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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 29, 2002 COMMISSION FILE NUMBER 0-49741
PACKAGING DYNAMICS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 32-0009217
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
3900 WEST 43RD STREET
CHICAGO, ILLINOIS 60632
(Address of Principal Executive Office) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(773) 843-8000
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, and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
At August 8, 2002, there were 9,452,097 shares of common stock, par
value $0.01 per share, outstanding.
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1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PACKAGING HOLDINGS, L.L.C.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
JUNE 29, 2002 JUNE 29, DECEMBER 31,
PRO FORMA 2002 2001
------------- ------------ -------------
(UNAUDITED) (UNAUDITED)
ASSETS (NOTE 9)
Current Assets:
Cash and cash equivalents ................................................... $ 2,191 $ 2,191 $ 1,041
Accounts receivable trade, net of allowance ................................. 24,667 24,667 18,859
Inventories ................................................................. 28,350 28,350 30,692
Prepaid expenses and other .................................................. 3,816 3,816 3,652
------------- ------------ -------------
Total current assets ..................................................... 59,024 59,024 54,244
------------- ------------ -------------
Property, Plant and Equipment:
Buildings and improvements .................................................. 23,628 23,628 23,584
Machinery and equipment ..................................................... 64,963 64,963 64,484
Projects in progress ........................................................ 1,505 1,505 396
------------- ------------ -------------
90,096 90,096 88,464
Less - accumulated depreciation ............................................. (24,361) (24,361) (20,930)
------------- ------------ -------------
65,735 65,735 67,534
Land ........................................................................ 1,276 1,276 1,297
------------- ------------ -------------
Total property, plant and equipment ...................................... 67,011 67,011 68,831
------------- ------------ -------------
Other Assets:
Goodwill, net of accumulated amortization ................................... 34,329 34,329 34,329
Miscellaneous ............................................................... 2,199 2,199 2,606
------------- ------------ -------------
Total other assets ....................................................... 36,528 36,528 36,935
------------- ------------ -------------
Total Assets ................................................................... $ 162,563 $ 162,563 $ 160,010
============= ============ =============
LIABILITIES AND MEMBERS' EQUITY/STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt ........................................ $ 6,920 $ 6,920 $ 6,420
Accounts payable ............................................................ 19,315 19,315 16,424
Accrued salary and wages .................................................... 4,753 3,381 1,763
Other accrued liabilities ................................................... 5,376 5,376 4,355
------------- ------------ -------------
Total current liabilities ................................................ 36,364 34,992 28,962
------------- ------------ -------------
Long-Term Debt ................................................................. 71,770 71,770 76,830
Note Payable to Related Party .................................................. -- 19,238 18,132
Deferred Income Taxes .......................................................... 6,689 2,089 2,089
------------- ------------ -------------
Total Liabilities .............................................................. 114,823 128,089 126,013
------------- ------------ -------------
Commitments and Contingencies (Note 7) .........................................
------------- ------------ -------------
Members' Equity/Stockholders' Equity:
Members' equity ............................................................. -- 34,474 33,997
Common stock, $.01 par value--40,000,000 shares authorized;
(9,437,747 shares issued and outstanding) ................................... 94 -- --
Preferred stock, $.01 par value--5,000,000 shares authorized; (no shares
issued or outstanding)....................................................... -- -- --
Paid in capital in excess of par value ...................................... 49,018 -- --
Accumulated deficit ......................................................... (1,372) -- --
------------- ------------ -------------
Total members' equity/stockholders' equity ............................... 47,740 34,474 33,997
------------- ------------ -------------
Total Liabilities and Members' Equity/Stockholders' Equity ..................... $ 162,563 $ 162,563 $ 160,010
============= ============ =============
The accompanying notes are an integral part of this statement.
2
PACKAGING HOLDINGS, L.L.C.
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
--------------- -------------- -------------- --------------
Net sales ........................................ $ 65,731 $ 59,712 $ 125,856 $ 116,732
Cost of goods sold ............................... 57,874 52,764 111,027 103,163
--------------- -------------- -------------- --------------
Gross profit ..................................... 7,857 6,948 14,829 13,569
--------------- -------------- -------------- --------------
Operating expenses:
Selling ....................................... 1,858 1,509 3,692 3,154
General and administrative .................... 2,183 1,683 5,204 3,452
Amortization of intangibles ................... 18 235 36 467
--------------- -------------- -------------- --------------
Total operating expenses ......................... 4,059 3,427 8,932 7,073
--------------- -------------- -------------- --------------
Income from operations ........................... 3,798 3,521 5,897 6,496
Other income (expense), net ...................... (118) 4 (13) 2
Interest expense ................................. (2,280) (2,803) (4,576) (5,809)
--------------- -------------- -------------- --------------
Income before income taxes ....................... 1,400 722 1,308 689
Income tax provision ............................. 293 82 681 28
--------------- -------------- -------------- --------------
Net income ....................................... $ 1,107 $ 640 $ 627 $ 661
=============== ============== ============== ==============
The accompanying notes are an integral part of this statement.
3
PACKAGING HOLDINGS, L.L.C.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
----------------
JUNE 29, 2002 JUNE 30, 2001
------------- -------------
Cash flows from operating activities:
Net income............................................................... $ 627 $ 661
Adjustments to reconcile net income to net cash from operating
activities:
Depreciation........................................................... 3,904 3,578
Amortization of intangibles assets..................................... 36 467
Amortization of deferred finance costs................................. 368 369
Loss on disposal of equipment.......................................... 13 2
Provision for doubtful accounts........................................ (28) (136)
Non-cash charge for long-term incentive compensation................... 1,295 --
Non-cash interest to related party..................................... 1,106 986
Changes in operating assets and liabilities:
Accounts receivable................................................. (5,780) (1,560)
Inventories......................................................... 2,225 4,627
Other assets........................................................ (164) (261)
Accounts payable and accrued liabilities............................ 4,092 (4,210)
------- -------
Net cash from operating activities............................... 7,694 4,523
------- -------
Cash flows from (used by) investing activities:
Proceeds from sale of assets........................................... 245 1
Additions to property, plant and equipment............................. (2,229) (1,167)
------- -------
Net cash used by investing activities............................ (1,984) (1,166)
------- -------
Cash flows from (used by) financing activities:
Payment of financing costs............................................. -- (350)
Principal payments for loan obligations................................ (2,860) (1,430)
Proceeds under revolving line of credit................................ 21,900 26,500
Repayments under revolving line of credit.............................. (23,600) (27,800)
Advances to members.................................................... -- (273)
------- -------
Net cash used by financing activities............................ (4,560) (3,353)
------- -------
Net increase in cash and cash equivalents................................... 1,150 4
Cash and cash equivalents at beginning of period............................ 1,041 460
------- -------
Cash and cash equivalents at end of period.................................. $ 2,191 $ 464
======= =======
Supplemental cash flow disclosures:
Cash paid during the period for:
Interest............................................................... $ 2,912 $ 4,514
Income taxes........................................................... 249 33
The accompanying notes are an integral part of this statement.
