecognized cost:
Actuarial loss (gain)................................... (849)
Prior service cost...................................... --
Transition liability (asset)............................ --
-------
Accrued benefit recognized at December 31, 1999........... $(4,893)
=======
The accrued postretirement benefit cost has been recorded based upon certain
actuarial estimates as described below. Those estimates are subject to revision
in future periods given new facts or circumstances.
F-12
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
5. PENSION AND OTHER POSTRETIREMENT BENEFITS (CONTINUED)
The net periodic postretirement benefit cost for the period April 12, 1999
through December 31, 1999 consists of the following:
(IN THOUSANDS)
Service cost for benefits earned during the year............ $441
Interest cost on accumulated postretirement benefit
obligation................................................ 210
Net amortization of unrecognized amounts.................... (2)
----
Net periodic postretirement benefit cost.................... $649
====
The initial weighted average assumed health care cost trend rate used in
determining 1999 accumulated postretirement benefit obligation was 5.0%.
Increasing the assumed health care cost trend rate by one percentage point
would increase the 1999 postretirement benefit obligation by approximately $0.4
million and would increase the net postretirement benefit cost by approximately
$0.1 million.
The discount rate (which is based on long-term market rates) used in
determining the accumulated postretirement benefit obligation was 7.5% for 1999.
6. LONG-TERM DEBT
(IN THOUSANDS)
Senior credit facility--
Term Loan A, weighted average interest at LIBOR (5.95% as
of December 31, 1999) + 2.75%, due in varying quarterly
installments through April 12, 2005..................... $ 296,148
Term Loan B, weighted average interest at LIBOR + 3.25%,
due in varying quarterly installments through April 12,
2007.................................................... 241,426
Term Loan C, weighted average interest at LIBOR + 3.50%,
due in varying quarterly installments through April 12,
2008.................................................... 241,426
Senior subordinated notes, interest at 9.625% payable
semi-annually, due April 1, 2009........................ 550,000
Other..................................................... 1,031
----------
Total....................................................... 1,330,031
Less: Current portion....................................... 829
----------
Total long-term debt........................................ $1,329,202
==========
F-13
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
6. LONG-TERM DEBT (CONTINUED)
PCA is required to pay commitment fees on the unused portion of the
revolving credit facility. At December 31, 1999, $150.0 million was available
under the revolving credit facility, and there were no borrowings outstanding.
The senior credit facility is (1) jointly and severally guaranteed by each
of PCA's existing subsidiaries and (2) secured by a first priority lien covering
substantially all of the owned timberland, mills, plants and other facilities
and substantially all tangible and intangible personal property of PCA and its
domestic subsidiaries and by a pledge of all of the capital stock of PCA's
domestic subsidiaries. In addition, the senior credit facility will also be
secured by a pledge of 65% of the capital stock of any first tier foreign
subsidiaries that PCA may acquire or form in the future. PCA's future domestic
subsidiaries will guarantee the senior credit facility and secure that guarantee
with certain of their real property and substantially all of their tangible and
intangible personal property.
As of December 31, 1999, annual principal payments for debt during the next
five years are: $0.8 million (2000), $13.6 million (2001), $79.2 million (2002),
$87.5 million (2003), $104.0 million (2004), and $1,044.9 million (2005 and
thereafter).
In May through December of 1999, PCA made voluntary prepayments totaling
approximately $431.0 million using excess cash and proceeds from the sale of
certain timberlands to permanently reduce its borrowings under the term loans.
As a result of these prepayments, PCA recorded a charge of $11.4 million
($6.9 million after tax) as an early extinguishment of debt in December, 1999.
No quarterly installments will be required under any of the term loans until
December 31, 2001.
Under the senior credit facility, the Company is required to maintain
interest rate collar agreements for 50% of its outstanding term loan balances
for a minimum period of two years after the initial borrowing. These LIBOR
interest rate collar agreements protect against rising interest rates while
simultaneously guaranteeing minimum interest rates. The notional amount of these
collars is $510.0 million at December 31, 1999, resulting in the interest rates
on approximately 65% of PCA's term loan obligations being capped. The weighted
average floor of the interest rate collar agreements is 4.96%, and the weighted
average ceiling is 6.75%. On November 29, 1999, PCA terminated $180.0 million of
interest rate collar agreements and received $1.2 million. The senior credit
facility also provides PCA with the right to lock-in LIBOR interest rates for
any amount of term loans for one, two, three, or six month periods. With the
approval of the lenders, PCA can lock-in LIBOR interest rates for either a
two-week or twelve month period.
Interest payments in connection with the Company's debt obligations for the
period from April 12, 1999 through December 31, 1999 amounted to $89.5 million.
At December 31, 1999, letters of credit amounting to approximately $19.7
million were outstanding which relate primarily to various environmental
obligations, including landfills and solid waste programs, management equity
loans, workers' compensation, and equipment leases.
PCA's various debt agreements require that it comply with certain covenants
and restrictions, including specific financial ratios that must be maintained on
the last day at the end of each fiscal quarter. Under the provisions of the
credit agreement dated April 12, 1999 ("Credit Agreement"), PCA must maintain a
consolidated interest coverage ratio of 1.50 at December 31, 1999, increasing
per the guidelines set forth in the Credit Agreement to 2.50 as of March 31,
2005, and each fiscal quarter thereafter. Also,
F-14
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
6. LONG-TERM DEBT (CONTINUED)
PCA must not exceed a leverage ratio (indebtedness divided by EBITDA) of 6.75 at
December 31, 1999, decreasing per the guidelines set forth in the Credit
Agreement to 4.00 as of March 31, 2006, and each fiscal quarter thereafter.
Lastly, PCA must maintain a minimum consolidated net worth of $325.0 million at
December 31, 1999, increasing per the guidelines set forth in the Credit
Agreement to $690.0 million as of March 31, 2008. The Company was in compliance
with all of its covenants as of December 31, 1999.
7. FINANCIAL INSTRUMENTS
The carrying and estimated fair values of PCA's financial instruments at
December 31, 1999 were as follows:
CARRYING
AMOUNT FAIR VALUE
---------- ----------
(IN THOUSANDS)
Short-term assets..................................... $ 219,354 $219,354
Short-term liabilities................................ 127,365 127,365
Long-term debt-
Senior credit facility.............................. 779,000 779,000
9.625% Senior subordinated notes.................... 550,000 563,750
Other............................................... 1,031 1,031
Redeemable preferred stock............................ 102,552 116,390
Interest rate collars................................. -- 5,638
SHORT-TERM ASSETS AND LIABILITIES
The fair value of cash and cash equivalents, accounts receivable, notes
receivable and accounts payable approximate their carrying amounts due to the
short-term nature of these financial instruments.
LONG-TERM DEBT
The fair value of the senior credit facility approximates its carrying
amount due to the variable interest-rate feature of the instrument. The fair
value of the senior subordinated notes is based on quoted market prices. The
fair values of the remaining debt were considered to be the same as or were not
determined to be materially different from the carrying amounts.
REDEEMABLE PREFERRED STOCK
The fair value of the redeemable preferred stock is based on amounts
obtained from investment advisors.
INTEREST RATE COLLARS
The fair values of the interest rate collars are the amounts at which they
could be settled and are estimated by obtaining quotes from banks.
F-15
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
8. MANDATORY REDEEMABLE PREFERRED STOCK
On April 12, 1999, PCA issued 1,000,000 shares of 12.375% senior
exchangeable preferred stock, liquidation preference of $100 per share. Holders
of the preferred shares are entitled to receive cumulative dividends paid in
cash or in kind at a rate of 12.375% which are paid semi-annually. If PCA fails
to pay dividends, holders of the preferred stock will be entitled to elect two
additional members to PCA's Board of Directors. Holders of the preferred stock
have no voting rights. The preferred stock ranks senior to the common stock.
3,000,000 shares were authorized, and 1,058,094 shares were issued and
outstanding as of December 31, 1999. PCA incurred $3.5 million of issuance
costs, which are being amortized through 2010 at which time the preferred stock
is required to be redeemed. See Note 18 for further discussion.
9. STOCKHOLDERS' EQUITY
On April 12, 1999, PCA issued 100 shares of Junior Preferred Stock,
liquidation preference of $1.00 per share. Holders of the Junior Preferred Stock
are not entitled to receive any dividends or distributions and have the right to
elect one director to PCA's Board of Directors. The holders of the Junior
Preferred Stock have agreed to elect the individual serving as PCA's chief
executive officer to fill this director position. Shares of Junior Preferred
Stock may not be reissued after being reacquired in any manner by PCA.
In June 1999, PCA entered into management equity agreements with 125 of its
management-level employees. Under these agreements, PCA Holdings and Pactiv
Corporation sold 3,132,800 shares of common stock to 113 of these employees at
$4.55 per share. The stock purchased under the management equity agreements is
subject to vesting and is subject to repurchase upon a termination of employment
by PCA at any time prior to an initial public offering of its common stock (see
Note 18). The management equity agreements also provide for the grant of options
(see Note 16).
On October 19, 1999, PCA effected a 220-for-one stock split of its common
stock which resulted in an increase in the number of shares outstanding from
430,000 to 94,600,000. All historical share numbers for PCA contained in the
financial statements and related notes reflect the 220-for-one split.
10. COMMITMENTS AND CONTINGENCIES
CAPITAL COMMITMENTS
The Company had authorized capital expenditures of approximately
$66.3 million as of December 31, 1999, in connection with the expansion and
replacement of existing facilities and equipment.
F-16
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEASE COMMITMENTS
The Company holds certain of its facilities, equipment, and other assets
under long-term leases. The minimum lease payments under non-cancelable
operating leases with lease terms in excess of one year are as follows:
(IN THOUSANDS)
2000........................................................ $ 22,361
2001........................................................ 17,137
2002........................................................ 13,146
2003........................................................ 7,681
2004........................................................ 5,434
Thereafter.................................................. 38,504
--------
Total..................................................... $104,263
========
Commitments under capital leases were not significant to the accompanying
financial statements. Total rental expense for continuing operations for the
period from April 12, 1999 through December 31, 1999 was $15.0 million. These
costs are included primarily in cost of goods sold.
PURCHASE COMMITMENTS
The Company has entered into various minimum purchase agreements to buy
energy over periods ranging from one to five years. Total purchase commitments
over the next five years are as follows:
(IN THOUSANDS)
2000........................................................ $ 5,393
2001........................................................ 4,317
2002........................................................ 2,603
2003........................................................ 2,603
2004........................................................ 2,602
-------
Total..................................................... $17,518
=======
The Company purchased approximately $7.8 million during the period from
April 12, 1999 through December 31, 1999 under these purchase agreements.
LITIGATION
The Company is involved in various legal proceedings and litigation arising
in the ordinary course of business. In the opinion of management and in-house
legal counsel, the outcome of such proceedings and litigation will not
materially affect the Company's financial position or results of operations.
ENVIRONMENTAL LIABILITIES
The estimated landfill closure and postclosure maintenance costs expected to
be incurred upon and subsequent to the closing of existing operating landfill
areas are accrued based on the landfill capacity used
F-17
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
to date. Amounts are estimates using current technologies for closure and
monitoring and are not discounted.
The potential costs for various environmental matters are uncertain due to
such factors as the unknown magnitude of possible cleanup costs, the complexity
and evolving nature of governmental laws and regulations and their
interpretations, and the timing, varying costs and effectiveness of alternative
cleanup technologies. Liabilities recorded by the Company for environmental
contingencies are estimates of the probable costs based upon available
information and assumptions. Because of these uncertainties, however, PCA's
estimates may change. PCA believes that any additional costs identified as
further information becomes available would not have a material effect on its
financial statements.
11. INCOME TAXES
Following is an analysis of the components of consolidated income tax
expense (benefit):
(IN THOUSANDS)
Current--
U.S....................................................... $(16,207)
State and local........................................... (1,083)
Deferred--
U.S....................................................... 44,976
State and local........................................... 9,553
--------
Total provision for taxes............................... $ 37,239
========
The effective tax rate varies from the U.S. Federal statutory tax rate for
the period April 12, 1999 through December 31, 1999, principally due to the
following:
(IN THOUSANDS)
Provision computed at U.S. Federal statutory rate of 35%.... $29,623
State and local taxes....................................... 4,855
Other....................................................... 2,761
-------
Total................................................... $37,239
=======
F-18
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
11. INCOME TAXES (CONTINUED)
The components of the deferred tax assets (liabilities) at December 31,
1999, were as follows:
(IN THOUSANDS)
Current deferred taxes--
Accrued liabilities....................................... $ 2,255
Employee benefits and compensation........................ 3,777
Reserve for doubtful accounts............................. 1,002
Inventory................................................. (223)
Pensions and postretirement benefits...................... 1,600
--------
Total current deferred taxes................................ $ 8,411
========
Noncurrent deferred taxes--
Pension and postretirement benefits....................... $ 1,933
Excess of financial reporting over tax basis in plant and
equipment............................................... (97,706)
Accrued liabilities....................................... 4,734
Asset for net operating loss carryforwards and minimum tax
credits................................................. 21,235
--------
Total noncurrent deferred taxes......................... $(69,804)
========
Cash payments for income taxes were $4.1 million for the period April 12,
1999 through December 31, 1999. As of December 31, 1999, the Company has
available for income tax purposes approximately $60.5 million in net operating
loss carryforwards and minimum tax credits which may be used to offset future
taxable income. These loss carryforwards and minimum tax credits expire in
fiscal year 2019.
