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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 SEPTEMBER 28, 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
At November 7, 2002, there were 9,618,767 shares of common stock, par
value $0.01 per share, outstanding.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PACKAGING DYNAMICS CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
September 28, December 31,
2002 2001
------------- ------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents .................................... $ 8,891 $ 1,041
Accounts receivable trade (net of allowance for doubtful
accounts of $322 and $373, respectively) ................... 24,507 18,859
Inventories .................................................. 28,957 30,692
Prepaid expenses and other.................................... 4,816 3,652
--------- ---------
Total current assets .................................... 67,171 54,244
--------- ---------
Property, Plant and Equipment:
Buildings and improvements ................................... 23,643 23,584
Machinery and equipment ...................................... 65,712 64,484
Projects in progress ......................................... 1,502 396
--------- ---------
90,857 88,464
Less - accumulated depreciation .............................. (25,909) (20,930)
--------- ---------
64,948 67,534
Land ......................................................... 1,276 1,297
--------- ---------
Total property, plant and equipment ..................... 66,224 68,831
--------- ---------
Other Assets:
Goodwill, net of accumulated amortization .................... 34,329 34,329
Miscellaneous ................................................ 1,997 2,606
--------- ---------
Total other assets ...................................... 36,326 36,935
--------- ---------
Total Assets ...................................................... $ 169,721 $ 160,010
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY/MEMBERS' EQUITY
Current Liabilities:
Current maturities of long-term debt ......................... $ 6,920 $ 6,420
Accounts payable ............................................. 25,858 16,424
Accrued salary and wages ..................................... 2,249 1,763
Other accrued liabilities .................................... 6,609 4,355
--------- ---------
Total current liabilities ............................... 41,636 28,962
Long-Term Debt .................................................... 69,640 76,830
Note Payable to Related Party ..................................... -- 18,132
Other Liabilities ................................................. 2,498 --
Deferred Income Taxes ............................................. 10,604 2,089
--------- ---------
Total Liabilities ................................................. 124,378 126,013
--------- ---------
Commitments and Contingencies (Note 7) ............................
--------- ---------
Stockholders' Equity/Members' Equity:
Common stock, $.01 par value--40,000,000 shares authorized;
(9,452,100 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 ....................... 44,578 --
Other comprehensive income ................................... (204) --
Retained earnings ............................................ 875 --
Members' equity .............................................. -- 33,997
--------- ---------
Total stockholders' equity/members' equity .............. 45,343 33,997
--------- ---------
Total Liabilities and Stockholders' Equity/Members' Equity ........ $ 169,721 $ 160,010
========= =========
The accompanying notes are an integral part of this statement.
2
PACKAGING DYNAMICS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
For the Three Months Ended, For the Nine Months Ended,
September 28, September 29, September 28, September 29,
2002 2001 2002 2001
------------- ------------- ----------- ------------
Net sales .......................... $ 64,132 $62,394 $ 189,988 $ 179,126
Cost of goods sold ................. 55,870 54,264 166,897 157,427
----------- ------- ----------- -----------
Gross profit ....................... 8,262 8,130 23,091 21,699
----------- ------- ----------- -----------
Operating expenses:
Selling ...................... 1,794 1,687 5,486 4,841
General and administrative ... 3,269 1,799 8,473 5,251
Amortization of intangibles .. 18 230 54 697
----------- ------- ----------- -----------
Total operating expenses ........... 5,081 3,716 14,013 10,789
----------- ------- ----------- -----------
Income from operations ............. 3,181 4,414 9,078 10,910
Other income (expense), net ........ (233) (13) (246) (11)
Interest expense ................... (1,501) (2,700) (6,077) (8,509)
----------- ------- ----------- -----------
Income before income taxes ......... 1,447 1,701 2,755 2,390
Income tax provision ............... 572 180 1,253 208
----------- ------- ----------- -----------
Net income ......................... $ 875 $ 1,521 $ 1,502 $ 2,182
=========== ======= =========== ===========
Net income per share (Note 1):
Basic ..................... $ 0.09
===========
Fully diluted ............. $ 0.09
===========
Weighted average shares outstanding:
Basic ..................... 9,446,391
===========
Fully diluted ............. 9,649,162
===========
The accompanying notes are an integral part of this statement.