4
PACKAGING HOLDINGS, L.L.C.
CONSOLIDATED STATEMENTS OF MEMBERS' EQUITY AND
OTHER COMPREHENSIVE INCOME (LOSS)
(DOLLARS IN THOUSANDS)
RETAINED ACCUMULATED
CONTRIBUTIONS ADVANCES EARNINGS OTHER
FROM TO (ACCUMULATED COMPREHENSIVE MEMBERS' COMPREHENSIVE
MEMBERS MEMBERS DEFICIT) LOSS EQUITY INCOME (LOSS)
----------- -------- ----------- ------------- ---------- -------------
Balance at December 31, 2000 $ 34,579 $ (25) $ (2,074) $ -- $ 32,480
Net income 2,344 2,344 $ 2,344
Due from members (273) (273)
Other comprehensive income (loss):
Cumulative effect of change in
accounting principle for derivatives
and hedging activities 363 363 363
Reclassification of derivative losses to
earnings 416 416 416
Change in fair value of derivative
instruments (1,333) (1,333) (1,333)
----------- -------- ----------- ------------- ---------- -------------
Comprehensive income $ 1,790
=============
Balance at December 31, 2001 34,579 (298) 270 (554) 33,997
Net income 627 627 $ 627
Other comprehensive income (loss):
Reclassification of derivative losses to
earnings 518 518 518
Change in fair value of derivative
instruments (668) (668) (668)
----------- -------- ----------- ------------- ---------- -------------
Comprehensive income $ 477
=============
Balance at June 29, 2002 (Unaudited) $ 34,579 $ (298) $ 897 $ (704) $ 34,474
=========== ======== =========== ============= ==========
The accompanying notes are an integral part of this statement.
5
PACKAGING HOLDINGS, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
NOTE 1--BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Packaging Holdings, L.L.C. (the "Company" or "Packaging Holdings") is a
limited liability company organized under the laws of the State of Delaware. The
Company is the sole member of Packaging Dynamics, L.L.C. ("PDLLC") which is the
parent company of several operating subsidiaries. References to the Company or
Packaging Holdings herein reflect the consolidated results of Packaging
Holdings, L.L.C.
Packaging Dynamics Corporation ("Packaging Dynamics") is a Delaware
corporation established as a holding company to own all of the limited liability
company interests in Packaging Holdings in connection with the distribution of
certain ownership interests in the business of Packaging Holdings. See Note 9--
Subsequent Event.
In the opinion of management, the information in the accompanying
unaudited financial statements reflects all adjustments (consisting solely of
normal recurring adjustments) necessary to present fairly the results of
operations, cash flows and comprehensive income (loss) for the six months ended
June 29, 2002 and June 30, 2001 and the financial position at June 29, 2002. The
interim results are not necessarily indicative of results for a full year and do
not contain information included in the Company's annual consolidated financial
statements and notes for the year ended December 31, 2001. The consolidated
balance sheet as of December 31, 2001 was derived from audited financial
statements, but does not include all disclosures required by generally accepted
accounting principles. These interim financial statements should be read in
conjunction with our audited consolidated financial statements and notes thereto
included with the Company's filings with the Securities and Exchange Commission.
INVENTORIES
Inventories are stated at the lower of cost or market as determined by the
first-in, first-out (FIFO) method. Such cost includes raw materials, direct
labor and manufacturing overhead. Inventories at June 29, 2002 and December 31,
2001 consist of the following:
JUNE 29, DECEMBER 31,
2002 2001
---------- ------------
Raw materials $ 12,672 $ 11,211
Work-in-process 1,271 1,385
Finished goods 14,407 18,096
---------- ------------
$ 28,350 $ 30,692
========== ============
PROPERTY, PLANT AND EQUIPMENT
The Company capitalizes expenditures for major renewals and betterments at
cost and charges to operating expenses the cost of current maintenance and
repairs. Provisions for depreciation have been computed principally on the
straight-line method over the estimated useful lives (generally 31 years for
buildings, 15 to 31 years for improvements and 7 to 12 years for machinery and
equipment).
The cost and accumulated depreciation relating to assets retired or
otherwise disposed of are eliminated from the respective accounts at the time of
disposition. The resulting gain or loss is included in the current operating
results.
6
PACKAGING HOLDINGS, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
(UNAUDITED)
LONG-LIVED ASSETS
Long-lived assets, including property, plant and equipment, other assets
and intangibles, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of assets may not be
recoverable. If the expected future cash flows (undiscounted and without
interest charges) is less than the carrying amount of the asset, an impairment
loss is recognized. No such impairment has occurred in 2002 or 2001.
During the first quarter of 2002, the Company adopted SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," which
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets. SFAS No. 144 generally establishes a standard framework from
which to measure impairment of long-lived assets and expands discontinued
operations income statement presentation to include a component of the entity.
The adoption did not have a material effect on the Company's consolidated
financial position or cash flows.
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses the accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS No. 143 requires that the fair value of
a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. SFAS
No. 143 is effective for financial statements issued for fiscal years beginning
after June 15, 2002. The Company does not expect SFAS No. 143 to have a material
effect on its consolidated financial position or cash flows.
GOODWILL AND OTHER INTANGIBLE ASSETS
On January 1, 2002, the Company adopted SFAS No. 141, "Business
Combinations," and No. 142, "Goodwill and Other Intangible Assets." These
statements eliminate the pooling-of-interest method of accounting for business
combinations and require goodwill and intangible assets with indefinite lives to
no longer be amortized but to instead be tested for impairment at least
annually. Other intangible assets with determinable lives will continue to be
amortized over their useful lives. The Company applied the new rules on
accounting for goodwill and other intangible assets effective January 1, 2002. A
comparison of net income for the first six months of 2002 and net income for the
first six months of 2001 adjusted to remove goodwill amortization is as follows:
SIX MONTHS ENDED
----------------
JUNE 29, JUNE 30,
2002 2001
---- ----
Reported net income $ 627 $ 661
Add back: Goodwill amortization -- 467
------ -------
Adjusted net income $ 627 $ 1,128
====== =======
Impairment of goodwill is measured according to a two--step approach. In
the first step, the fair value of a reporting unit is compared to the carrying
amount of the reporting unit, including goodwill. If the carrying amount exceeds
the fair value, the second step of the goodwill impairment test is performed to
measure the amount of impairment loss, if any. In the second step, the implied
fair value of the goodwill is estimated as the fair value of the reporting unit
less the fair values of all the other tangible and intangible assets of the
reporting unit. If the carrying amount of the goodwill exceeds the implied fair
value of the goodwill, an impairment loss is recognized in an amount equal to
that excess, not to exceed the carrying amount of the goodwill. According to
this statement, any impairment loss recognized as a result of its initial
application will be reported as resulting from a change in accounting principle.