12. RELATED PARTY TRANSACTIONS
PCA's sales to Pactiv Corporation are included in the accompanying
consolidated financial statements. The net sales to Pactiv Corporation for the
period April 12, 1999 through December 31, 1999 were approximately
$57.4 million. The accounts receivable relating to these sales as of
December 31, 1999 are $12.3 million.
PCA purchases wood on the behalf of the 50% joint venture with American
Cellulose Corporation and transfers the wood to the joint venture at cost. The
accounts receivable relating to these transfers as of December 31, 1999 is
$1.3 million.
PCA entered into a transition services agreement with Pactiv which provides
for the performance of transitional services by Pactiv and its affiliates to PCA
that PCA currently requires to operate its business. These services include:
payroll, general accounting, tax support, treasury/cash management,
insurance/risk management, procurement, human resources, telecommunications and
information services. The initial term of the transition services agreement is
for one year, but may be extended by PCA for an additional six month term.
During the period April 12, 1999 through December 31, 1999, PCA paid Pactiv
$6.5 million for these services.
F-19
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
12. RELATED PARTY TRANSACTIONS (CONTINUED)
Pactiv also agreed to reimburse PCA for up to $5.4 million in expenditures
incurred by PCA relating to system enhancement and year 2000 compliance in the
transition services agreement. The full $5.4 million was received by PCA during
1999.
PCA and Pactiv entered into a facility use agreement which provides for
PCA's use of a portion of Pactiv's headquarters located in Lake Forest,
Illinois, for up to four years following the closing of the transactions. PCA
paid Pactiv $1.5 million for the period April 12, 1999 through December 31,
1999.
13. RESTRUCTURING AND OTHER CHARGES
As part of the April 12, 1999 Transactions, the Company assumed accruals
related to a previously recorded restructuring charge set forth below. This
charge was recorded prior to the Transactions following approval by Tenneco's
Board of Directors of a comprehensive restructuring plan for all of Tenneco's
operations, including those of the Company. In connection with this
restructuring plan, four corrugated facilities were closed and 109 positions
were eliminated.
The following table reflects the components of this assumed accrual:
BALANCE BALANCE
4/12/99 ACTIVITY 12/31/99
-------- -------- --------
(IN THOUSANDS)
Severance........................................... $1,087 $ 819 $ 268
Facility exit costs................................. 1,920 278 1,642
------ ------ ------
Total accrual....................................... $3,007 $1,097 $1,910
====== ====== ======
The fixed assets at the closed facilities were written down to their
estimated fair value. No significant cash proceeds are expected from the
ultimate disposal of these assets. The remaining liability balance at
December 31, 1999 will be used for rent payments related to the two closed
facilities.
14. SALE OF TIMBERLANDS
In August, 1999, PCA signed purchase and sale agreements with various buyers
to sell approximately 405,000 acres of timberland. PCA completed the sales in
October and November 1999. Total proceeds received from the sales were
$263.3 million, resulting in a pre-tax gain of $12.2 million.
15. SUMMARIZED COMBINED FINANCIAL INFORMATION ABOUT GUARANTOR
SUBSIDIARIES
The following is summarized aggregated financial information for Dahlonega
Packaging Corporation, Dixie Container Corporation, PCA Hydro, Inc., PCA
Tomahawk Corporation and PCA Valdosta Corporation, each of which was a
wholly-owned subsidiary of PCA and included in the Company's consolidated
financial statements. Each of these subsidiaries fully, unconditionally, jointly
and severally guaranteed $550.0 million in senior subordinated notes issued by
PCA in connection with the Transactions. Separate
F-20
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
15. SUMMARIZED COMBINED FINANCIAL INFORMATION ABOUT GUARANTOR
SUBSIDIARIES (CONTINUED)
financial statements of the guarantor subsidiaries are not presented because, in
the opinion of management, such financial statements are not material to
investors.
(IN THOUSANDS)
Current assets.............................................. $12,703
Non-current assets.......................................... 14,115
-------
Total assets.............................................. 26,818
Current liabilities......................................... 2,902
Non-current liabilities..................................... 4,414
-------
Total liabilities......................................... 7,316
-------
Net assets.................................................. $19,502
=======
Net sales................................................... $43,941
Gross profit................................................ 3,555
Net (loss).................................................. (179)
16. STOCK-BASED COMPENSATION
PCA entered into management equity agreements in June 1999 with 125 of its
management-level employees. These agreements provide for the grant of options to
purchase up to an aggregate of 6,576,460 shares of PCA's common stock at
approximately $4.55 per share, the same price per share at which PCA Holdings
purchased common stock in the Transactions. These options vest ratably over a
five-year period. Upon completion of an initial public offering, the options
become immediately exercisable. The option shares are subject to contractual
restrictions on transfer for a period of up to 18 months following completion of
the offering (see Note 18 for further discussion).
A summary of the Company's stock option activity, and related information
for the year ended December 31, 1999 follows:
WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE
--------- ----------------
Granted............................................ 6,576,460 $4.55
Forfeited.......................................... (7,260) 4.55
--------- -----
Outstanding at December 31, 1999................... 6,569,200 4.55
Options exercisable at December 31, 1999........... -- --
F-21
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
16. STOCK-BASED COMPENSATION (CONTINUED)
The minimum value of the Company stock options estimated on the date of
grant using the Black-Scholes option-pricing model was $1.29 per option for
1999, with the following assumptions:
Expected life in years...................................... 5
Interest rate............................................... 6.65%
Volatility.................................................. NA
Dividend yield.............................................. 0.0%
The weighted-average remaining contractual life of the options exercisable
at December 31, 1999 is approximately ten years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company has elected to account for its stock option plan under Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and adopt the disclosure only provisions of SFAS No. 123. Under APB
No. 25, no compensation costs are recognized because the number of options is
fixed and the option exercise price is equal to the fair market price of the
common stock on the date of the grant. Under SFAS No. 123, stock options are
valued at the grant date using the Black-Scholes valuation model and
compensation costs are recognized ratably over the vesting period. Had
compensation costs been determined as prescribed by SFAS No. 123, the Company's
net earnings would have been reduced by $0.6 million.
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
FISCAL QUARTER
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) FIRST SECOND THIRD FOURTH TOTAL
- ---------------------------------------- -------- --------- -------- -------- ----------
1999:
Net sales................................... * $373,035* $443,503 $445,747 $1,262,285
Income before interest, taxes and
extraordinary item........................ * 45,390* 63,824 83,016 192,230
Net income.................................. * 6,766* 14,167 19,567 40,500
Net income available to common
shareholders.............................. * 4,088 11,036 16,080 31,204
Basic earnings per share.................... * 0.04* 0.12 0.18 0.34
Diluted earnings per share.................. * 0.04* 0.11 0.17 0.32
- ------------------------
* PCA acquired the Group on April 12, 1999. As such, operating results for the
period prior to April 12, 1999 have been excluded from PCA's 1999 results.
F-22
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
18. SUBSEQUENT EVENTS
On February 2, 2000, the Company completed an initial public offering of its
common stock in which Pactiv Corporation sold 35,000,000 of its
41,160,240 shares of common stock in PCA, and PCA issued an additional
11,250,000 shares. The net proceeds to PCA were approximately $125.5 million at
an initial public offering price of $12.00 per share, after deducting the
underwriting discounts and estimated offering expenses.
PCA will use the net proceeds to redeem all outstanding shares of its
12.375% senior exchangeable preferred stock due 2010 (1,058,094 shares as of
December 31, 1999) at a redemption price of 112.375% of its liquidation
preference, plus accrued and unpaid dividends through March 3, 2000, the date of
redemption. The total to be paid to redeem the senior exchangeable preferred
stock will be $124.4 million, which will include $5.5 million of accrued and
unpaid dividends.
F-23
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Tenneco Inc.:
We have audited the accompanying combined statements of assets, liabilities
and interdivision account of THE CONTAINERBOARD GROUP (a division of Tenneco
Packaging Inc., which is a Delaware corporation and a wholly owned subsidiary of
Tenneco Inc.) as of April 11, 1999, and the related combined statements of
revenues, expenses and interdivision account and cash flows for the period from
January 1, 1999, through April 11, 1999. These financial statements are the
responsibility of the Group's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the combined financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the combined financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall combined
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of The Containerboard
Group as of April 11, 1999, and the results of its operations and its cash flows
for the period from January 1, 1999, through April 11, 1999, in conformity with
generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
July 16, 1999
F-24
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
COMBINED STATEMENT OF
ASSETS, LIABILITIES AND INTERDIVISION ACCOUNT
AS OF APRIL 11, 1999
(IN THOUSANDS)
ASSETS
Current assets:
Cash...................................................... $ 1
Accounts receivable (net of allowance for doubtful
accounts of $3,947)..................................... 171,710
Receivables from affiliated companies..................... 9,037
Notes receivable.......................................... 27,933
Inventories............................................... 158,233
Prepaid expenses and other current assets................. 32,950
----------
Total current assets.................................. 399,864
----------
Property, plant and equipment, at cost:
Land, timber, timberlands and buildings................... 701,922
Machinery and equipment................................... 1,864,962
Other, including construction in progress................. 110,842
Less--Accumulated depreciation and depletion.............. (757,476)
----------
Property, plant and equipment, net.................... 1,920,250
----------
Intangibles................................................. 1,942
----------
Investment.................................................. 1,388
----------
Other long-term assets...................................... 67,645
----------
Total assets................................................ $2,391,089
==========
LIABILITIES AND INTERDIVISION ACCOUNT
Current liabilities:
Accounts payable.......................................... $ 114,050
Payables to Tenneco affiliates............................ 7,652
Current portion of long-term debt......................... 31,841
Accrued liabilities....................................... 64,371
----------
Total current liabilities............................. 217,914
----------
Long-term liabilities:
Long-term debt, net of current portion.................... 1,728,625
Deferred taxes............................................ 263,936
Other..................................................... 23,917
----------
Total long-term liabilities........................... 2,016,478
----------
Interdivision account....................................... 156,697
----------
Total liabilities and interdivision account................. $2,391,089
==========
The accompanying notes to combined financial statements are an integral part of
these statements.
F-25
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
COMBINED STATEMENT OF REVENUES,
EXPENSES AND INTERDIVISION ACCOUNT
FOR THE PERIOD FROM JANUARY 1, 1999, THROUGH APRIL 11, 1999
(IN THOUSANDS)
Net sales................................................... $ 433,182
Cost of sales............................................... (367,483)
---------
Gross profit............................................ 65,699
Selling and administrative expenses......................... (30,584)
Impairment loss............................................. (230,112)
Other expense, net.......................................... (2,207)
Corporate allocations....................................... (14,890)
---------
Loss before interest, income taxes and extraordinary
loss.................................................. (212,094)
Interest expense, net....................................... (221)
---------
Loss before income taxes and extraordinary loss......... (212,315)
Benefit for income taxes.................................... 83,716
Extraordinary loss, net of income tax....................... (6,327)
---------
Net loss.................................................... (134,926)
Interdivision account, beginning of period.................. 908,392
Interdivision account activity, net......................... (616,769)
---------
Interdivision account, end of period........................ $ 156,697
=========
Basic and diluted earnings per share (unaudited):
Loss before extraordinary item.............................. $ (1.36)
Extraordinary item.......................................... (.07)
---------
Net loss per common share................................... $ (1.43)
=========
Weighted average common shares outstanding.................. 94,600
The accompanying notes to combined financial statements are an integral part of
these statements.
F-26
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
COMBINED STATEMENT OF CASH FLOWS
FOR THE PERIOD FROM JANUARY 1, 1999, THROUGH APRIL 11, 1999
(IN THOUSANDS)
Cash flows from operating activities:
Net loss.................................................. $ (134,926)
-----------
Adjustments to reconcile net loss to net cash provided by
operating activities--
Depreciation, depletion and amortization................ 30,905
Extraordinary loss--early debt extinguishment........... 6,327
Loss on sale of assets.................................. 230,112
Amortization of deferred gain........................... (493)
Increase in deferred income taxes....................... 9,782
Undistributed earnings of affiliated companies.......... (106)
Increase in other noncurrent reserves................... 56
-----------
Total charges to net income not involving cash...... 276,583
-----------
Changes in noncash components of working capital--
Working capital transactions, excluding transactions with
Tenneco and working capital from acquired businesses--
Decrease (increase) in current assets--
Accounts and notes receivable......................... (8,183)
Inventories, net...................................... (7,514)
Prepaid expenses and other current assets............. 4,201
(Decrease) increase in current liabilities--
Accounts payable...................................... 26,996
Accrued liabilities................................... (3,508)
-----------
Net decrease in noncash components of working
capital............................................. 11,992
-----------
Net cash provided by operating activities........... 153,649
-----------
Cash flows from investing activities:
Additions to property, plant and equipment................ (1,128,255)
Other long-term assets.................................... 2,284
Proceeds from disposals................................... 825
Other transactions, net................................... 4,001
-----------
Net cash used for investing activities.............. (1,121,145)
-----------
Cash flows from financing activities:
Proceeds from long-term debt issued....................... 1,760,000
Payments on long-term debt................................ (27,550)
Decrease in interdivision account......................... (616,769)
Working capital transactions with Tenneco and affiliated
companies--
Decrease in receivables from affiliated companies....... 1,353
Decrease in factored receivables........................ (150,099)
Increase in accounts payable to affiliated companies.... 561
-----------
Net cash provided by financing activities........... 967,496
-----------
Net change in cash
Cash, beginning of period................................... 1
-----------
Cash, end of period......................................... $ 1
===========
The accompanying notes to combined financial statements
are an integral part of these statements.