3
PACKAGING DYNAMICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
For the Nine Months Ended,
September 28, 2002 September 29, 2001
------------------ ------------------
Cash flows from operating activities:
Net income ...................................................................... $ 1,502 $ 2,182
Adjustments to reconcile net income to net cash from operating activities:
Depreciation ............................................................... 5,667 5,389
Amortization of intangibles assets ......................................... 54 697
Amortization of deferred finance costs ..................................... 555 571
Loss on disposal of equipment .............................................. 246 15
Provision for doubtful accounts ............................................ (51) (88)
Non-cash charge for long-term incentive compensation ....................... 2,545 --
Non-cash interest to related party ......................................... 1,106 1,503
Changes in operating assets and liabilities:
Accounts receivable ..................................................... (5,597) (3,713)
Inventories ............................................................. 1,735 7,541
Other assets ............................................................ (1,321) (1,411)
Accounts payable and accrued liabilities ................................ 11,135 (2,669)
-------- --------
Net cash from operating activities ................................ 17,576 10,017
-------- --------
Cash flows from (used by) investing activities:
Proceeds from sale of assets ............................................... 402 33
Additions to property, plant and equipment ................................. (3,551) (2,912)
-------- --------
Net cash used by investing activities ............................. (3,149) (2,879)
-------- --------
Cash flows from (used by) financing activities:
Payment of financing costs ................................................. -- (357)
Principal payments for loan obligations .................................... (4,990) (3,560)
Proceeds under revolving line of credit .................................... 21,900 39,200
Repayments under revolving line of credit .................................. (23,600) (42,000)
Other, net ................................................................. 113 (273)
-------- --------
Net cash used by financing activities ............................. (6,577) (6,990)
-------- --------
Net increase in cash and cash equivalents ............................................ 7,850 148
Cash and cash equivalents at beginning of period ..................................... 1,041 460
-------- --------
Cash and cash equivalents at end of period ........................................... $ 8,891 $ 608
======== ========
Supplemental cash flow disclosures:
Cash paid during the period for:
Interest ................................................................... $ 4,101 $ 6,567
Income taxes ............................................................... 889 36
Cancellation of subordinated note payable ....................................... 19,238 --
The accompanying notes are an integral part of this statement.
4
PACKAGING DYNAMICS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY/MEMBERS' EQUITY AND
OTHER COMPREHENSIVE INCOME (LOSS)
(DOLLARS IN THOUSANDS)
Packaging Dynamics Corporation Packaging Holdings, L.L.C.
------------------------------- --------------------------------------
Common Stock Retained
------------------ Contributions Advances Earnings
Paid In from To (Accumulated
Shares Amount Capital Members Members (Deficit)
--------- ------- ------- ------------- --------- ------------
Balance at December 31, 2000 $ 34,579 $ (25) $ (2,074)
Net income 2,344
Due from members (273)
Other comprehensive income (loss):
Cumulative effect of change in
accounting principle for derivatives
and hedging activities
Reclassification of derivative losses to earnings
Change in fair value of derivative instruments
--------- ---- -------- -------- -------- --------
Comprehensive income
Balance at December 31, 2001 34,579 (298) 270
Formation of Packaging Dynamics
Corporation (Note 1) 9,437,850 $ 94 $ 44,475 (34,579) 298 (897)
Net income 1,502
Exercise of common stock options 14,350 103
Other comprehensive income (loss):
Reclassification of derivative losses
to earnings
Change in fair value of derivative
instruments, net of income taxes
Comprehensive income
--------- ---- -------- -------- -------- --------
Balance at September 28, 2002 (Unaudited) 9,452,100 $ 94 $ 44,578 $ -- $ -- $ 875
========= ==== ======== ======== ======= ========
Packaging Holdings, L.L.C.