The Company completed the first of the required impairment tests during the
first half of 2002 which indicated no transitional impairment charge was
required.
7
PACKAGING HOLDINGS, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
(UNAUDITED)
DERIVATIVES AND OTHER COMPREHENSIVE INCOME (LOSS)
The Company recognizes all derivative instruments as assets or liabilities
at fair value, with the related gain or loss reflected within members' equity
through accumulated other comprehensive income (loss) or within operations
depending upon the nature of the derivative instrument.
The Company maintains interest rate swap agreements that are designated as
cash flow hedges to manage the market risk from changes in interest rates on a
portion of its variable rate term loans. Such derivative financial instruments
are recorded at fair value of a loss of $704 at June 29, 2002 in accrued
liabilities within the accompanying consolidated balance sheet. Changes in fair
value, based upon the amount at which the swap could be settled with a third
party, are recorded in other comprehensive income (loss). The differentials to
be received or paid under the interest rate swap agreements are recognized in
income over the life of the contract as adjustments to interest expense.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the FASB issued SFAS No. 145, "Rescission of FAS Nos. 4,
44, and 64, Amendment of FAS 13 and Technical Corrections as of April 2002"
which mainly addresses the accounting and disclosure related to early
extinguishment of debt transactions as well as several other technical
corrections. SFAS No. 145 is effective for financial statements for fiscal years
beginning after May 15, 2002 with early application encouraged. The Company does
not expect SFAS No. 145 to have a material effect on our consolidated financial
position or cash flows.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" which nullifies EITF Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The principle difference in accounting under SFAS No. 146 is
that a liability for the cost associated with an exit or disposal activity
cannot be recognized until the liability has been incurred. Under EITF 94-3, an
exit cost liability could be recognized at the date of any entity's commitment
to an exit plan. SFAS No. 146 is effective for exit or disposal activities
initiated after December 31, 2002 with early application encouraged. The Company
does not expect SFAS No. 146 to have a material effect on our consolidated
financial position or cash flows.
NOTE 2--OTHER ASSETS
Other assets at June 29, 2002 and December 31, 2001 consist of the
following:
JUNE 29, DECEMBER 31,
2002 2001
-------- ------------
Covenants not to compete $ 5,216 $ 5,216
Deferred financing costs 4,515 4,515
-------- -----------
9,731 9,731
Accumulated amortization (7,532) (7,125)
-------- -----------
$ 2,199 $ 2,606
======== ===========
8
PACKAGING HOLDINGS, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS )
(UNAUDITED)
NOTE 3--LONG-TERM DEBT
Long-term debt at June 29, 2002 and December 31, 2001 consists of the
following:
JUNE 29, DECEMBER 31,
2002 2001
------------- --------------
Senior Credit Facility:
Tranche A Term Loan $ 15,875 $ 18,375
Tranche B Term Loan 57,715 58,075
Revolving credit loan -- 1,700
Seller note payable 3,000 3,000
Baxter Springs facility HUD loan 2,100 2,100
------------- --------------
Subtotal 78,690 83,250
Current maturities of long term debt (6,920) (6,420)
------------- --------------
Long-term debt $ 71,770 $ 76,830
============= ==============
NOTE 4--RELATED PARTY TRANSACTIONS
The Company issued a $12,500 note subordinated to the Senior Credit
Facility on November 20, 1998 to IPMC, Inc., an indirect wholly-owned subsidiary
of Ivex Packaging Corporation ("Ivex"), in connection with the acquisition of
the assets of Ivex's paper mill operations located in Detroit, Michigan.
Interest on this note was paid-in-kind at a rate of 12% on a semi-annual basis.
The note is unsecured and matures on November 21, 2005. On July 1, 2002, the
note payable of $19,238 was canceled.
Pursuant to a consulting agreement, the Company paid Ivex an annual
consulting fee for management and administrative services rendered to the
Company by Ivex including financial, tax, accounting and legal services. During
the first six months of 2002 and 2001, the Company recorded consulting fee
expense of $250 and $269, respectively, related to this agreement. On July 1,
2002, the consulting agreement was canceled.
NOTE 5--INCOME TAXES
The Company's federal and state taxable income is reported by the
Company's members on their income tax returns as if the Company was a
partnership.
International Converter, Inc. ("ICI"), an operating subsidiary of the
Company, has remained a taxable C corporation since its acquisition by the
Company. As a result, the Company provides for federal and state income taxes on
the income of the ICI subsidiary. Furthermore, the Company recognizes deferred
tax assets and liabilities based on the differences between the financial
statement and tax bases of assets and liabilities of ICI.
NOTE 6--EMPLOYEE BENEFIT PLANS
The Company has an unfunded 2001 Long-Term Incentive Compensation Plan
(the "2001 LTIP") for certain key executives. Under the terms of this plan,
3,000,000 incentive units, subject to adjustment, and representing 8.2% of the
fully diluted outstanding limited liability shares, have been granted. The plan
is designed to reward these individuals on the increased equity value of the
Company, and provides that 40% of the incentive units were earned on the
effective date and the remaining 60% can be earned based upon the Company's
attainment of certain annual earnings targets. Participants in the plan vest on
a pro-rata basis over three years from the plan's origination date. In the event
the Company completes a transaction which causes a substantial change in
ownership control, the plan provides for an accelerated vesting schedule.
Primarily as a result of the merger and distribution announced on March 18, 2002
(see Note 9 -- Subsequent Events), the equity value of the Company increased and
accordingly, the Company recorded a long-term incentive compensation charge of
$1,295 during the first six months of 2002. The $1,295 long-term incentive
compensation charge recorded during the first six months of 2002 represents the
earned and vested portion of the Long-Term Incentive Compensation Plan for
certain key executives through June 29, 2002.
9
PACKAGING HOLDINGS, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
(UNAUDITED)
NOTE 7--COMMITMENTS AND CONTINGENCIES
The Company is currently a party to various legal proceedings in various
federal and state jurisdictions arising out of the operations of its business.
The amount of alleged liability, if any, from these proceedings cannot be
determined with certainty; however, the Company believes that its ultimate
liability, if any, arising from the pending legal proceedings, as well as from
asserted legal claims and known potential legal claims which are probable of
assertion, would not have a material effect on the Company's financial
condition, results of operations or liquidity.
The Company's manufacturing operations are subject to federal, state and
local regulations governing the environment and the discharge of materials into
air, land and water, as well as the handling and disposal of solid and hazardous
wastes. As is the case with manufacturers in general, if a release of hazardous
substances occurs on or from the Company's properties or any associated offsite
disposal location, or if contamination from prior activities is discovered at
any of the Company's properties, the Company may be held liable. From time to
time, the Company is involved in regulatory proceedings and inquiries relating
to compliance with environmental laws, permits and other environmental matters.