F-27
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS
APRIL 11, 1999
1. BUSINESS DESCRIPTION
The Containerboard Group (the "Group") is a division of Tenneco
Packaging Inc., ("Packaging") which is a wholly owned subsidiary of
Tenneco Inc. ("Tenneco"). The Group is comprised of mills and corrugated
products operations. Madison Dearborn Partners, LLC ("MDP"), is a private equity
investment firm.
The Mill operations ("The Mills") consist of two Kraft linerboard mills
located in Counce, Tennessee, and Valdosta, Georgia, and two medium mills
located in Filer City, Michigan, and Tomahawk, Wisconsin. The Mills also include
two recycling centers located in Nashville, Tennessee, and Jackson, Tennessee.
The Mills also control and manage approximately 950,000 acres of timberlands.
The Mills transfer the majority of their output to The Corrugated Products
operations ("Corrugated").
Corrugated operations consist of 39 corrugated combining plants, 28
specialty/sheet plants and 5 design centers. All plants are located in North
America. Corrugated combines linerboard and medium (primarily from The Mills)
into sheets that are converted into corrugated shipping containers,
point-of-sale graphics packaging, point-of-purchase displays and other
specialized packaging. Corrugated sells to diverse customers primarily in North
America.
On January 25, 1999, Packaging entered into a definitive agreement (the
"Contribution Agreement") to sell its containerboard and corrugated packaging
products business to Packaging Corporation of America ("PCA") for $2.2 billion.
Under the terms of the Contribution Agreement, PCA Holdings, an entity organized
and controlled by MDP and its coinvestors, acquired a 55% common equity interest
in PCA, and Packaging contributed the Group to PCA in exchange for cash, the
assumption of debt and a 45% common equity interest in PCA (in each case before
giving effect to issuances of common equity to management).
The sale was completed on April 12, 1999. The financing of the transaction
consisted of borrowings under a new $1.46 billion senior credit facility, the
offering of notes and preferred stock, the cash equity investment of
$236.5 million by PCA Holdings and a rollover equity investment by Packaging
valued at $193.5 million.
The Group's sales to other Packaging entities and other Tenneco entities are
included in the accompanying combined financial statements. The net sales to
other Packaging entities for the period from January 1, 1999, through April 11,
1999, were approximately $21,350,000. The net sales to other Tenneco entities
for the period from January 1, 1999, through April 11, 1999, were approximately
$3,298,000. The profit relating to these sales is included in the accompanying
combined financial statements.
As a result of the Group's relationship with Packaging, the combined
statements of assets, liabilities and interdivision account and the related
combined statements of revenues, expenses and interdivision account are not
necessarily indicative of what actually would have occurred had the Group been a
stand-alone entity. Additionally, these combined financial statements are not
necessarily indicative of the future financial position or results of operations
of the Group.
F-28
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
2. SUMMARY OF ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying combined financial statements include the selected assets
and liabilities of the Group as of April 11, 1999, and the revenues and expenses
of the Group for the period January 1, 1999, through April 11, 1999. All
significant intragroup accounts and transactions have been eliminated.
REVENUE RECOGNITION
The Group recognizes revenue as products are shipped to customers.
ACCOUNTS RECEIVABLE
Historically, a substantial portion of the Group's trade accounts receivable
were sold by Packaging, generally without recourse, to a financing subsidiary of
Tenneco Inc. Expenses relating to cash discounts, credit losses, pricing
adjustments and other allowances on these factored receivables are accrued and
charged to the Group. As part of the Containerboard transaction, these
receivables were purchased by Packaging from the financing subsidiary and
contributed to PCA. All purchase and sale transactions were consummated at fair
value, which was the same as the net book value of the receivables as reflected
on the Group's financial statements prior to the initial sale. Therefore, due to
the pending sale transaction, the amount of trade accounts receivable sold was
$0 at April 11, 1999.
INVENTORIES
Raw materials and finished goods are valued using the last-in, first-out
("LIFO") cost method and include material, labor and manufacturing-related
overhead costs. Supplies and materials inventories are valued using a moving
average cost. All inventories are stated at the lower of cost or market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Interest costs relating
to construction in progress are capitalized based upon the total amount of
interest cost (including interest costs on notes payable to Tenneco) incurred by
Packaging.
The amount of interest capitalized related to construction in progress at
the Group was approximately $19,000 for the period ended April 11, 1999.
Depreciation is computed on the straight-line basis over the estimated
useful lives of the related assets. The following useful lives are used for the
various categories of assets:
Buildings and land improvements.......................... 5 to 40 years
Machinery and equipment.................................. 3 to 25 years
Trucks and automobiles................................... 3 to 10 years
Furniture and fixtures................................... 3 to 20 years
Computers and software................................... 3 to 7 years
Leasehold improvements................................... Period of the lease
===================
F-29
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
Timber depletion is provided on the basis of timber cut during the period
related to the estimated quantity of recoverable timber. Assets under capital
leases are depreciated on the straight-line method over the term of the lease.
Expenditures for repairs and maintenance are expensed as incurred.
Long-lived assets to be held and used are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be fully recoverable. In the event that facts and circumstances indicate
that the carrying amount of any long-lived assets may be impaired, an evaluation
of recoverability would be performed. If an evaluation is required, the
estimated future undiscounted cash flows associated with the asset would be
compared to the asset's carrying amount to determine if a write-down to
discounted cash flows is required.
CHANGES IN ACCOUNTING PRINCIPLES
In June, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes new accounting
and reporting standards requiring that all derivative instruments (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement and requires
that a company must formally document, designate and assess the effectiveness of
transactions that receive hedge accounting. This statement is effective for all
fiscal years beginning after June 15, 2000. The adoption of this new standard is
not expected to have a significant effect on the Group's financial position or
results of operations.
In April, 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-5, "Reporting on the Costs of
Start-Up Activities," which requires costs of start-up activities to be expensed
as incurred. This statement is effective for fiscal years beginning after
December 15, 1998. The statement requires capitalized costs related to start-up
activities to be expensed as a cumulative effect of a change in accounting
principle when the statement is adopted. Tenneco adopted this new accounting
principle in the first quarter of 1999. The adoption of this new standard did
not have a significant effect on the Group's financial position or results of
operations.
In March, 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," which establishes new
accounting and reporting standards for the costs of computer software developed
or obtained for internal use. This statement will be applied prospectively and
is effective for fiscal years beginning after December 15, 1998. The adoption of
this new standard did not have a significant effect on the Group's financial
position or results of operations.
FREIGHT TRADES
The Group regularly trades containerboard with other manufacturers primarily
to reduce shipping costs. The freight trade transactions are accounted for
primarily as transactions in the inventory accounts; the impact on income is not
material.
F-30
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
ENVIRONMENTAL LIABILITIES
The estimated landfill closure and postclosure maintenance costs expected to
be incurred upon and subsequent to the closing of existing operating landfill
areas are accrued based on the landfill capacity used to date. Amounts are
estimates using current technologies for closure and monitoring and are not
discounted.
The potential costs related to the Group for various environmental matters
are uncertain due to such factors as the unknown magnitude of possible cleanup
costs, the complexity and evolving nature of governmental laws and regulations
and their interpretations, and the timing, varying costs and effectiveness of
alternative cleanup technologies. Liabilities recorded by the Group for
environmental contingencies are estimates of the probable costs based upon
available information and assumptions relating to the Group. Because of these
uncertainties, however, the Group's estimates may change. The Group believes
that any additional costs identified as further information becomes available
would not have a material effect on the combined statements of assets,
liabilities and interdivision account or revenues, expenses and interdivision
account of the Group.
COMBINED STATEMENTS OF CASH FLOWS
As a division of Packaging, the Group does not maintain separate cash
accounts other than for petty cash. The Group's disbursements for payroll,
capital projects, operating supplies and expenses are processed and funded by
Packaging through centrally managed accounts. In addition, cash receipts from
the collection of accounts receivable and the sales of assets are remitted
directly to bank accounts controlled by Packaging. In this type of centrally
managed cash system in which the cash receipts and disbursements of Packaging's
various divisions are commingled, it is not feasible to segregate cash received
from Packaging (e.g., as financing for the business) from cash transmitted to
Packaging (e.g., as a distribution). Accordingly, the net effect of these cash
transactions with Packaging are presented as a single line item within the
financing section of the cash flow statements. Similarly, the activity of the
interdivision account presents the net transfer of funds and charges between
Packaging and the Group as a single line item.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred. The amounts charged
were $1,015,000 from January 1, 1999, through April 11, 1999.
INTANGIBLE ASSETS
The Group has capitalized certain intangible assets, primarily trademarks
and patents, based on their estimated fair value at the date of acquisition.
Amortization is provided for these intangible assets on a straight-line basis
over periods ranging from 3 to 10 years. Covenants not to compete are amortized
on a straight-line basis over the terms of the respective agreements. Such
amortization amounted to $890,000 as of April 11, 1999.
Intangible assets to be held and used are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be fully recoverable. In the event that
F-31
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
facts and circumstances indicate that the carrying amount of any intangible
assets may be impaired, an evaluation of recoverability would be performed. If
an evaluation is required, the estimated future undiscounted cash flows through
the remaining amortization period associated with the asset would be compared to
the asset's carrying amount to determine if a write-down to discounted cash
flows is required.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent 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.
SEGMENT INFORMATION
The Group adopted SFAS No. 131, "Disclosure About Segments of an Enterprise
and Related Information," in 1998 and determined that the Group is primarily
engaged in one line of business: the manufacture and sale of packaging
materials, boxes and containers for industrial and consumer markets. No single
customer accounts for more than 10% of total revenues. The Group has no foreign
operations.
EARNINGS PER SHARE (UNAUDITED)
Earnings per share has been calculated using the historical earnings of the
Group and the number of shares resulting from the April 12, 1999 transaction
(430,000 common shares), as adjusted to reflect the anticipated 220-for-one
stock split. For the period presented, basic and diluted earnings per share are
the same because there are not potentially dilutive securities.
3. INVESTMENT IN JOINT VENTURE
The Group has a 50% U.S. joint venture with American Cellulose Corporation
to manufacture and market hardwood chips. The net investment, which was
accounted for under the equity method, was $1,388,000 as of April 11, 1999.
F-32
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
4. LONG-TERM DEBT
AS OF
APRIL 11, 1999
---------------
(IN THOUSANDS)
Senior subordinated notes, interest at 9.625%, payable
semiannually, due in 2009................................. $ 550,000
Senior credit facility--
Term loan A, interest at LIBOR plus 2.75%, due in varying
quarterly installments through 2005..................... 460,000
Term loan B, interest at LIBOR plus 3.25%, due in varying
quarterly installments through 2007..................... 375,000
Term loan C, interest at LIBOR plus 3.50%, due in varying
quarterly installments through 2008..................... 375,000
Other obligations........................................... 466
----------
Total................................................... 1,760,466
Less- Current portion....................................... 31,841
----------
Total long-term debt.................................... $1,728,625
==========
As of April 11, 1999, the annual payments for debt during the next five
years and thereafter are (in thousands): $31,841 (1999), $35,699 (2000), $67,570
(2001), $97,570 (2002), $107,536 (2003) and $1,420,250 (2004 and thereafter).
In February, 1999, Tenneco Inc. paid off the remaining note payable as it
relates to the Counce Limited Partnership. The payment was $27,220,000,
including a $10,456,000 premium payment (net of tax $6,327,000) for the early
extinguishment of debt.
Going-forward, PCA's various debt agreements require that it comply with
certain covenants and restrictions, including specific financial ratios that
must be maintained on the last day at the end of each fiscal quarter. Under the
provisions of the credit agreement dated April 12, 1999 ("Credit Agreement"),
PCA must maintain a consolidated interest coverage ratio of a minimum of 1.5
beginning on September 30, 1999, increasing per the guidelines set forth in the
Credit Agreement to 2.5 as of March 31, 2005, and each fiscal quarter
thereafter. Also, PCA must not exceed a leverage ratio of 6.75 at September 30,
1999, decreasing per the guidelines set forth in the Credit Agreement to 4.0 as
of March 31, 2006, and each fiscal quarter thereafter. Lastly, PCA must maintain
a minimum consolidated net worth beginning on June 30, 1999 of $315,000,000,
increasing per the guidelines set forth in the Credit Agreement to $690,000,000
as of March 31, 2008.
In May through October of 1999, PCA made voluntary prepayments totaling
approximately $322,100,000 using excess cash and proceeds from the sale of
certain timberlands to permanently reduce its borrowings under the term loans.
As a result of this prepayment, no payments will be required under any of the
term loans until December, 2001.
F-33
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
5. PENSION AND OTHER BENEFIT PLANS
Substantially all of the Group's salaried and hourly employees are covered
by retirement plans sponsored by Packaging and Tenneco. Benefits generally are
based on years of service and, for most salaried employees, on final average
compensation. Packaging's funding policies are to contribute to the plans, at a
minimum, amounts necessary to satisfy the funding requirements of federal laws
and regulations. The assets of the plans consist principally of listed equity
and fixed and variable income securities, including Tenneco Inc. common stock.