--------------------------------------------------------
Accumulated
Other Stockholders'
Comprehensive /Members' Comprehensive
Income (Loss) Equity Income (Loss)
---------------- ------------- --------------
Balance at December 31, 2000 $ -- $ 32,480
Net income 2,344 $ 2,344
Due from members (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 (554) 33,997
Formation of Packaging Dynamics
Corporation (Note 1) 704 10,095
Net income 1,502 1,502
Exercise of common stock options 103
Other comprehensive income (loss):
Reclassification of derivative losses
to earnings 908 908 908
Change in fair value of derivative
instruments, net of income taxes (1,262) (1,262) (1,262)
--------- --------- ---------
Comprehensive income $ 1,148
=========
Balance at September 28, 2002 (Unaudited) $ (204) $ 45,343
======== =========
The accompanying notes are an integral part of this statement.
5
PACKAGING DYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
NOTE 1--BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Packaging Dynamics Corporation ("the Company" or "Packaging Dynamics") is
a Delaware corporation established as a holding company to own all of the
limited liability interest in Packaging Holdings L.L.C. ("Packaging Holdings" or
"PHLLC"). Packaging Holdings is a limited liability company organized under the
laws of the state of Delaware and is the sole member of Packaging Dynamics,
L.L.C. ("PDLLC") which is the parent company of several operating subsidiaries.
On March 18, 2002, the board of directors of Ivex Packaging Corporation
("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, a C-corporation for income tax
purposes, 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. The consolidated financial
statements of Packaging Dynamics presented herein include the results of
operations, financial position and cash flows of Packaging Holdings.
Also in connection with the merger and distribution, a new holding company
structure was created by contributing all of the limited liability company
interests of Packaging Holdings to Packaging Dynamics, a C-corporation for
income tax purposes, in exchange for the common stock; the $12,500 12%
subordinated note payable to Ivex, plus accreted interest, totaling
approximately $19,238 was canceled; and a consulting agreement with Ivex was
canceled. The impact of the distribution is reflected on the Consolidated
Statements of Stockholders' Equity/Members' Equity and Other Comprehensive
Income (Loss) as Formation of Packaging Dynamics Corporation. The impact on
Stockholders' Equity of the distribution includes (i) an increase of $19,238
resulting from the cancellation of the $12,500 12% subordinated note payable to
Ivex; (ii) a decrease of $9,200 resulting from additional deferred tax
liabilities due to Packaging Dynamics' C-corporation status; (iii) an increase
of $423 resulting from the repayment of certain advances and obligations of
members of Packaging Holdings; and (iv) a decrease of $366 resulting from
expenses associated with the transaction.
On July 1, 2002, the Company issued 9,437,750 shares of common stock in
connection with the merger and distribution. Prior to July 1, 2002, the Company
ownership consisted of membership units. Accordingly, no earnings per share
information has been presented for any period prior to July 1, 2002.
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 nine months ended
September 28, 2002 and September 29, 2001 and the financial position at
September 28, 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.
6
PACKAGING DYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
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 September 29, 2002 and December
31, 2001 consist of the following:
SEPTEMBER 28, DECEMBER 31,
2002 2001
------------ ------------
Raw materials $ 13,280 $ 11,211
Work-in-process 1,233 1,385
Finished goods 14,444 18,096
-------- --------
$ 28,957 $ 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 25 years for machinery and
equipment). The Company changed the estimate of useful lives for certain of its
paper machinery and equipment to have a maximum useful life of 25 years
resulting in a net reduction of annual depreciation expense of $200.
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.
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.
7
PACKAGING DYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
(UNAUDITED)
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.
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 nine months of 2002 which indicated no transitional impairment charge was
required.
A comparison of net income for the first nine months of 2002 and net
income for the first nine months of 2001 adjusted to remove goodwill
amortization is as follows:
For the Three Months Ended, For the Nine Months Ended,
September 28, September 29, September 28, September 29,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Reported net income $ 875 $ 1,521 $ 1,502 $ 2,182
Add back: Goodwill amortization -- 230 -- 697
------- -------- -------- --------
Adjusted net income $ 875 $ 1,751 $ 1,502 $ 2,879
======= ======== ======== ========
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 stockholders'
equity/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, and at September 28, 2002, the fair value
approximates a loss of $1,044 which is 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.