The Company believes that it is in substantial compliance with applicable
environmental regulations and does not believe that costs of compliance will
have a material adverse effect on the Company's financial condition, results of
operations or liquidity.
NOTE 8--RESTRUCTURING CHARGE
At June 29, 2002 and December 31, 2001, there was $92 and $127,
respectively, of severance and other benefits costs remaining to be paid in
future periods.
The reserve for restructuring charge was as follows:
SIX MONTHS YEAR ENDED
ENDED DECEMBER 31,
JUNE 29, 2002 2001
------------- ------------
Balance at the beginning of the period $ 127 $ 567
Payments of severance and other benefits (35) (440)
-------- --------
Balance at the end of the period $ 92 $ 127
======== ========
NOTE 9--SUBSEQUENT EVENTS AND PRO FORMA BALANCE SHEET
On March 18, 2002, the board of directors of Ivex approved a merger
agreement providing for the merger with Ivex of a wholly-owned subsidiary of
Alcoa Inc. As a result of the merger, Ivex became a wholly-owned subsidiary of
Alcoa on July 1, 2002. The merger was conditioned upon, among other things, the
prior distribution to Ivex stockholders and option holders of Ivex's 48.19%
ownership interest in Packaging Holdings. To facilitate the distribution, Ivex
formed Packaging Dynamics to be the holding company for all of the ownership
interests in Packaging Holdings. In preparation for the distribution, Ivex and
the other members of Packaging Holdings exchanged their ownership interests in
Packaging Holdings for common stock of Packaging Dynamics. On July 1, 2002, Ivex
distributed its shares of Packaging Dynamics to its stockholders and certain of
its option holders immediately prior to the merger.
10
PACKAGING HOLDINGS, L.L.C.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Also in connection with the merger and distribution, the Company changed
its corporate structure from that of a limited liability company to a
C-corporation in connection with the distribution; the $12,500 12% subordinated
note payable to Ivex including accreted interest totaling approximately $19,238
was forgiven; and, the consulting agreement with Ivex was canceled.
The unaudited pro forma column of the balance sheet at June 29, 2002 has been
prepared to show the effect that this transaction would have had on the balance
sheet if it had occurred on June 29, 2002.
Stock Options--On July 1, 2002, Packaging Dynamics granted to management,
for incentive purposes and in consideration of their waiver of cash payments
under the 2001 LTIP described above, stock options for the purchase of an
aggregate of 815,089 shares of its common stock under the 2002 Long Term
Incentive Stock Plan. Additionally, on July 1, 2002, Packaging Dynamics granted
to former employees stock options for the purchase of an aggregate of 29,047
shares of its common stock under individual nonqualified stock option agreements
in consideration of their waiver of cash payments under the 2001 LTIP. The
options have an exercise price of $3.90 per share that was below the fair market
value of Packaging Dynamics common stock on the grant date and, although fully
vested, are not exercisable for three years after the grant date. Consequently,
the Company has the right to repurchase an executive's options if he terminates
employment before the end of the three-year period. The announcement of the
merger and distribution on March 18, 2002 resulted in an increase in the value
of the Company and in turn in the valuation of the incentive units under the
2001 LTIP. The Company expects to record a total non-cash compensation charge of
approximately $2,667 (of which $1,295 was taken in the first six months of 2002)
in fiscal 2002 related to these management incentive plans.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITIONS AND
RESULT OF OPERATIONS (DOLLARS IN THOUSANDS)
The following discussion addresses the consolidated financial
statements of Packaging Holdings, L.L.C. (the "Company," "Packaging Holdings,"
"We" or "Our") which is a limited liability company organized under the laws of
the State of Delaware and wholly owned by Packaging Dynamics Corporation
("Packaging Dynamics"). The Company is the sole member of Packaging Dynamics,
L.L.C. ("PDLLC") which is the parent company of several operating companies.
RESULTS OF OPERATIONS -- FOR THE THREE MONTHS ENDED JUNE 29, 2002 AND JUNE 30,
2001
Net Sales
Net sales increased by 10.1% during the second quarter of 2002 over our
net sales during the corresponding period in 2001. The increase primarily
resulted from additional volumes associated with promotional business of higher
sales price foil based sandwich wrap products with major quick service
restaurants (QSR'S). Overall, net sales of foodservice products increased $6,320
during the three months ended June 29, 2002 compared to the prior year. The
increased sales volume was partially offset by decreased selling price for paper
based products at some of our locations resulting from lower raw material costs
and increased competitive pricing in the marketplace.
Gross Profit
Gross profit increased 13.1% during the second quarter of 2002 compared
to the corresponding period in the 2001 primarily as a result of the increased
sales volume. The gross profit margin was 12% which was .4% higher than the same
period in 2001. The current period gross profit margin was favorably impacted by
lower raw material and energy costs partially offset by increased competitive
pricing in the marketplace.
Operating Expenses
Selling and administrative expenses increased $849 or 26.6% during the
second quarter of 2002 compared to the corresponding period in 2001. As a
percentage of net sales, selling and administrative expenses increased to 6.1%
during 2002 compared to 5.3% in 2001. The increase resulted primarily from
long-term incentive compensation expense and higher selling expenses associated
with the sales and marketing efforts of obtaining additional sales volumes of
specialty and converted paper and foil products and new product development
costs.
In conjunction with the merger and distribution announced by Ivex on
March 18, 2002, our equity value increased and we recorded a non-cash charge
during the three months ended June 29, 2002. We recorded additional long-term
incentive compensation expense of $219 that represented incremental earning and
vesting related to the 2001 Long-Term Incentive Compensation Plan for certain
key executives during the three months ended June 29, 2002. For the three months
ended June 30, 2001, the Company recorded no expense related to this plan.
On January 1, 2002, we adopted SFAS No. 141 "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets". These statements eliminate
the pooling-of-interest method of accounting for business combinations and
requires goodwill and intangible assets with indefinite lives to no longer be
amortized but to instead be tested for impairment at least annually. Other
intangible assets with determinable lives will continue to be amortized over
their useful lives. We applied the new rules on accounting for goodwill and
other intangible assets effective January 1, 2002. The application of this
statement resulted in the reduction of goodwill amortization of $235 for the
three months ended June 29, 2002 compared to the corresponding period in 2001.
Income From Operations.
Income from operations and operating margins were $3,798 and 5.8%,
respectively, during the second quarter of 2002 compared to income from
operations and operating margin of $3,521 and 5.9%, respectively, during the
second quarter of 2001. The increase in operating income resulted primarily from
the increased sales volume and the elimination of amortization of goodwill. The
decrease in operating margin during the second quarter of 2002 compared to 2001
resulted primarily from increase in operating expenses.