The Group's eligible salaried employees participate in the Tenneco Inc.
Retirement Plan (the "Retirement Plan"), a defined benefit plan, along with
other Tenneco divisions and subsidiaries. The pension expense allocated to the
Group by Packaging for this plan was approximately $1,696,000 for the period
ended April 11, 1999. Amounts allocated are principally determined based on
payroll. This plan is overfunded and a portion of the prepaid pension costs has
not been allocated to the Group.
The Group's eligible hourly employees participate in the Tenneco Packaging
Pension Plan for Certain Hourly-Rated Employees, also a defined benefit plan,
along with other Packaging divisions. As stated, due to the fact that other
divisions within Packaging participate in the plan, certain of the disclosures
required by SFAS No. 132, "Employers' Disclosures About Pension and Other
Postretirement Benefits, such as a summary of the change in benefit obligation
and the change in plan assets, are not available. Actuarial information as of
April 11, 1999 is not available and in connection with the sale of the Group as
described in Note 1 to these financial statements, the pension asset allocated
to the Group will be excluded from the sale transaction and remain with Tenneco.
As such, the actuarial information below is reported as of December 31, 1998.
The net pension income allocated to the Group for this plan was $213,000 for
the period ended April 11, 1999. This plan is overfunded, and a portion of the
related pension asset of $41,965,000 for April 11, 1999, has been allocated to
the Group and is included in Other Long-Term Assets.
Actuarially allocated net pension cost for the Group's defined benefit
plans, excluding the Retirement Plan, consists of the following components for
the year ended December 31, 1998 (in thousands):
Service cost--benefits earned during the year............... $ 3,112
Interest cost on projected benefit obligations.............. 6,990
Expected return on plan assets.............................. (11,312)
Amortization of--
Transition liability...................................... (164)
Unrecognized loss......................................... --
Prior service cost........................................ 908
--------
Net pension income...................................... $ (466)
========
F-34
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
5. PENSION AND OTHER BENEFIT PLANS (CONTINUED)
The funded status of the Group's allocation of defined benefit plans,
excluding the Retirement Plan, reconciles with amounts recognized in the 1998
statements of assets and liabilities and interdivision account as follows (in
thousands):
Actuarial present value at September 30, 1998--
Vested benefit obligation................................. $ (98,512)
Accumulated benefit obligation............................ (108,716)
=========
Projected benefit obligation................................ $(108,716)
Plan assets at fair value at September 30, 1998............. 146,579
Unrecognized transition liability........................... (1,092)
Unrecognized net gain....................................... (14,623)
Unrecognized prior service cost............................. 13,455
---------
Prepaid pension cost at December 31, 1998................... $ 35,603
=========
The weighted average discount rate used in determining the actuarial present
value of the benefit obligations was 7.00% for the year ended December 31, 1998.
The weighted average expected long-term rate of return on plan assets was 10%
for 1998.
Middle management employees participate in a variety of incentive
compensation plans. These plans provide for incentive payments based on the
achievement of certain targeted operating results and other specific business
goals. The targeted operating results are determined each year by senior
management of Packaging. The amounts charged to expense for these plans were
$1,599,000 for the period ended April 11, 1999.
In June, 1992, Tenneco initiated an Employee Stock Purchase Plan ("ESPP").
The plan allows U.S. and Canadian employees of the Group to purchase
Tenneco Inc. common stock through payroll deductions at a 15% discount. Each
year, an employee in the plan may purchase shares with a discounted value not to
exceed $21,250. The weighted average fair value of the employee purchase right,
which was estimated using the Black-Scholes option pricing model and the
assumptions described below except that the average life of each purchase right
was assumed to be 90 days, was $6.31 for the period ended December 31, 1998. The
ESPP was terminated as of September 30, 1996. Tenneco adopted a new employee
stock purchase plan effective April 1, 1997. Under the respective ESPPs, Tenneco
sold 36,883 shares to Group employees for the period ended April 11, 1999.
In December, 1996, Tenneco adopted the 1996 Stock Ownership Plan, which
permits the granting of a variety of awards, including common stock, restricted
stock, performance units, stock appreciation rights, and stock options to
officers and employees of Tenneco. Tenneco can issue up to 17,000,000 shares of
common stock under this plan, which will terminate December 31, 2001.
The April 11, 1999, fair market value of the options granted was calculated
using Tenneco's stock price at the grant date and multiplying the amount by the
historical percentage of past Black-Scholes pricing values fair value
(approximately 25%). The fair value of each stock option issued by Tenneco to
the Group in prior periods was estimated on the date of grant using the
Black-Sholes option pricing model using the following ranges of weighted average
assumptions for grants during the past three years: (a) risk-free
F-35
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
5. PENSION AND OTHER BENEFIT PLANS (CONTINUED)
interest rate ranging from 5.7% to 6.7%, (b) expected lives ranging from
5.0 years to 19.7 years, (c) expected volatility ranging from 24.6% to 27.8%,
and (d) dividend yields ranging from $10.91 to $13.99.
The Group applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," to its stock-based compensation plans. The Group
recognized after-tax stock-based compensation expense of approximately $146,000
for the period ended April 11, 1999. Had compensation costs for the Group's
stock-based compensation plans been determined in accordance with SFAS 123,
"Accounting for Stock-Based Compensation," based on the fair value at the grant
dates for the awards under those plans, the Group's pro forma net income for the
year ended April 11, 1999, would have been lower by $734,000.
6. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
In addition to providing pension benefits, the Group provides certain health
care and life insurance benefits for certain retired and terminated employees. A
substantial number of the Group's employees may become eligible for such
benefits if they reach normal retirement age while working for the Group. The
cost of these benefits for salaried employees is allocated to the Group by
Packaging through a payroll charge and the interdivision account. Amounts
allocated are principally determined based on payroll. The net obligation for
these salaried benefits is maintained by Packaging and is not included in the
liabilities section of the accompanying combined statements of assets,
liabilities and interdivision account for the Group's share of the obligation.
Currently, the Group's postretirement benefit plans are not funded and a
portion of the related postretirement obligation has been allocated to the
Group. However, due to the fact that other divisions participate in the plan,
certain of the disclosures required by SFAS No. 132, such as a summary of the
change in benefit obligation, are not available. Actuarial information as of
April 11, 1999, is not available and in connection with the sale of the Group as
described in Note 1 to these financial statements, the long-term portion of the
postretirement liability will not be assumed by PCA but will remain with
Tenneco. As such, the actuarial information below is reported as of
December 31, 1998, and the portion of the liability allocated as of April 11,
1999, is the same as the allocated amount as of December 31, 1998.
F-36
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
6. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS (CONTINUED)
The obligation of the plans, related to hourly employees, reconciles with
amounts recognized in the combined statements of assets, liabilities and
interdivision account at December 31, 1998, and April 11, 1999, as follows (in
thousands):
Actuarial present value at September 30--
Accumulated postretirement benefit obligation--
Retirees and beneficiaries.............................. $ (8,401)
Fully eligible active plan participants................. (3,582)
Other active plan participants.......................... (2,950)
--------
Total................................................. (14,933)
Plan assets at fair value at September 30................. --
Funded status............................................. (14,933)
Claims paid during the fourth quarter..................... 473
Unrecognized prior service cost........................... --
Unrecognized net gain..................................... (1,764)
--------
Accrued postretirement benefit cost at December 31.......... $(16,224)
========
The net periodic postretirement benefit costs as determined by actuaries for
hourly employees for 1998 consist of the following components (in thousands):
Service cost................................................ $ 159
Interest cost............................................... 1,024
Amortization of net (gain) loss............................. (138)
Amortization of prior service cost.......................... (293)
------
Net periodic postretirement benefit cost.................. $ 752
======
The amounts expensed by the Group may be different because it was allocated
by Packaging.
The weighted average assumed health care cost trend rate used in determining
the 1998 accumulated postretirement benefit obligation was 5%.
Increasing the assumed health care cost trend rate by one percentage point
would increase the accumulated postretirement benefit obligation as of
September 30, 1998, by approximately $1,268,000, and would increase the net
postretirement benefit cost for 1998 by approximately $130,000.
The discount rate (which is based on long-term market rates) used in
determining the accumulated postretirement benefit obligation was 7% for 1998.
F-37
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
7. INVENTORIES
The components of inventories as of April 11, 1999, are as follows (in
thousands):
Raw materials............................................... $ 87,159
Work in process and finished goods.......................... 22,419
Materials and supplies...................................... 48,655
--------
$158,233
========
The amount by which current FIFO cost exceeded the stated LIFO inventory was
$22,588,000 as of April 11, 1999.
8. RESTRUCTURING AND OTHER CHARGES
In the fourth quarter of 1998, the Group recorded a pretax restructuring
charge of approximately $14 million. This charge was recorded following the
approval by Tenneco's Board of Directors of a comprehensive restructuring plan
for all of Tenneco's operations, including those of the Group. In connection
with this restructuring plan, the Group will close four corrugated facilities
and eliminate 109 positions.
The following table reflects components of this charge (in thousands):
BALANCE, BALANCE,
DECEMBER 31, INTERIM APRIL 11,
COMPONENT 1998 ACTIVITY 1999
- --------- ------------- -------- ----------
Cash charges--
Severance.................................... $4,283 $1,290 $2,993
Facility exit costs and other................ 3,447 748 2,699
------ ------ ------
Total cash charges......................... 7,730 2,038 5,692
Noncash charges--
Asset impairments............................ 1,596 1,510 86
------ ------ ------
$9,326 $3,548 $5,778
====== ====== ======
Asset impairments are comprised mainly of goodwill totaling approximately
$1,510,000 related to two of the facilities. The fixed assets at the closed
facilities were written down to their estimated fair value. No significant cash
proceeds are expected from the ultimate disposal of these assets. Of the
$5,692,000 remaining cash charges at April 11, 1999, approximately $4,514,000 is
expected to be spent in 1999. The actions contemplated by the restructuring plan
should be substantially completed during 1999.
9. IMPAIRMENT LOSS
As a result of the sale transaction (Note 1), Tenneco recognized a pretax
loss in the first quarter of 1999 of approximately $293 million. Part of that
loss consisted of an impairment charge relating to the Group's property, plant
and equipment and intangible assets, which was pushed down to the accompanying
combined financial statements. The amount of the impairment charge was
approximately $230.1 million.
F-38
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
9. IMPAIRMENT LOSS (CONTINUED)
The impairment charge of $230.1 million has been allocated to the following
financial statement line items (in thousands):
Intangibles................................................. $ 46,206
Machinery and equipment..................................... 183,906
--------
Total..................................................... $230,112
========
The impairment charge will first be applied against the goodwill
specifically attributable to the containerboard assets and the remaining amount
will be applied against plant, property and equipment.
10. INCOME TAXES
The Group's method of accounting for income taxes requires that a deferred
tax be recorded to reflect the tax expense (benefit) resulting from the
recognition of temporary differences. Temporary differences are differences
between the tax basis of assets and liabilities and their reported amounts in
the financial statements that will result in differences between income for tax
purposes and income for financial statement purposes in future years.
As a division, this Group is not a taxable entity. For purposes of these
combined financial statements, income taxes have been allocated to the Group and
represent liabilities to Packaging.
Following is an analysis of the components of combined income tax benefit
through April 11, 1999 (in thousands):
Current--
U.S....................................................... $82,867
State and local........................................... 10,630
-------
93,497
-------
Deferred--
U.S....................................................... (8,670)
State and local........................................... (1,111)
-------
(9,781)
-------
Income tax benefit...................................... $83,716
=======
The primary difference between income taxes computed at the statutory U.S.
federal income tax rate and the income tax benefit in the combined statement of
revenues, expenses and interdivision account is due to the effect of state
income taxes.
F-39
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
10. INCOME TAXES (CONTINUED)
The components of the deferred tax assets (liabilities) at April 11, 1999,
were as follows (in thousands):
Current deferred taxes--
Accrued liabilities....................................... $ 10,232
Employee benefits and compensation........................ (6,314)
Reserve for doubtful accounts............................. 1,148
Inventory................................................. 829
Pensions and postretirement benefits...................... (3,154)
State deferred tax........................................ 10,695
Other..................................................... (75)
---------
Total current deferred taxes.......................... 13,361
---------
Noncurrent deferred taxes--
Pension and postretirement benefits....................... 13,945
Excess of financial reporting over tax basis in plant and
equipment............................................... (302,029)
Accrued liabilities....................................... 1,130
Capital leases............................................ 9,333
Other..................................................... 13,685
---------
Total noncurrent deferred taxes....................... (263,936)
---------
Net deferred tax liabilities.......................... $(250,575)
=========
11. ASSETS, LIABILITIES AND OTHER EXPENSE, NET DETAIL
PREPAID EXPENSES AND OTHER CURRENT ASSETS
The components of prepaid expenses and other current assets include (in
thousands):
Prepaid stumpage............................................ $13,877
Deferred taxes.............................................. 13,361
Prepaid professional services............................... 2,392
Other....................................................... 3,320
-------
Total................................................... $32,950
=======
F-40
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
11. ASSETS, LIABILITIES AND OTHER EXPENSE, NET DETAIL (CONTINUED)
OTHER LONG-TERM ASSETS
The components of the other long-term assets include (in thousands):
Prepaid pension cost........................................ $41,965
Deferred software........................................... 12,556
Timberland rights........................................... 11,739
Other....................................................... 1,385
-------
Total................................................... $67,645
=======
ACCRUED LIABILITIES
The components of accrued liabilities include (in thousands):
Accrued payroll, vacation and taxes......................... $29,608
Accrued insurance........................................... 11,618
Accrued volume discounts and rebates........................ 5,414
Restructuring............................................... 5,778
Current portion of accrued postretirement benefit cost...... 1,460
Shutdown reserve............................................ 988
Other....................................................... 9,505
-------
Total................................................... $64,371
=======
OTHER LONG-TERM LIABILITIES
The components of the other long-term liabilities include (in thousands):
Accrued postretirement benefit cost......................... $14,764
Environmental liabilities................................... 7,034
Other....................................................... 2,119
-------
Total................................................... $23,917
=======
OTHER EXPENSE, NET
The components of other expense, net include (in thousands):
Discount on sale of factored receivables.................... $(2,369)
Other....................................................... 162
-------
Total................................................... $(2,207)
=======
F-41
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
12. RELATED-PARTY TRANSACTIONS
FUNDING OF CASH REQUIREMENTS
As discussed in Note 2, Packaging provides centralized treasury functions
and financing for the Group including funding of its cash requirements for
processing of accounts payable and payroll requirements.