12
Other Income (Expense)
Other expense of $118 during the second quarter of 2002 was primarily
attributable to the loss on the sale of certain converting equipment. The
elimination of this equipment is part of our ongoing productivity improvement
program. We expect to continue the productivity improvement program which may
result in future gains or losses on the sale of equipment.
Interest Expense
Interest expense during 2002 was $2,280 compared to $2,803 during the
same period in 2001. The decrease in interest expense in 2002 compared to 2001
resulted primarily from decreased average outstanding indebtedness and reduced
interest rates. The average interest rate on borrowings on our senior credit
facility were approximately 2.16% less during 2002 compared to 2001. This
decrease in 2002 was partially offset by an increase in paid-in-kind interest
accruing on the 12% Promissory Note payable to Ivex. Paid-in-kind interest
expense on the 12% Promissory Note was $558 and $500 during 2002 and 2001.
Income Taxes
Federal and state taxable income is reported by the members on their
income tax returns as if we were a partnership. International Converter, Inc.
("ICI") has remained a taxable C corporation since its acquisition by us in
July, 1999. As a result, we provide for federal and state income taxes on the
income of the ICI subsidiary. The income tax expense for the second quarter of
2002 was $293 as compared to $82 in the second quarter of 2001. The increase in
income tax expense was primarily associated with strong earnings on products
sold through ICI.
Net Income
Net income increased to $1,107 during the second quarter of 2002
compared to net income of $640 in the prior year. The increase was primarily
attributable to the higher sales volume and margins and the reduction in
amortization of goodwill. These favorable items were negatively offset by higher
operating expenses including the long-term incentive compensation charge.
EBITDA and Adjusted EBITDA
We have presented EBITDA information solely as supplemental disclosure
because we believe that it is generally accepted as providing useful information
regarding our ability to service or incur debt. We have furnished adjusted
EBITDA to provide additional information regarding supplemental items that we
believe are of interest to investors.
EBITDA consists of earnings from operations plus depreciation and
amortization. EBITDA should not be construed as an alternative to earnings from
operations as determined in accordance with generally accepted accounting
principles, as an indicator of our operating performance, as a measure of
liquidity or as an alternative to cash flow from operating activities as
determined in accordance with generally accepted accounting principles. We have
significant uses of cash flow, including capital expenditures and debt principal
repayments that are not reflected in EBITDA. It should also be noted that not
all companies that report EBITDA or Adjusted EBITDA information calculate EBITDA
or Adjusted EBITDA in the same manner as we do.
Adjusted EBITDA is EBITDA plus the supplemental adjustments summarized in
the table below. Adjusted EBITDA is not a calculation prepared in accordance
with generally accepted accounting principles. It should not be considered in
isolation or as a substitute for measures of performance in accordance with
generally accepted accounting principles and is not indicative of operating
profit or cash flow from operations as determined under generally accepted
accounting principles. EBITDA and Adjusted EBITDA for the three months ended
June 29, 2002 and June 30, 2001 are computed as follows:
THREE MONTHS ENDED
------------------
JUNE 29, JUNE 30,
2002 2001
---------- ---------
Income from operations, as reported $ 3,798 $ 3,521
Depreciation and amortization 1,981 2,039
---------- ---------
EBITDA 5,779 5,560
Long-Term incentive compensation expense 219 --
---------- ---------
Adjusted EBITDA $ 5,998 $ 5,560
========== =========
13
In the three months ended June 29, 2002, Adjusted EBITDA and Adjusted
EBITDA margins were $5,998 and 9.1% respectively as compared to $5,560 and 9.3%
respectively in the three months ended June 30, 2001. The increase in Adjusted
EBITDA primarily resulted from increased sales volume and improved gross profit.
The decrease in Adjusted EBITDA margin primarily resulted from increased
operating expenses.
RESULTS OF OPERATIONS - FOR THE SIX MONTHS ENDED JUNE 29, 2002 AND JUNE 30, 2001
Net Sales
Net sales increased by 7.8% during the first six months of 2002 over
our net sales during the corresponding period in 2001. The increase primarily
resulted from additional volume associated with promotional business of higher
sales price foil based sandwich wrap products with major quick service
restaurants (QSR'S). Overall, net sales of foodservice products increased
$10,727 during the six months ended June 29, 2002 compared to the prior year.
The increased sales volume was partially offset by decreased selling price for
paper based products at all locations resulting from lower raw material costs
and increased competitive pricing in the marketplace.
Gross Profit
Gross profit increased 9.3% during the first six months of 2002
compared to the corresponding period in the prior year primarily as a result of
the increased sales volume. The gross profit margin was 11.8% which was .2%
higher than 2001. The current period gross profit margin was favorably impacted
by lower raw material and energy costs partially offset by increased competitive
pricing in the marketplace.
Operating Expenses
Selling and administrative expenses increased $2,290 or 34.7% during
the six months ended June 29, 2002 compared to the corresponding period in 2001.
As a percentage of net sales, selling and administrative expenses increased to
7.1% during 2002 compared to 5.7% in 2001. The increase resulted primarily from
long term incentive compensation expense and higher selling expenses associated
with the sales and marketing efforts of obtaining additional sales volumes of
specialty and converted paper and foil products and new product development
costs.
In conjunction with the merger and distribution announced by Ivex on
March 18, 2002, our equity value increased and accordingly, we recorded a
non-cash charge of $1,295 during the six months ended June 29, 2002. The $1,295
long-term incentive compensation expense recorded during the six months ended
June 29, 2002 represents the earned and vested portion of the 2001 Long-Term
Incentive Compensation Plan for certain key executives through June 29, 2002.
For the six months ended June 30, 2001, we recorded no expense related to this
plan.
On January 1, 2002, we adopted SFAS No. 141 "Business Combinations" and
SFAS No. 142, "Goodwill and Other Intangible Assets". These statements eliminate
the pooling of interest method of accounting for business combinations and
requires goodwill and intangible assets with indefinite lives to no longer be
amortized but to instead be tested for impairment at least annually. Other
intangible assets with determinable lives will continue to be amortized over
their useful lives. We applied the new rules on accounting for goodwill and
other intangible assets effective January 1, 2002. The application of this
statement resulted in the reduction of goodwill amortization of $467 for the six
months ended June 29, 2002 compared to the corresponding period in 2001.
Income From Operations
Income from operations and operating margins were $5,897 and 4.7%,
respectively, during the first six months of 2002 compared to income from
operations and operating margin of $6,496 and 5.6%, respectively, during the
same period of 2001. The decrease in operating income and margin in 2002
compared to 2001 primarily resulted from the long-term incentive compensation
expense, additional selling expenses associated with obtaining additional
specialty and converted paper and foil sales and increased product development
costs. These unfavorable factors were partially offset by the increased sales
volume, improved gross profit margins and the elimination of amortization of
goodwill in 2002.