CORPORATE ALLOCATIONS
Packaging and Tenneco provide various services to the Group, including
legal, human resources, data processing systems support, training, finance and
treasury, public relations and insurance management. These expenses are
allocated based on a combination of factors such as actual usage of the service
provided, revenues, gross salaries and fixed assets and may not reflect actual
costs the Group would incur if it were a stand-alone entity.
Certain receivables and transactions resulting from the financing
relationship between Packaging and Tenneco are not reflected in the accompanying
financial statements.
INSURANCE AND BENEFITS
The Group is self-insured for medical benefits and workers' compensation.
Expenses related to workers' compensation, health care claims for hourly and
salaried workers and postretirement health care benefits for hourly and salaried
workers are determined by Packaging and are allocated to the Group. The Group
incurred charges of $9,337,000 for health care and $1,801,000 for workers'
compensation for the period ended April 11, 1999.
In general, all costs and expenses incurred and allocated are based on the
relationship the Group has with Tenneco. If the Group had been a stand-alone
entity, the costs and expenses would differ.
13. COMMITMENTS AND CONTINGENCIES
The Group had authorized capital expenditures of approximately $55,358,000
as of April 11, 1999, in connection with the expansion and replacement of
existing facilities.
The Group is involved in various legal proceedings and litigation arising in
the ordinary course of business. In the opinion of management and in-house legal
counsel, the outcome of such proceedings and litigation will not materially
affect the Group's financial position or results of operations.
14. LEASES
Rental expense included in the accompanying combined financial statements
was $25,411,000 for the period ended April 11, 1999. These costs are primarily
included in cost of goods sold.
As a result of the sale of the Group, Packaging received total consideration
of $2.2 billion, which includes the $1.1 billion used to buy out certain timber
and mill operating leases prior and concurrent to
F-42
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
14. LEASES (CONTINUED)
the sale transaction on April 12, 1999. Therefore, the remaining outstanding
aggregate minimum rental commitments under noncancelable operating leases are as
follows (in thousands):
Remainder of 1999........................................... $ 7,606
2000........................................................ 7,583
2001........................................................ 4,891
2002........................................................ 3,054
2003........................................................ 1,415
Thereafter.................................................. 1,178
-------
Total................................................... $25,727
=======
15. SALE OF ASSETS
In the second quarter of 1996, Packaging entered into an agreement to
form a joint venture with Caraustar Industries whereby Packaging sold its two
recycled paperboard mills and a fiber recycling operation and brokerage business
to the joint venture in return for cash and a 20% equity interest in the joint
venture. Proceeds from the sale were approximately $115 million and the Group
recognized a $50 million pretax gain ($30 million after taxes) in the second
quarter of 1996.
In June, 1998, Packaging sold its remaining 20% equity interest in the joint
venture to Caraustar Industries for cash and a note of $26,000,000. The Group
recognized a $15 million pretax gain on this transaction. At April 11, 1999, the
balance of the note with accrued interest is $27,122,000. The note was paid in
June, 1999.
16. SUBSEQUENT EVENTS
On August 25, 1999, PCA and Packaging agreed that the acquisition
consideration should be reduced as a result of a postclosing price adjustment by
an amount equal to $20 million plus interest through the date of payment by
Packaging. The Group recorded $11.9 million of this amount as part of the
impairment charge on the accompanying financial statements, representing the
amount that was previously estimated by Packaging. PCA intends to record the
remaining amount in September, 1999.
In August, 1999, PCA signed purchase and sales agreements with various
buyers to sell approximately 405,000 acres of timberland. PCA has completed the
sale of approximately 260,000 of these acres and expects to complete the sale of
the remaining acres by mid-November, 1999.
F-43
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Tenneco Inc.:
We have audited the accompanying combined statements of assets, liabilities
and interdivision account of THE CONTAINERBOARD GROUP (a division of Tenneco
Packaging Inc., which is a Delaware corporation and a wholly owned subsidiary of
Tenneco Inc.) as of December 31, 1998, 1997 and 1996, and the related combined
statements of revenues, expenses and interdivision account and cash flows for
the years then ended. These financial statements are the responsibility of the
Group's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the combined financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the combined financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall combined
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of The Containerboard
Group as of December 31, 1998, 1997 and 1996, and the results of its operations
and its cash flows for the years then ended in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 26, 1999
F-44
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
COMBINED STATEMENTS OF
ASSETS, LIABILITIES AND INTERDIVISION ACCOUNT
DECEMBER 31,
------------------------------------
1998 1997 1996
---------- ---------- ----------
ASSETS
(IN THOUSANDS)
Current assets:
Cash...................................................... $ 1 $ 1 $ 1,027
Accounts receivable (net of allowance for doubtful
accounts of $5,220 in 1998, $5,023 in 1997 and $5,010 in
1996)................................................... 13,971 27,080 16,982
Receivables from affiliated companies..................... 10,390 19,057 10,303
Notes receivable.......................................... 27,390 573 547
Inventories:
Raw materials............................................. 86,681 100,781 99,459
Work in process and finished goods........................ 48,212 38,402 36,995
Materials and supplies.................................... 44,310 42,043 35,834
---------- ---------- ----------
Inventory, gross...................................... 179,203 181,226 172,288
Excess of FIFO over LIFO cost............................. (28,484) (25,445) (28,308)
---------- ---------- ----------
Inventory, net........................................ 150,719 155,781 143,980
---------- ---------- ----------
Prepaid expenses and other current assets................. 41,092 35,019 35,536
---------- ---------- ----------
Total current assets.................................. 243,563 237,511 208,375
---------- ---------- ----------
Property, plant and equipment, at cost:
Land, timber, timberlands and buildings................... 287,510 280,060 269,134
Machinery and equipment................................... 1,289,459 1,175,805 1,082,912
Other, including construction in progress................. 100,136 130,696 140,522
Less-Accumulated depreciation and depletion............... (735,749) (656,915) (582,437)
---------- ---------- ----------
Property, plant and equipment, net.................... 941,356 929,646 910,131
---------- ---------- ----------
Intangibles................................................. 50,110 56,470 55,660
---------- ---------- ----------
Other long-term assets...................................... 131,092 77,312 72,076
---------- ---------- ----------
Investments................................................. 1,282 16,324 14,809
---------- ---------- ----------
Total assets................................................ $1,367,403 $1,317,263 $1,261,051
========== ========== ==========
LIABILITIES AND INTERDIVISION ACCOUNT
Current liabilities:
Accounts payable.......................................... $ 87,054 $ 124,633 $ 111,588
Payables to Tenneco affiliates............................ 7,091 6,164 29,402
Current portion of long-term debt......................... 617 3,923 1,603
Current portion of deferred gain.......................... -- 1,973 1,973
Accrued liabilities....................................... 69,390 70,426 166,663
---------- ---------- ----------
Total current liabilities............................. 164,152 207,119 311,229
---------- ---------- ----------
Long-term liabilities:
Long-term debt............................................ 16,935 23,941 18,713
Deferred taxes............................................ 254,064 174,127 87,165
Deferred gain............................................. - 34,262 36,235
Other..................................................... 23,860 23,754 23,287
---------- ---------- ----------
Total long-term liabilities........................... 294,859 256,084 165,400
---------- ---------- ----------
Interdivision account....................................... 908,392 854,060 784,422
---------- ---------- ----------
Total liabilities and interdivision account................. $1,367,403 $1,317,263 $1,261,051
========== ========== ==========
The accompanying notes to combined financial statements
are an integral part of these statements.
F-45
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
COMBINED STATEMENTS OF
REVENUES, EXPENSES AND INTERDIVISION ACCOUNT
YEAR ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
----------- ----------- ------------
(IN THOUSANDS)
Net sales............................................. $ 1,571,019 $ 1,411,405 $ 1,582,222
Cost of sales......................................... (1,289,644) (1,242,014) (1,337,410)
----------- ----------- ------------
Gross profit........................................ 281,375 169,391 244,812
Selling and administrative expenses................... (108,944) (102,891) (95,283)
Restructuring, impairment and other................... (14,385) -- --
Other income, net..................................... 26,818 44,681 56,243
Corporate allocations................................. (63,114) (61,338) (50,461)
----------- ----------- ------------
Income before interest, and taxes................... 121,750 49,843 155,311
Interest expense, net................................. (2,782) (3,739) (5,129)
----------- ----------- ------------
Income before taxes................................. 118,968 46,104 150,182
Provision for income taxes............................ (47,529) (18,714) (59,816)
----------- ----------- ------------
Net income............................................ 71,439 27,390 90,366
Interdivision account, beginning of period............ 854,060 784,422 640,483
Interdivision account activity, net................... (17,107) 42,248 53,573
----------- ----------- ------------
Interdivision account, end of period.................. $ 908,392 $ 854,060 $ 784,422
=========== =========== ============
Basic and diluted earnings per share (unaudited):
Net income per common share......................... .76 .29 .96
=========== =========== ============
Weighted average common shares outstanding.......... 94,600 94,600 94,600
The accompanying notes to combined financial statements
are an integral part of these statements.
F-46
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
COMBINED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
Cash flows from operating activities:
Net income................................................ $ 71,439 $ 27,390 $ 90,366
--------- --------- ---------
Adjustments to reconcile net income to net cash provided
by operating activities--
Depreciation, depletion and amortization................ 96,950 87,752 78,730
Extraordinary loss-early debt extinguishment............
Restructuring and other................................. 14,385 -- --
Gain on sale of joint venture interest.................. (15,060) -- --
Gain on sale of timberlands............................. (16,944) -- --
Gain on sale of assets.................................. -- -- (51,268)
Gain on lease refinancing............................... -- (37,730) --
Gain on Willow Flowage.................................. -- (4,449) --
Gain on sale of mineral rights.......................... -- (1,646) --
Amortization of deferred gain........................... (1,973) (1,973) (1,973)
Increase (decrease) in deferred income taxes............ 71,342 85,070 8,318
Undistributed earnings of affiliated companies.......... 302 (2,264) (536)
Increase (decrease) in other noncurrent reserves........ 107 467 (27,287)
Changes in noncash components of working capital,
excluding transactions with Tenneco
Decrease (increase) in current assets--
Accounts receivable................................. 12,100 (26,092) 38,261
Inventories, net.................................... 5,062 (10,932) 1,287
Prepaid expenses and other.......................... 4,572 782 (8,070)
(Decrease) increase in current liabilities--
Accounts payable.................................... (37,580) 13,045 (47,930)
Accrued liabilities................................. (9,301) (22,207) (24,041)
--------- --------- ---------
Net cash provided by operating activities......... 195,401 107,213 55,857
--------- --------- ---------
Cash flows from investing activities:
Additions to property, plant and equipment................ (103,429) (110,186) (168,642)
Prepaid Meridian Lease.................................... (84,198) -- --
Acquisition of businesses................................. -- (5,866) --
Other long-term assets.................................... (10,970) (6,983) (23,478)
Proceeds from disposals................................... 26,214 10,460 122,654
Other transactions, net................................... (5,350) 690 (4,766)
--------- --------- ---------
Net cash used for investing activities............ (177,733) (111,885) (74,232)
--------- --------- ---------
F-47
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
COMBINED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
-------- -------- ---------
(IN THOUSANDS)
Cash flows from financing activities:
Proceeds from long-term debt issued....................... $ -- $ 1,146 $ 430
Payments on long-term debt................................ (10,346) (1,618) (1,886)
(Decrease) increase in interdivision account.............. (17,109) 19,907 168,074
Working capital transactions with Tenneco and affiliated
companies--
Decrease (increase) in receivables from affiliated
companies............................................. 8,667 (8,754) (1,781)
Decrease (increase) in factored receivables............. 192 16,204 (25,563)
Increase (decrease) in accounts payable to affiliated
companies............................................. 928 (23,239) (8,007)
Dividends paid to Tenneco............................... -- -- (114,500)
-------- -------- ---------
Net cash (used for) provided by financing
activities.......................................... (17,668) 3,646 16,767
-------- -------- ---------
Net decrease in cash........................................ -- (1,026) (1,608)
Cash, beginning of period................................... 1 1,027 2,635
-------- -------- ---------
Cash, end of period......................................... $ 1 $ 1 $ 1,027
======== ======== =========
The accompanying notes to combined financial statements
are an integral part of these statements.