Other Income (Expense)
Other expense of $13 during 2002 was comprised of a loss on the sale of
converting equipment of $118 recorded during the second quarter of 2002
partially offset by a gain on the sale of a parcel of land in Ohio recorded
during the first quarter of 2002.
14
Interest Expense
Interest expense during 2002 was $4,576 compared to $5,809 during the
same period in 2001. The decrease in interest expense in 2002 compared to 2001
resulted primarily from decreased average outstanding indebtedness as a result
of reductions in working capital and reduced interest rates. The average
interest rate on borrowings on our senior credit facility were approximately
1.74% less during 2002 compared to 2001. This decrease in 2002 was partially
offset by an increase in paid-in-kind interest accruing on the 12% Promissory
Note payable to Ivex. Paid-in-kind interest expense on the 12% Promissory Note
was $1,106 and $986 during the first six months of 2002 and 2001, respectively.
Income Taxes
Federal and state taxable income is reported by the members on their
income tax returns as if we were a partnership. International Converter, Inc.
("ICI") has remained a taxable C corporation since its acquisition by us in
July, 1999. As a result, we provide for federal and state income taxes on the
income of the ICI subsidiary. The income tax expense for the first quarter of
2002 was $681 as compared to $28 in the same period of 2001. The increase in
income tax expense was primarily associated with strong earnings on products
sold through ICI.
Net Income
Net income was $627 during the first six months of 2002 compared to net
income of $661 in the prior year. The decrease was primarily attributed to the
$1,295 long-term incentive expense in 2002 partially offset by increased sales
volume and reduced interest expense.
EBITDA and Adjusted EBITDA
We have presented EBITDA information solely as supplemental disclosure
because we believe that it is generally accepted as providing useful information
regarding our ability to service or incur debt. We have furnished adjusted
EBITDA to provide additional information regarding supplemental items that we
believe are of interest to investors.
EBITDA consists of earnings from operations plus depreciation and
amortization. EBITDA should not be construed as an alternative to earnings from
operations as determined in accordance with generally accepted accounting
principles, as an indicator of our operating performance, as a measure of
liquidity or as an alternative to cash flow from operating activities as
determined in accordance with generally accepted accounting principles. We have
significant uses of cash flow, including capital expenditures and debt principal
repayments that are not reflected in EBITDA. It should also be noted that not
all companies that report EBITDA or Adjusted EBITDA information calculate EBITDA
or Adjusted EBITDA in the same manner as we do.
Adjusted EBITDA is EBITDA plus the supplemental adjustments summarized
in the table below. Adjusted EBITDA is not a calculation prepared in accordance
with generally accepted accounting principles. It should not be considered in
isolation or as a substitute for measures of performance in accordance with
generally accepted accounting principles and is not indicative of operating
profit or cash flow from operations as determined under generally accepted
accounting principles. EBITDA and Adjusted EBITDA for the six months ended June
29, 2002 and June 30, 2001 are computed as follows:
SIX MONTHS ENDED
----------------
JUNE 29, JUNE 30,
2002 2001
--------- ----------
Income from operations, as reported $ 5,897 $ 6,496
Depreciation and amortization 3,940 4,045
--------- ----------
EBITDA 9,837 10,541
Long-Term incentive compensation expense 1,295 --
--------- ----------
Adjusted EBITDA $ 11,132 $ 10,541
========= ==========
15
In the six months ended June 29, 2002, Adjusted EBITDA and Adjusted
EBITDA margins were $11,132 and 8.9% respectively as compared to $10,541 and
9.0% respectively in the six months ended June 30, 2001. The increase in
Adjusted EBITDA primarily resulted from increased sales volume and gross profit
margin. The decrease in Adjusted EBITDA margin primarily resulted from increased
operating expenses.
DISCLOSURE ABOUT CRITICAL ACCOUNTING POLICIES
On December 12, 2001, the SEC issued FR-60, "Cautionary Advice
Regarding Disclosure About Critical Accounting Policies". We have been advised
that FR-60 is an intermediate step to alert companies to the need for greater
investor awareness of the sensitivity of financial statements to the methods,
assumptions, and estimates underlying their preparation including the judgments
and uncertainties affecting the application of those policies, and the
likelihood that materially different amounts would be reported under different
conditions or using different assumptions.
Our accounting policies are disclosed in Note 1 to our interim
consolidated financial statements. The more critical of our policies include
revenue recognition, long-lived assets and the use of estimates in valuing
inventories and accounts receivable which are described below.
Revenue Recognition
We recognize revenue primarily at the time title transfers to the
customer (generally upon shipment of products). Our revenue recognition policies
are in accordance with Staff Accounting Bulletin, or SAB, No. 101, "Revenue
Recognition in Financial Statements". Shipping and handling costs are included
as a component of cost of goods sold.
Inventories
We state inventories at the lower of cost or market using the first-in,
first-out, or FIFO, method to determine the cost of raw materials and finished
goods. This cost includes raw materials, direct labor and manufacturing
overhead. Valuing inventories at the lower of cost or market requires the use of
estimates and judgment. Our policy is to evaluate all inventory quantities for
amounts on-hand that are potentially in excess of estimated usage requirements,
and to write down any excess quantities to estimated net realizable value.
Inherent in the estimates of net manufacturing schedules, customer demand,
possible alternative uses and ultimate realization of potentially excess
inventory.
Accounts Receivable
Accounts receivable from sales to customers are unsecured, and we value
accounts receivable net of allowances for doubtful accounts. These allowances
are based on estimates of the portion of the receivables that will not be
collected in the future. However, the ultimate collectibility of a receivable is
significantly dependent upon the financial condition of the individual customer,
which can change rapidly and without advance warning.
Long-Lived Assets
Long-lived assets, including property, plant and equipment, other
assets and intangibles, are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of assets may not be
recoverable. If the expected future cash flows (undiscounted and without
interest charges) is less the carrying amount of the asset, an impairment loss
is recognized.
16
LIQUIDITY AND CAPITAL RESOURCES
At June 29, 2002, we had cash and cash equivalents of $2,191, and
$23,675 was available under the revolving portion of the Senior Credit Facility.
Our working capital at June 29, 2002 was $24,032.
Our primary short-term and long-term operating cash requirements are
for debt service, working capital and capital expenditures. We expect to rely on
cash generated from operations supplemented by revolving borrowings under the
Senior Credit Facility to fund principal short-term and long-term cash
requirements.