F-48
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
1. BUSINESS DESCRIPTION
The Containerboard Group (the "Group") is a division of Tenneco
Packaging Inc. ("Packaging") which is a wholly owned subsidiary of Tenneco Inc.
("Tenneco"). The Group is comprised of mills and corrugated products operations.
The Mill operations ("The Mills") consist of two Kraft linerboard mills
located in Counce, Tennessee, and Valdosta, Georgia, and two medium mills
located in Filer City, Michigan, and Tomahawk, Wisconsin. The Mills also include
two recycling centers located in Nashville, Tennessee, and Jackson, Tennessee.
The Mills also control and manage approximately 950,000 acres of timberlands.
The Mills transfer the majority of their output to The Corrugated Products
operations ("Corrugated").
Corrugated operations consist of 39 corrugated combining plants, 28
specialty/sheet and other plants and 5 design centers. All plants are located in
North America. Corrugated combines linerboard and medium (primarily from The
Mills) into sheets that are converted into corrugated shipping containers,
point-of-sale graphics packaging, point-of-purchase displays and other
specialized packaging. Corrugated sells to diverse customers primarily in North
America.
The Group's sales to other Packaging entities and other Tenneco entities are
included in the accompanying combined financial statements. The net sales to
other Packaging entities for the years ended December 31, 1998, 1997 and 1996,
were approximately $76,906,000, $69,981,000 and $76,745,000, respectively. The
net sales to other Tenneco entities for the years ended December 31, 1998, 1997
and 1996, were approximately $14,251,000, $13,108,000 and $10,376,000,
respectively. The profit relating to these sales are included in the
accompanying combined financial statements.
As a result of the Group's relationship with Packaging, the combined
statements of assets, liabilities and interdivision account and the related
combined statements of revenues, expenses and interdivision account are not
necessarily indicative of what actually would have occurred had the Group been a
stand-alone entity. Additionally, these combined financial statements are not
necessarily indicative of the future financial position or results of operations
of the Group.
2. SUMMARY OF ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying combined financial statements include the selected assets,
liabilities, revenues and expenses of the Group. All significant intragroup
accounts and transactions have been eliminated.
REVENUE RECOGNITION
The Group recognizes revenue as products are shipped to customers.
ACCOUNTS RECEIVABLE
A substantial portion of the Group's trade accounts receivable are sold by
Packaging, generally without recourse, to a financing subsidiary of
Tenneco Inc. Expenses relating to cash discounts, credit losses, pricing
adjustments and other allowances on these factored receivables are accrued and
charged to
F-49
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
the Group. The amount of trade accounts receivable sold was approximately
$150,099,000, $149,907,000 and $133,703,000 at December 31, 1998, 1997 and 1996,
respectively.
INVENTORIES
Inventories for raw materials and finished goods are valued using the
last-in, first-out ("LIFO") cost method and include material, labor and
manufacturing-related overhead costs. Supplies and materials inventories are
valued using a moving average cost. All inventories are stated at the lower of
cost or market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Interest costs relating
to construction in progress are capitalized based upon the total amount of
interest cost (including interest costs on notes payable to Tenneco) incurred by
Packaging.
The amount of interest capitalized related to construction in progress at
the Group was approximately $576,000, $975,000 and $5,207,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
Depreciation is computed on the straight-line basis over the estimated
useful lives of the related assets. The following useful lives are used for the
various categories of assets:
Buildings and land improvements...................... 5 to 40 years
Machinery and equipment.............................. 3 to 25 years
Trucks and automobiles............................... 3 to 10 years
Furniture and fixtures............................... 3 to 20 years
Computers and software............................... 3 to 7 years
Leasehold improvements............................... Period of the lease
===================
Timber depletion is provided on the basis of timber cut during the period
related to the estimated quantity of recoverable timber. Assets under capital
leases are depreciated on the straight-line method over the term of the lease.
Expenditures for repairs and maintenance are expensed as incurred.
Long-lived assets to be held and used are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be fully recoverable. In the event that facts and circumstances indicate
that the carrying amount of any long-lived assets may be impaired, an evaluation
of recoverability would be performed. If an evaluation is required, the
estimated future undiscounted cash flows associated with the asset would be
compared to the asset's carrying amount to determine if a write-down to
discounted cash flows is required.
F-50
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
DEFERRED GAIN
In 1992, Packaging entered into a sale-leaseback transaction for financial
reporting purposes involving certain of its timberlands. The deferred gain
recognized upon sale is being amortized on a straight-line basis over the
initial lease term.
This deferred gain relates to a lease which was prepaid by the Group in
December, 1998 (Note 12). The 1998 financial statements have reclassed the
current and long-term portions of the deferred gain against the prepaid payment
in Prepaid Expenses and Other Current Assets and Other Long-Term Assets.
CHANGES IN ACCOUNTING PRINCIPLES
In June, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes new accounting
and reporting standards requiring that all derivative instruments (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
statement requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement and requires
that a company must formally document, designate and assess the effectiveness of
transactions that receive hedge accounting. This statement is effective for all
fiscal years beginning after June 15, 1999. The adoption of this new standard is
not expected to have a significant effect on the Group's financial position or
results of operations.
In April, 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-5, "Reporting on the Costs of
Start-Up Activities," which requires costs of start-up activities to be expensed
as incurred. This statement is effective for fiscal years beginning after
December 15, 1998. The statement requires capitalized costs related to start-up
activities to be expensed as a cumulative effect of a change in accounting
principle when the statement is adopted. Tenneco currently expects to adopt this
new accounting principle in the first quarter of 1999. The adoption of this new
standard is not expected to have a significant effect on the Group's financial
position or results of operations.
In March, 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," which establishes new
accounting and reporting standards for the costs of computer software developed
or obtained for internal use. This statement will be applied prospectively and
is effective for fiscal years beginning after December 15, 1998. The adoption of
this new standard is not expected to have a significant effect on the Group's
financial position or results of operations.
FREIGHT TRADES
The Group regularly trades containerboard with other manufacturers primarily
to reduce shipping costs. The freight trade transactions are accounted for
primarily as transactions in the inventory accounts; the impact on income is not
material.
F-51
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
ENVIRONMENTAL LIABILITIES
The estimated landfill closure and postclosure maintenance costs expected to
be incurred upon and subsequent to the closing of existing operating landfill
areas are accrued based on the landfill capacity used to date. Amounts are
estimates using current technologies for closure and monitoring and are not
discounted.
The potential costs related to the Group for various environmental matters
are uncertain due to such factors as the unknown magnitude of possible cleanup
costs, the complexity and evolving nature of governmental laws and regulations
and their interpretations, and the timing, varying costs and effectiveness of
alternative cleanup technologies. Liabilities recorded by the Group for
environmental contingencies are estimates of the probable costs based upon
available information and assumptions relating to the Group. Because of these
uncertainties, however, the Group's estimates may change. The Group believes
that any additional costs identified as further information becomes available
would not have a material effect on the combined statements of assets,
liabilities and interdivision account or revenues, expenses and interdivision
account of the Group.
COMBINED STATEMENTS OF CASH FLOWS
As a division of Packaging, the Group does not maintain separate cash
accounts other than for petty cash. The Group's disbursements for payroll,
capital projects, operating supplies and expenses are processed and funded by
Packaging through centrally managed accounts. In addition, cash receipts from
the collection of accounts receivable and the sales of assets are remitted
directly to bank accounts controlled by Packaging. In this type of centrally
managed cash system in which the cash receipts and disbursements of Packaging's
various divisions are commingled, it is not feasible to segregate cash received
from Packaging (e.g., as financing for the business) from cash transmitted to
Packaging (e.g., as a distribution). Accordingly, the net effect of these cash
transactions with Packaging are presented as a single line item within the
financing section of the cash flow statements. Similarly, the activity of the
interdivision account presents the net transfer of funds and charges between
Packaging and the Group as a single line item.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred. The amounts charged
were $3,728,000, $4,345,000 and $4,789,000 in 1998, 1997 and 1996, respectively.
F-52
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
INTANGIBLE ASSETS
Goodwill and intangibles, net of amortization, by major category are as
follows:
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Goodwill..................................... $48,046 $52,958 $51,721
Intangibles.................................. 2,064 3,512 3,939
------- ------- -------
$50,110 $56,470 $55,660
======= ======= =======
Goodwill is being amortized on a straight-line basis over 40 years. Such
amortization amounted to $1,449,000, $1,452,000 and $1,440,000 for 1998, 1997
and 1996, respectively. Goodwill totaling approximately $3,463,000 was written
off in 1998 related to a closed facility (Note 7).
The Group has capitalized certain intangible assets, primarily trademarks
and patents, based on their estimated fair value at the date of acquisition.
Amortization is provided for these intangible assets on a straight-line basis
over periods ranging from 3 to 10 years. Covenants not to compete are amortized
on a straight-line basis over the terms of the respective agreements. Such
amortization amounted to $1,127,000, $1,234,000 and $1,416,000 in 1998, 1997 and
1996, respectively.
Intangible assets to be held and used are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be fully recoverable. In the event that facts and circumstances indicate
that the carrying amount of any intangible assets may be impaired, an evaluation
of recoverability would be performed. If an evaluation is required, the
estimated future undiscounted cash flows through the remaining amortization
period associated with the asset would be compared to the asset's carrying
amount to determine if a write-down to discounted cash flows is required.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent 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.
RECLASSIFICATIONS
The prior years' financial statements have been reclassified, where
appropriate, to conform to the 1998 presentation.
SEGMENT INFORMATION
The Group adopted SFAS No. 131, "Disclosure About Segments of an Enterprise
and Related Information," in 1998 and determined that the Group is primarily
engaged in one line of business: the manufacture and sale of packaging
materials, boxes and containers for industrial and consumer markets. No single
customer accounts for more than 10% of total revenues. The Group has no foreign
operations.
F-53
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER SHARE (UNAUDITED)
Earnings per share has been calculated using the historical earnings of the
Group and the number of common shares resulting from the April 12, 1999
transaction (430,000 common shares), as adjusted to reflect the anticipated
220-for-one stock split. For all periods presented, basic and diluted earnings
per share are the same because there are no potentially dilutive other
securities.
3. INVESTMENTS IN JOINT VENTURES
The Group has a 50% U.S. joint venture with American Cellulose Corporation
to manufacture and market hardwood chips. The net investment, which was
accounted for under the equity method, was $1,282,000, $1,310,000 and $1,519,000
as of December 31, 1998, 1997 and 1996, respectively. In the second quarter of
1996, Packaging entered into an agreement to form a joint venture with Caraustar
Industries whereby Packaging sold its two recycled paperboard mills and a fiber
recycling operation and brokerage business to the joint venture in return for
approximately $115 million and a 20% equity interest in the joint venture. In
June, 1998, Packaging sold its remaining 20% equity interest in the joint
venture to Caraustar Industries. The net investment, which was accounted for
under the equity method, was $0, $15,014,000 and $13,290,000 as of December 31,
1998, 1997 and 1996, respectively.
4. LONG-TERM DEBT AND CAPITALIZED LEASE OBLIGATIONS
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Capital lease obligations, interest at 8.5% for 1998 and
1997 and a weighted average interest rate of 8.2% for 1996
due in varying amounts through 2000....................... $ 18 $ 32 $18,658
Non-interest-bearing note, due in annual installments of
$70,000 through July 1, 2004, net of discount imputed at
10.0% of $182,000, $216,000 and $249,000 in 1998, 1997 and
1996, respectively........................................ 308 344 381
Notes payable, interest at an average rate of 13.5%, 13.3%
and 8.8% for 1998, 1997 and 1996, respectively, with
varying amounts due through 2010.......................... 16,553 26,187 680
Other obligations........................................... 673 1,301 597
------- ------- -------
Total................................................. 17,552 27,864 20,316
Less--Current portion....................................... 617 3,923 1,603
------- ------- -------
Total long-term debt.................................. $16,935 $23,941 $18,713
======= ======= =======
In January, 1997, the General Electric Capital Corporation ("GECC")
operating leases were refinanced. Through this refinancing, several capital
lease obligations were extinguished as the assets were incorporated into the new
operating lease (Note 12).
F-54
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
4. LONG-TERM DEBT AND CAPITALIZED LEASE OBLIGATIONS (CONTINUED)
Annual payments for debt during the next five years and thereafter are:
$617,000 (1999), $214,000 (2000), $3,569,000 (2001), $4,387,000 (2002),
$4,240,000 (2003) and $4,525,000 (2004 and thereafter).
In 1997, Tenneco contributed the Counce Limited Partnership to Packaging
which included notes payable totaling approximately $26,187,000.
In February, 1999, Tenneco Inc. paid off the remaining note payable as it
relates to the Counce Limited Partnership. The payment was $27,220,000,
including a $10,456,000 premium payment for the early extinguishment of debt.
5. PENSION AND OTHER BENEFIT PLANS
Substantially all of the Group's salaried and hourly employees are covered
by retirement plans sponsored by Packaging and Tenneco. Benefits generally are
based on years of service and, for most salaried employees, on final average
compensation. Packaging's funding policies are to contribute to the plans, at a
minimum, amounts necessary to satisfy the funding requirements of federal laws
and regulations. The assets of the plans consist principally of listed equity
and fixed and variable income securities, including Tenneco Inc. common stock.