The Senior Credit Facility provides for Term A Loans and Term B Loans
totaling $89,250 and a $25,000 revolving credit facility, up to $5,000 of which
may be in the form of letters of credit. The Term A Loan had a balance of
$15,875 at June 29, 2002 and is required to be repaid in quarterly payments
totaling $2,500 in 2002, $6,000 in 2003, and $7,375 in 2004. The Term B Loan had
a balance of $57,715 at June 29, 2002 and is required to be repaid in quarterly
payments totaling $360 in 2002, $720 in 2003, $28,400 in 2004 and $28,235 in
2005.
Loans under the Senior Credit Facility are designated from time to
time, at our election, either (1) as Eurodollar Loans, which bear interest at a
rate based on the London Interbank Offered Rate, or LIBOR, adjusted for
regulatory reserve requirements, or (2) as Base Rate Loans, which bear interest
at a rate based on the Federal Funds Rate or the prime rate. The interest rate
on Eurodollar Loans is equal to LIBOR plus an applicable percentage that varies
with the leverage ratio of PDLLC and its consolidated subsidiaries. The interest
rate on Base Rate Loans is equal to
- a base rate equal to the greater of (1) the Federal Funds rate
plus 1/2 of 1% and (2) the prime rate, plus
- an applicable percentage that varies with the leverage ratio
of PDLLC and its consolidated subsidiaries.
Accordingly, Tranche A Term Loans and revolving loans bear interest at
rates of up to 2.5% plus the base rate, in the case of Base Rate Loans, and up
to 3.5% plus LIBOR, in the case of Eurodollar Loans. Tranche B Term Loans bear
interest at rates of up to 3.25% plus the base rate, in the case of Base Rate
Loans, and up to 4.25% plus LIBOR, in the case of Eurodollar Loans.
At June 29, 2002, the interest rates on borrowings under the Tranche A
Term Loan and the Tranche B Term Loan were 2.75% plus LIBOR and 3.75% plus
LIBOR, respectively, compared with 3.50% plus LIBOR and 4.25% plus LIBOR,
respectively, at June 30, 2001. As of June 29, 2002, we had interest rate swap
agreements with a group of banks having notional amounts totaling $40,000 and
maturing on December 10, 2003. These agreements effectively fix our LIBOR rate
for $40,000 of our indebtedness at a rate of 3.83%. Borrowings are
collateralized by substantially all of the assets of our operating subsidiaries.
The revolving credit facility and Term A Loan will terminate on November 20,
2004 and the Term B Loan will terminate on November 20, 2005.
Under the Senior Credit Facility, PDLLC is required to comply on a
quarterly basis with the following four financial covenants:
- under the leverage ratio covenant, as of the last day of each
fiscal quarter, PDLLC's ratio of total funded debt to
consolidated EBITDA for the 12-month period then ended must
not exceed specified levels, decreasing from 3.5 to 1 at
present to 2 to 1 from and after April 1, 2004;
- under the interest coverage ratio covenant, as of the last day
of each fiscal quarter, PDLLC's ratio of consolidated EBITDA
for the 12-month period then ended to cash interest expense
for such 12-month period must be equal to or greater than
certain specified levels, increasing from 2.75 to 1 at present
to 4 to 1 from and after July 1, 2004;
- under the fixed charge coverage ratio covenant, as of the last
day of each fiscal quarter, for the 12-month period then
ended, PDLLC's ratio of consolidated EBITDA less capital
expenditures and taxes to PDLLC's cash interest expense and
scheduled funded debt payments must be equal to or greater
than certain specified levels, increasing from 1.1 to 1 at
present to 1.3 to 1 from and after January 1, 2003; and
- under the net worth covenant, Packaging Holdings consolidated
net worth as of the last day of each fiscal quarter must be
equal to or greater than $27,500 increased on a cumulative
basis by (1) as of the last day of each fiscal quarter, 50% of
the consolidated net income of Packaging Holdings (to the
extent positive) for the fiscal quarter then ended, commencing
with the fiscal quarter ended December 31, 1998 and (2) 50% of
the net cash proceeds from any equity issuance after November
20, 1998 by Packaging Holdings or any subsidiary of Packaging
Holdings.
17
For purposes of the Senior Credit Facility, consolidated EBITDA,
calculated on a consolidated basis for PDLLC and its subsidiaries, consists of
(1) net income, excluding the effect of any extraordinary or other non-recurring
gains or losses or non-cash losses, plus (2) an amount which, in the
determination of net income, has been deducted for interest expense, taxes,
depreciation and amortization.
The Senior Credit Facility also contains various negative covenants that,
among other things, require Packaging Holdings and its subsidiaries to limit
future capital expenditures, borrowings, dividend payments, and payments to
related parties, and restricts Packaging Holdings' ability and the ability of
its subsidiaries to merge or consolidate. In addition, the Senior Credit
Facility prevents our subsidiaries from making distributions, prohibits changes
in the nature of business conducted by our subsidiaries and effectively
requires, subject to limited exceptions, that Packaging Dynamics'
pre-distribution stockholders, other than Ivex, retain beneficial ownership of
at least 51% in Packaging Dynamics. The failure to comply with the covenants
would result in a default under the Senior Credit Facility and permit the
lenders under the Senior Credit Facility to accelerate the maturity of the
indebtedness governed by the senior credit facility. We believe that we are
currently in compliance with the terms and conditions of the Senior Credit
Facility in all material respects.
Packaging Holdings issued the 12% Promissory Note in the amount of $12,500
to Ivex on November 20, 1998 in connection with the acquisition of Ivex's paper
mill operations located in Detroit, Michigan. Interest on this note is currently
paid in kind at a rate of 12% on a semi-annual basis, and the note had an
accreted value of $19,238 at June 29, 2002. The 12% Promissory Note is
unsecured, subordinated to the Senior Credit Facility and matures on November
21, 2005. The note was cancelled on July 1, 2002 in connection with the
distribution.
On July 14, 1999, Packaging Holdings issued a $3,000 note to the sellers
in connection with the acquisition of ICI. Interest on this note is 7.5% payable
semi-annually commencing on December 31, 1999. This note is unsecured and
subordinated to the senior credit facility. The note matures on July 14, 2004
and may be accelerated under specified circumstances, including a change in
control or an acceleration under the Senior Credit Facility.
The Senior Credit Facility and the ICI note include terms that limit
changes in our ownership structure. Modifications to the ownership structure
outside the limits prescribed by such agreements could place us in default under
these debt instruments. We do not believe that the distribution and common stock
exchange as described in the merger agreement by and between Ivex and Alcoa will
result in a change in control as defined in the Senior Credit Facility or the
ICI note.
We have outstanding obligations under debt agreements with the U.S.
Department of Housing and Urban Development, or HUD, in the form of promissory
notes payable to the City of Baxter Springs. These notes bear interest at rates
varying from 4.57% to 6.57%, as determined by HUD, and interest is payable on a
semi-annual basis. These notes are payable in annual installments of $700
through August 2004. Borrowings are collateralized by a first lien on the land
and building at our Baxter Springs, Kansas production facility and by a second
lien on specified machinery and equipment. Under specified circumstances,
repayment of the borrowings is subordinated to the repayment of obligations
under the senior credit facility.
To reduce the impact of changes in interest rates on our variable rate
debt, the Company has entered into interest rate derivative instruments, which
are discussed in " -- Quantitative and Qualitative Disclosures About Market
Risk".
We made capital expenditures for the six months ended June 29, 2002 and
June 30, 2001 of $2,229 and $1,167, respectively. The increase in capital
expenditures during 2002 compared to 2001 resulted primarily from expenditures
that are expected to improve and increase converting productivity and capacity
as well as reduce utility related costs at our paper mill facility. At June 29,
2002, we have capital projects ongoing at all locations. In 2002, capital
expenditures are expected to approximate $5,000.
During the six months ended June 29, 2002, we made payments related to
restructuring reserves totaling $35. The remaining reserve balance at June 29,
2002 of $92 represents future severance payments.
On January 22, 2002, the SEC issued FR-61, "Commission Statement about
Management's Discussion and Analysis of Financial Condition and Results of
Operations." While the SEC intends to consider rulemaking regarding the topics
addressed in this statement and other topics covered by management's discussion
and analysis, the purpose of this statement is to suggest steps that issuers
should consider in meeting their current disclosure obligations with respect to
the topics described. Generally, FR-61 addresses disclosure relating to (1)
liquidity and capital resources, including "off balance sheet" arrangements, (2)
certain trading activities that include non-exchange traded contracts accounted
for at fair value and (3) effects of transactions with related and certain other
parties.
The Senior Credit Facility requires PDLLC to maintain specified financial
ratios and levels of tangible net worth. PDLLC was in compliance with those
covenants as of June 29, 2002, the latest measurement date. The occurrence of
any default of these covenants could result in acceleration of our obligations
under the Senior Credit Facility ($73,590 as of June 29, 2002) and foreclosure
on the collateral securing those obligations.
18
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses the accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. SFAS No. 143 requires that the fair value of
a liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. SFAS
No. 143 is effective for financial statements issued for fiscal years beginning
after June 15, 2002. We do not expect SFAS No. 143 to have a material effect on
our consolidated financial position or cash flows.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FAS Nos. 4,
44, and 64, Amendment of FAS 13 and Technical Corrections as of April 2002"
which mainly addresses the accounting and disclosure related to early
extinguishment of debt transactions as well as several other technical
corrections. SFAS No. 145 is effective for financial statements for fiscal years
beginning after May 15, 2002 with early application encouraged. We do not expect
SFAS No. 145 to have a material effect on our consolidated financial position or
cash flows.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" which nullifies EITF Issue No.
94-3, "Liability Recognition for Certain Employee Termination Benefits and other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The principle difference in accounting under SFAS No. 146 is
that a liability for the cost associated with an exit or disposal activity
cannot be recognized until the liability has been incurred. Under EITF 94-3, an
exit cost liability could be recognized at the date of any entity's commitment
to an exit plan. SFAS No. 146 is effective for exit or disposal activities
initiated after December 31, 2002 with early application encouraged. We do not
expect SFAS No. 146 to have a material effect on our consolidated financial
position or cash flows.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use interest rate swaps and collars to modify our exposure to interest
rate movements and to reduce borrowing costs. We have designated these
instruments as cash flow hedges and consider these instruments effective at
offsetting our risk to variable interest rates on debt. Our exposure to interest
rate risk consists of floating rate debt instruments that are benchmarked to
LIBOR. As of June 29, 2002, we had interest rate swap agreements with a group of
banks having notional amounts totaling $40,000 and maturing on December 10,
2003. These agreements effectively fix our LIBOR rate for $40,000 of our Senior
Credit Facility indebtedness at a rate of 3.83%. A 10% unfavorable movement in
LIBOR would not expose us to material losses of earnings or cash flows.
Income or expense related to settlements under these agreements is
recorded as adjustments to interest expense in our financial statements. The
fair market value of our derivative instruments outlined above approximates a
loss of $704 as of June 29, 2002 and is based upon the amount at which it could
be settled with a third party, although we have no current intention to trade
any of these instruments and plan to hold them as hedges for the Senior Credit
Facility. The fair market value of our derivative instruments, net of tax, was
recorded in other comprehensive income (loss).
SPECIAL NOTE REGARDING FORWARD -- LOOKING STATEMENTS
Certain statements in "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Results of Operations -- For
the Six Months Ended June 29, 2002 -- Liquidity and Capital Resources, and --
Quantitative and Qualitative Disclosure About Market Risk" constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 (the "Reform Act"). Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of the Company
to be materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Among the factors that
could cause results to differ materially from current expectations are: (i)
changes in consumer demand and prices resulting in a negative impact on revenues
and margins; (ii) raw material substitutions and increases in the costs of raw
materials, utilities, labor and other supplies; (iii) increased competition in
the Company's product lines; (iv) changes in capital availability or costs; (v)
workforce factors such as strikes or labor interruptions; (vi) the ability of
the Company and it subsidiaries to develop new products, identify and execute
capital programs and efficiently integrate acquired businesses; (vii) the cost
of compliance with applicable governmental regulations and changes in such
regulations, including environmental regulations; (viii) the general political,
economic and competitive conditions in markets and countries where the Company
and its subsidiaries operate, including currency fluctuations and other risks
associated with operating in foreign countries; and (ix) the timing and
occurrence (or non-occurrence) of transactions and events which may be subject
to circumstances beyond the control of the Company and its subsidiaries.
19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time Packaging Dynamics and its subsidiaries are involved
in various litigation matters arising in the ordinary course of business.
Packaging Dynamics believes that none of the matters which arose during the
quarter, either individually or in the aggregate, is material to Packaging
Dynamics.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit No. Description
----------- -----------
2 Amendment to Distribution Agreement dated as of March
18, 2002 between Ivex Packaging Corporation and
Packaging Dynamics Corporation, dated July 1, 2002
4.1 Stockholders Agreement among Packaging Dynamics
Corporation, DCBS Investors, L.L.C., CB Investors,
L.L.C. and Packaging Investors, L.P., dated July 1,
2002
4.2 Registration Rights Agreement by and among Packaging
Dynamics Corporation, Packaging Investors, L.P., DCBS
Investors, L.L.C. and CB Investors, L.L.C., dated
July 1, 2002
10 Tax Sharing Agreement by and between Ivex Packaging
Corporation and Packaging Dynamics Corporation, dated
July 1, 2002
99 Certification of CEO and CFO Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
SIGNATURE
Pursuant to the requirements 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.
PACKAGING DYNAMICS CORPORATION
By: /s/ DAVID E. WARTNER
-------------------------
DAVID E. WARTNER
Vice President and Chief Financial Officer
August 8, 2002
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