The Group's eligible salaried employees participate in the Tenneco
Retirement Plan (the "Retirement Plan"), a defined benefit plan, along with
other Tenneco divisions and subsidiaries. The pension expense allocated to the
Group by Packaging for this plan was approximately $5,595,000, $3,197,000 and
$3,111,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
Amounts allocated are principally determined based on payroll. This plan is
overfunded and a portion of the prepaid pension costs has not been allocated to
the Group.
The Group's eligible hourly employees participate in the Tenneco Packaging
Pension Plan for Certain Hourly Rated Employees, also a defined benefit plan,
along with other Packaging divisions. As stated, due to the fact that other
divisions within Packaging participate in the plan, certain of the disclosures
required by SFAS No. 132, "Employers' Disclosures About Pension and Other
Postretirement Benefits", such as a summary of the change in benefit obligation
and the change in plan assets, are not available. The net pension (income) cost
actuarially allocated to the Group for this plan was $(466,000), $144,000 and
$2,373,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
This plan is overfunded, and a portion of the related pension asset of
$35,603,000, $35,137,000 and $34,429,000 for December 31, 1998, 1997 and 1996,
respectively, has been actuarially allocated to the Group and is included in
Other Long-Term Assets.
However, in connection with the pending sale of the Group as described in
Note 14 to these financial statements, the pension asset allocated to the Group
will be excluded from the sale transaction and remain with Tenneco.
F-55
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
5. PENSION AND OTHER BENEFIT PLANS (CONTINUED)
Actuarially allocated net pension cost for the Group's defined benefit
plans, excluding the Retirement Plan, consists of the following components:
FOR THE YEARS ENDED DECEMBER 31
---------------------------------
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
Service cost-benefits earned during the year................ $ 3,112 $ 3,652 $ 4,021
Interest cost on projected benefit obligations.............. 6,990 6,675 6,174
Expected return on plan assets.............................. (11,312) (10,819) (8,389)
Amortization of-
Transition liability...................................... (164) (164) (164)
Unrecognized loss......................................... -- -- 10
Prior service cost........................................ 908 800 721
-------- -------- -------
Net pension (income) cost............................. $ (466) $ 144 $ 2,373
======== ======== =======
The funded status of the Group's allocation of defined benefit plans,
excluding the Retirement Plan, reconciles with amounts recognized in the
statements of assets and liabilities and interdivision account as follows:
1998 1997 1996
--------- -------- --------
(IN THOUSANDS)
Actuarial present value at September 30--
Vested benefit obligation.............................. $ (98,512) $(86,865) $(79,818)
Accumulated benefit obligation......................... (108,716) (95,711) (87,481)
========= ======== ========
Projected benefit obligation............................. $(108,716) $(96,118) $(88,555)
Plan assets at fair value at September 30................ 146,579 141,961 118,968
Unrecognized transition liability........................ (1,092) (1,256) (1,420)
Unrecognized net gain.................................... (14,623) (21,573) (5,111)
Unrecognized prior service cost.......................... 13,455 12,123 10,547
--------- -------- --------
Prepaid pension cost at December 31................ $ 35,603 $ 35,137 $ 34,429
========= ======== ========
The weighted average discount rate used in determining the actuarial present
value of the benefit obligations was 7.00% for the year ended December 31, 1998,
and 7.75% for the years ended December 31, 1997 and 1996. The weighted average
expected long-term rate of return on plan assets was 10% for 1998, 1997 and
1996.
Middle management employees participate in a variety of incentive
compensation plans. These plans provide for incentive payments based on the
achievement of certain targeted operating results and other specific business
goals. The targeted operating results are determined each year by senior
management of Packaging. The amounts charged to expense for these plans were
$5,920,000, $6,407,000 and $6,722,000 in 1998, 1997 and 1996, respectively.
F-56
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
5. PENSION AND OTHER BENEFIT PLANS (CONTINUED)
In June, 1992, Tenneco initiated an Employee Stock Purchase Plan ("ESPP").
The plan allows U.S. and Canadian employees of the Group to purchase
Tenneco Inc. common stock through payroll deductions at a 15% discount. Each
year, an employee in the plan may purchase shares with a discounted value not to
exceed $21,250. The weighted average fair value of the employee purchase right,
which was estimated using the Black-Sholes option pricing model and the
assumptions described below except that the average life of each purchase right
was assumed to be 90 days, was $6.31, $11.09 and $10.77 in 1998, 1997 and 1996,
respectively. The ESPP was terminated as of September 30, 1996. Tenneco adopted
a new employee stock purchase plan effective April 1, 1997. Under the respective
ESPPs, Tenneco sold 133,223 shares, 85,024 shares and 73,140 shares to Group
employees in 1998, 1997 and 1996, respectively.
In December, 1996, Tenneco adopted the 1996 Stock Ownership Plan, which
permits the granting of a variety of awards, including common stock, restricted
stock, performance units, stock appreciation rights, and stock options to
officers and employees of Tenneco. Tenneco can issue up to 17,000,000 shares of
common stock under this plan, which will terminate December 31, 2001.
The fair value of each stock option issued by Tenneco to the Group during
1998, 1997 and 1996 is estimated on the date of grant using the Black-Sholes
option pricing model using the following weighted average assumptions for grants
in 1998, 1997 and 1996, respectively: (a) risk-free interest rate of 5.7%, 6.7%
and 6.0%, (b) expected lives of 10.0 years, 19.7 years and 5.0 years;
(c) expected volatility of 25.6%, 27.8% and 24.6%; and (d) dividend yield of
3.2%, 2.9% and 3.2%. The weighted-average fair value of options granted during
the year is $10.91, $13.99 and $11.51 for 1998, 1997 and 1996, respectively.
The Group applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," to its stock-based compensation plans. The Group
recognized after-tax stock-based compensation expense of approximately $210,000
in 1998, 1997 and 1996. Had compensation costs for the Group's stock-based
compensation plans been determined in accordance with SFAS 123, "Accounting for
Stock-Based Compensation," based on the fair value at the grant dates for the
awards under those plans, the Group's pro forma net income for the years ended
December 31, 1998, 1997 and 1996, would have been lower by $7,828,000,
$8,205,000 and $1,874,000, respectively.
6. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
In addition to providing pension benefits, the Group provides certain health
care and life insurance benefits for certain retired and terminated employees. A
substantial number of the Group's employees may become eligible for such
benefits if they reach normal retirement age while working for the Group. The
cost of these benefits for salaried employees is allocated to the Group by
Packaging through a payroll charge and the interdivision account. Amounts
allocated are principally determined based on payroll. The net obligation for
these salaried benefits is maintained by Packaging and is not included in the
liabilities section of the accompanying combined statements of assets,
liabilities and interdivision account for the Group's share of the obligation.
Currently, the Group's postretirement benefit plans are not funded and a
portion of the related postretirement obligation has been actuarially allocated
to the Group. However, due to the fact that other divisions participate in the
plan, certain of the disclosures required by SFAS No. 132, such as a summary of
the change in benefit obligation, are not available. The obligation of the
plans, related to hourly
F-57
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
6. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS (CONTINUED)
employees, reconciles with amounts recognized on the accompanying combined
statements of assets, liabilities and interdivision account at December 31,
1998, 1997 and 1996, as follows:
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Actuarial present value at September 30--
Accumulated postretirement benefit obligation--
Retirees and beneficiaries............................. $ (8,401) $ (7,199) $ (8,213)
Fully eligible active plan participants................ (3,582) (4,081) (4,283)
Other active plan participants......................... (2,950) (2,426) (1,738)
-------- -------- --------
Total.............................................. (14,933) (13,706) (14,234)
Plan assets at fair value at September 30................ -- -- --
Funded status............................................ (14,933) (13,706) (14,234)
Claims paid during the fourth quarter.................... 473 178 142
Unrecognized prior service cost.......................... -- (293) (797)
Unrecognized net gain.................................... (1,764) (2,861) (2,205)
-------- -------- --------
Accrued postretirement benefit cost at December 31......... $(16,224) $(16,682) $(17,094)
======== ======== ========
The net periodic postretirement benefit costs as determined by actuaries for
hourly employees for the years 1998, 1997 and 1996 consist of the following
components:
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Service cost................................................ $ 159 $ 105 $ 144
Interest cost............................................... 1,024 1,065 1,012
Amortization of net (gain) loss............................. (138) (80) 55
Amortization of prior service cost.......................... (293) (504) (643)
------ ------ ------
Net periodic postretirement benefit cost.............. $ 752 $ 586 $ 568
====== ====== ======
The amounts expensed by the Group may be different because it was allocated
by Packaging.
The weighted average assumed health care cost trend rate used in determining
the 1998 and 1997 accumulated postretirement benefit obligation was 5% in 1997,
remaining at that level thereafter.
The weighted average assumed health care cost trend rate used in determining
the 1996 accumulated postretirement benefit obligation was 6.0% in 1996
declining to 5.0% in 1997 and remaining at that level thereafter.
Increasing the assumed health care cost trend rate by one percentage point
in each year would increase the accumulated postretirement benefit obligation as
of September 30, 1998, 1997 and 1996, by approximately $1,268,000, $868,000 and
$1,103,000, respectively, and would increase the net postretirement benefit cost
for 1998, 1997 and 1996 by approximately $130,000, $75,000 and $102,000,
respectively.
F-58
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
6. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS (CONTINUED)
The discount rate (which is based on long-term market rates) used in
determining the accumulated postretirement benefit obligations was 7.00% for
1998 and 7.75% for 1997 and 1996.
7. RESTRUCTURING AND OTHER CHARGES
In the fourth quarter of 1998, the Group recorded a pretax restructuring
charge of approximately $14 million. This charge was recorded following the
approval by Tenneco's Board of Directors of a comprehensive restructuring plan
for all of Tenneco's operations, including those of the Group. In connection
with this restructuring plan, the Group will close four corrugated facilities
and eliminate 109 positions. The following table reflects components of this
charge:
DECEMBER 31,
RESTRUCTURING FOURTH-QUARTER 1998
COMPONENT CHARGE ACTIVITY BALANCE
--------- ------------- -------------- -------------
(IN THOUSANDS)
Cash charges--
Severance........................................ $ 5,135 $ 852 $4,283
Facility exit costs and other.................... 3,816 369 3,447
------- ------ ------
Total cash charges........................... 8,951 1,221 7,730
Noncash charges--
Asset impairments................................ 5,434 3,838 1,596
------- ------ ------
$14,385 $5,059 $9,326
======= ====== ======
Asset impairments include goodwill totaling approximately $5,043,000 related
to two of the facilities. The fixed assets at the closed facilities were written
down to their estimated fair value. No significant cash proceeds are expected
from the ultimate disposal of these assets. Of the $7,730,000 remaining cash
charges at December 31, 1998, approximately $7,300,000 is expected to be spent
in 1999. The actions contemplated by the restructuring plan should be completed
during the second quarter of 1999.
8. INCOME TAXES
The Group's method of accounting for income taxes requires that a deferred
tax be recorded to reflect the tax expense (benefit) resulting from the
recognition of temporary differences. Temporary differences are differences
between the tax basis of assets and liabilities and their reported amounts in
the financial statements that will result in differences between income for tax
purposes and income for financial statement purposes in future years.
As a division, this Group is not a taxable entity. For purposes of these
combined financial statements, income taxes have been allocated to the Group and
computed on a separate return basis. These income taxes represent liabilities to
Packaging and do not reflect any tax attributes of the Tenneco consolidated tax
group.
F-59
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
8. INCOME TAXES (CONTINUED)
Following is an analysis of the components of combined income tax expense
(benefit):
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Current--
U.S...................................................... $(21,105) $(58,813) $45,641
State and local.......................................... (2,708) (7,545) 5,855
-------- -------- -------
(23,813) (66,358) 51,496
-------- -------- -------
Deferred--
U.S...................................................... 63,230 75,399 7,374
State and local.......................................... 8,112 9,673 946
-------- -------- -------
71,342 85,072 8,320
-------- -------- -------
Income tax expense................................... $ 47,529 $ 18,714 $59,816
======== ======== =======
The primary difference between income taxes computed at the statutory U.S.
federal income tax rate and the income tax expense in the combined statements of
revenues, expenses and interdivision account is due to the effect of state
income taxes.
The components of the deferred tax assets (liabilities) at December 31,
1998, 1997 and 1996, were as follows:
1998 1997 1996
--------- --------- ---------
(IN THOUSANDS)
Current deferred taxes--
Accrued liabilities................................... $ 10,232 $ 6,374 $ 7,046
Employee benefits and compensation.................... (5,969) (4,946) (929)
Reserve for doubtful accounts......................... 1,275 1,230 1,261
Inventory............................................. 707 614 38
Pensions and postretirement benefits.................. (2,994) (4,196) (5,053)
State deferred tax.................................... 10,096 5,724 511
Other................................................. (76) (123) (89)
--------- --------- ---------
Total current deferred taxes...................... 13,271 4,677 2,785
--------- --------- ---------
Noncurrent deferred taxes--
Pension and postretirement benefits................... 13,898 7,934 8,012
Excess of financial reporting over tax basis in plant
and equipment....................................... (293,830) (210,797) (121,707)
Accrued liabilities................................... 1,336 1,701 1,947
Capital leases........................................ 9,333 7,517 24,672
Other................................................. 15,199 19,518 (89)
--------- --------- ---------
Total noncurrent deferred taxes................... (254,064) (174,127) (87,165)
--------- --------- ---------
Net deferred tax liabilities...................... $(240,793) $(169,450) $ (84,380)
========= ========= =========
F-60
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
9. ASSETS, LIABILITIES AND OTHER INCOME, NET DETAIL
PREPAID EXPENSES AND OTHER CURRENT ASSETS
The components of prepaid expenses and other current assets include:
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Prepaid stumpage............................................ $15,189 $19,231 $15,595
Prepaid taxes............................................... 13,272 7,549 7,044
Current portion--Meridian Lease, net of deferred gain....... 5,193 -- --
Prepaid professional services/leases........................ 2,356 1,918 5,506
Other....................................................... 5,082 6,321 7,391
------- ------- -------
Total................................................. $41,092 $35,019 $35,536
======= ======= =======
OTHER LONG-TERM ASSETS
The components of the other long-term assets include:
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Prepaid pension cost........................................ $ 35,603 $35,137 $34,429
Leased timberlands and mills................................ 14,636 11,857 9,510
Long-term portion--Meridian Lease, net of deferred gain..... 44,743 -- --
Deferred software........................................... 15,864 11,088 6,047
Timberland rights........................................... 10,919 9,775 8,615
Capitalized fees............................................ -- 474 3,962
Other....................................................... 9,327 8,981 9,513
-------- ------- -------
Total................................................. $131,092 $77,312 $72,076
======== ======= =======
ACCRUED LIABILITIES
The components of accrued liabilities include:
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Accrued payroll, vacation and taxes......................... $42,282 $48,119 $ 49,162
Accrued insurance........................................... 6,012 5,248 4,296
Accrued volume discounts and rebates........................ 5,727 4,428 3,515
Restructuring............................................... 9,326 -- --
Current portion of accrued postretirement benefit cost...... 1,460 875 892
Deferred lease credits...................................... 1,918 1,014 94,360
Other....................................................... 2,665 10,742 14,438
------- ------- --------
Total................................................. $69,390 $70,426 $166,663
======= ======= ========
F-61
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
9. ASSETS, LIABILITIES AND OTHER INCOME, NET DETAIL (CONTINUED)
As part of the refinancing of the GECC leases in January, 1997 (Note 12),
certain deferred lease credits were eliminated.
OTHER LONG-TERM LIABILITIES
The components of the other long-term liabilities include:
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Accrued postretirement benefit cost......................... $14,764 $15,807 $16,202
Environmental liabilities................................... 6,599 5,421 6,673
Other....................................................... 2,497 2,526 412
------- ------- -------
Total................................................. $23,860 $23,754 $23,287
======= ======= =======
OTHER INCOME, NET
The components of other income (expense), net include:
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Discount on sale of factored receivables................... $(14,774) $(12,006) $(12,351)
Gain on sale of timberlands................................ 16,944 -- --
Gain on sale of joint venture interest..................... 15,060 -- --
Gain on operating lease refinancing........................ -- 37,730 --
Gain on Willow Flowage..................................... -- 4,449 --
Gain on sale of mineral rights............................. -- 1,646 --
Capitalization of barter credits........................... -- 1,563 --
Sylva Mill rebate income................................... -- -- 4,500
Gain on sale of recycled mills............................. -- -- 50,000
Other...................................................... 9,588 11,299 14,094
-------- -------- --------
Total................................................ $ 26,818 $ 44,681 $ 56,243
======== ======== ========
10. RELATED-PARTY TRANSACTIONS
FUNDING OF CASH REQUIREMENTS
As discussed in Note 2, Packaging provides centralized treasury functions
and financing for the Group including funding of its cash requirements for
processing of accounts payable and payroll requirements.
CORPORATE ALLOCATIONS
Packaging and Tenneco affiliates provide services to the Group which are
typical of a consolidated entity with operations in several businesses. These
services included general management, investor and
F-62
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
10. RELATED-PARTY TRANSACTIONS (CONTINUED)
media relations, legal, human resources, accounting, public company reporting,
data processing systems, support, training, finance, treasury, and insurance
management. These expenses were allocated to the Group in the aggregate, not
individually, from Packaging and Tenneco affiliates, based upon the relative
level of effort and time spent on Group activities. This was generally measured
using a formula based upon the Group's percentage of Tenneco's fixed assets,
revenues and payroll. The Group believes the method for the historical
allocations was reasonable.
As a stand-alone entity, the Group does not expect that it will incur a
similar level of costs due to a less complex corporate structure and a different
level of need for such services. The Group estimates it will incur approximately
$30 million in stand-alone overhead costs in the first year following the
acquisition and believes this is representative of what the costs would have
been as a stand-alone entity for historical periods.
Certain receivables and transactions resulting from the financing
relationship between Packaging and Tenneco are not reflected in the accompanying
financial statements.
INSURANCE AND BENEFITS
The Group is self-insured for medical benefits and workers' compensation.
Expenses related to workers' compensation, health care claims for hourly and
salaried workers and postretirement health care benefits for hourly and salaried
workers are determined by Packaging and are allocated to the Group. The Group
incurred charges of $32,151,000, $34,004,000 and $32,298,000 in 1998, 1997 and
1996, respectively, for health care and $5,109,000, $9,209,000 and $8,853,000 in
1998, 1997 and 1996, respectively, for workers' compensation.
In general, all costs and expenses incurred and allocated are based on the
relationship the Group has with Tenneco. If the Group had been a stand-alone
entity, the costs and expenses would differ.
11. COMMITMENTS AND CONTINGENCIES
The Group had authorized capital expenditures of approximately $49,392,000
as of December 31, 1998, in connection with the expansion and replacement of
existing facilities.
The Group is involved in various legal proceedings and litigation arising in
the ordinary course of business. In the opinion of management and in-house legal
counsel, the outcome of such proceedings and litigation will not materially
affect the Group's financial position or results of operations.
12. LEASES
Rental expense included in the combined financial statements was
$96,193,340, $95,284,000 and $118,821,000 for 1998, 1997 and 1996, respectively.
These costs are primarily included in cost of goods sold.
On January 31, 1997, Packaging executed an operating lease agreement with
Credit Suisse Leasing 92A, L.P., and a group of financial institutions led by
Citibank, N.A. The agreement refinanced the previous operating leases between
GECC and Packaging which were entered into at the same time as GECC's purchase
of certain assets from Georgia-Pacific in January, 1991. Through this
refinancing, several capital lease obligations were extinguished as the assets
were incorporated into the new operating
F-63
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
12. LEASES (CONTINUED)
lease. Also with this refinancing, certain fixed assets and deferred credits
were eliminated resulting in a net gain of approximately $38 million in the
first quarter of 1997.
Aggregate minimum rental commitments under noncancelable operating leases
are as follows (in thousands):
1999........................................ $ 83,804
2000........................................ 81,368
2001........................................ 79,428
2002........................................ 686,390
2003........................................ 26,975
Thereafter.................................. 113,154
----------
Total................................. $1,071,119
==========
Minimum rental commitments under noncancelable operating leases include
$68 million for 1999, $68 million for 2000, $68 million for 2001, $676 million
for 2002, $18 million for 2003 and $34 million for years thereafter, payable to
credit Suisse Leasing 92A, L.P. and Citibank, N.A., along with John Hancock,
Metropolitan Life and others (the "Lessors") for certain mill and timberland
assets. The remaining terms of such leases extend over a period of up to five
years.
Following the initial lease period, Packaging may, under the provision of
the lease agreements, extend the leases on terms mutually negotiated with the
Lessors or purchase the leased assets under conditions specified in the lease
agreements. If the purchase options are not exercised or the leases are not
extended, Packaging will make a residual guarantee payment to the Lessors of
approximately $653 million, included in the schedule above, which will be
refunded up to the total amount of the residual guarantee payment based on the
Lessors' subsequent sales price for the leased assets. Throughout the lease
period, Packaging is required to maintain the leased properties which includes
reforestation of the timberlands harvested.
Packaging's various lease agreements require that it comply with certain
covenants and restrictions, including financial ratios that, among other things,
place limitations on incurring additional "funded debt" as defined by the
agreements. Under the provisions of the lease agreements, in order to incur
funded debt, Packaging must maintain a pretax cash flow coverage ratio, as
defined, on a cumulative four quarter basis of a minimum of 2.0, subsequently
modified to 1.75 as of December 31, 1998. Packaging was in compliance with all
of its covenants at December 31, 1998.
In December, 1998, the Group made a payment of $84 million to acquire the
Meridian timberlands utilized by the Group. This transaction was undertaken in
preparation for the separation of the Group's assets from Tenneco. Subsequent to
year end, the Group paid a fee of $50,000 to effect the conveyance of the
Meridian timberlands to the Group.
In connection with the pending sale of the Group described in Note 14 to
these financial statements, Tenneco may purchase the Tomahawk and Valdosta mills
and selected timberland assets currently under lease prior to the sale.
F-64
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
13. SALE OF ASSETS
In the second quarter of 1996, Packaging entered into an agreement to
form a joint venture with Caraustar Industries whereby Packaging sold its two
recycled paperboard mills and a fiber recycling operation and brokerage business
to the joint venture in return for cash and a 20% equity interest in the joint
venture. Proceeds from the sale were approximately $115 million and the Group
recognized a $50 million pretax gain ($30 million after taxes) in the second
quarter of 1996.
In June, 1998, Packaging sold its remaining 20% equity interest in the joint
venture to Caraustar Industries for cash and a note of $26,000,000. The Group
recognized a $15 million pretax gain on this transaction.
At December 31, 1998, the balance of the note with accrued interest is
$26,756,000.
14. SALE OF COMPANY AND RELATED IMPAIRMENT (UNAUDITED)
On January 26, 1999, Tenneco announced that it had entered into an agreement
to contribute a majority interest in the Group to a new joint venture with
Madison Dearborn Partners, in exchange for cash and debt assumption totaling
approximately $2 billion, and a 45% common equity interest in the joint venture.
The owned and leased assets to be contributed included the Group's four
linerboard and medium mills, 67 plants, three sawmills, an air-drying yard,
three recycling facilities, miscellaneous other property, which includes sales
offices and woodlands forest management offices, numerous distribution centers,
warehouses and five design centers and an ownership or controlling interest in
approximately 950,000 acres of timberland. The transactions closed on April 12,
1999.
In connection with the transactions, Packaging borrowed approximately $1.8
billion, most of which was used to acquire assets used by the Group pursuant to
operating leases and timber cutting rights, with the remainder remitted to
Tenneco for corporate debt reduction.
Tenneco then contributed the Group's assets (subject to the new indebtedness
and the Group's liabilities) to a joint venture, Packaging Corporation of
America ("PCA") in exchange for (a) a 45% common equity interest in PCA valued
at approximately $200 million and (b) approximately $240 million in cash. As a
result of the sale transaction, Tenneco recognized a pretax loss in the first
quarter of 1999 of approximately $293 million. Part of that loss consisted of an
impairment charge relating to the Group's property, plant and equipment and
intangible assets, which was pushed down to the Group's March 31, 1999 financial
statements. The amount of the impairment charge is approximately $230.1 million.
The impairment charge of $230.1 million recorded in the Group's financial
statements has been allocated to the following financial statement line items
(in thousands):
Intangibles................................................. $ 46,206
Machinery and equipment..................................... 183,906
--------
Total..................................................... $230,112
========
The impairment charge will first be applied against the goodwill
specifically attributable to the containerboard assets and the remaining amount
will be applied against plant, property and equipment.
F-65
THE CONTAINERBOARD GROUP
(A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
14. SALE OF COMPANY AND RELATED IMPAIRMENT (UNAUDITED) (CONTINUED)
The Group's financial statements reflect $230.1 million of the
$293.0 million charge representing the impairment attributable to the assets
reflected in the Group's financial statements.
15. SUMMARIZED COMBINED FINANCIAL INFORMATION ABOUT GUARANTOR
SUBSIDIARIES
The following is summarized aggregated financial information for Dahlonega
Packaging Corporation, Dixie Container Corporation, PCA Hydro, Inc., PCA
Tomahawk Corporation and PCA Valdosta Corporation, each of which was a
wholly-owned subsidiary of Packaging and included in the Group's combined
financial statements. In conjunction with the sale of the Group as described in
Note 14, each of these companies became subsidiaries of PCA and fully,
unconditionally, jointly and severally guaranteed $550 million in subordinated
debt issued by PCA in conjunction with the transaction. Separate financial
statements of the guarantor subsidiaries are not presented because, in the
opinion of management, such financial statements are not material to investors.
DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Current assets....................................... $49,463 $42,844 $42,664
Non-current assets................................... 13,985 46,399 45,051
------- ------- -------
Total assets................................... 63,448 89,243 87,715
Current liabilities.................................. 13,826 12,687 10,542
Non-current liabilities.............................. 7,264 4,785 4,559
------- ------- -------
Total liabilities.............................. 21,090 17,472 15,101
------- ------- -------
Interdivision Account................................ $42,358 $71,771 $72,614
======= ======= =======
YEAR ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- -------- --------
(IN THOUSANDS)
Net sales............................................ $32,970 $25,758 $24,666
Gross profit......................................... 1,172 3,253 4,719
Net loss............................................. (866) (1,217) (351)
F-66