8
PACKAGING DYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
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 its 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 its consolidated
financial position or cash flows.
RECLASSIFICATION
Certain prior period amounts have been reclassified to conform to the
current period's presentation.
NOTE 2--OTHER ASSETS
Other assets at September 28, 2002 and December 31, 2001 consist of the
following:
September 28, 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 (7,734) (7,125)
------- -------
$ 1,997 $ 2,606
======= =======
9
PACKAGING DYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(DOLLARS IN THOUSANDS)
(UNAUDITED)
NOTE 3--LONG-TERM DEBT
Long-term debt at September 28, 2002 and December 31, 2001 consists of the
following:
September 28, December 31,
2002 2001
------------ ------------
Senior Credit Facility:
Tranche A Term Loan $ 14,625 $ 18,375
Tranche B Term Loan 57,535 58,075
Revolving credit loan -- 1,700
Seller note payable 3,000 3,000
Baxter Springs facility HUD loan 1,400 2,100
-------- --------
Subtotal 76,560 83,250
Current maturities of long term debt (6,920) (6,420)
-------- --------
Long-term debt $ 69,640 $ 76,830
======== ========
NOTE 4--RELATED PARTY TRANSACTIONS
PHLLC 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, 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 was unsecured and matured on November
21, 2005. On July 1, 2002, the note payable for $19,238 was canceled.
Pursuant to a consulting agreement, PHLLC paid Ivex an annual consulting
fee for management and administrative services rendered to PHLLC by Ivex
including financial, tax, accounting and legal services. During the first nine
months of 2002 and 2001, PHLLC recorded consulting fee expense of $250 and $396,
respectively, related to this agreement. On July 1, 2002, the consulting
agreement was canceled.
NOTE 5--INCOME TAXES
Packaging Dynamics' corporate structure is a C-corporation and, as such,
the federal and state taxable income of the Company and its subsidiaries is
recorded on the consolidated income tax returns of the Packaging Dynamics. Prior
to the distribution, the members of Packaging Holdings reported federal and
state taxable income on their income tax returns. International Converter, Inc.
("ICI") had remained a taxable C-corporation from the time the Company acquired
it in July, 1999 through the date of the distribution.
The Company recognizes deferred tax assets and liabilities based on the
differences between the financial statement and tax bases of assets and
liabilities. In connection with the merger and distribution, Packaging Dynamics
recorded deferred tax assets and liabilities associated with the differences
between the financial statement and tax bases of its consolidated assets and
liabilities. The increase in deferred tax liabilities related to the change in
tax status was approximately $9,200.
10
PACKAGING DYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
NOTE 6--EMPLOYEE BENEFIT PLANS
PHLLC had an unfunded 2001 Long-Term Incentive Compensation Plan (the
"2001 LTIP") for certain key executives prior to the distribution. 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, had
been granted. The plan was designed to reward those individuals on the increased
equity value of PHLLC, and provided that 40% of the incentive units were earned
on the effective date and the remaining 60% could have been earned based upon
PHLLC's attainment of certain annual earnings targets. Participants in the plan
vested on a pro-rata basis over three years from the plan's origination date. In
the event PHLLC completed a transaction which caused a substantial change in
ownership control, the plan provided for an accelerated vesting schedule.
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, 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 certain 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, which 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 Company recorded a non-cash compensation charge of
$1,372 and $2,667 for the third quarter and nine months ended September 28, 2002
related to these management incentive plans. During the third quarter, 43,397
options were repurchased from former employees for approximately $124.
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--SUBSEQUENT EVENT
On October 23, 2002, the Company announced the acquisition of Wolf
Packaging, Inc. ("Wolf") for approximately $10,700 comprised of $6,700 in cash,
$1,000 of newly issued common stock and $3,000 of assumed debt. Wolf is a
manufacturer of foil and paper sandwich wraps located in Fort Madison, Iowa.
Wolf is a significant supplier to the quick-service restaurant industry and
expects to generate annual revenues of approximately $22,000 during 2002.
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 Dynamics Corporation (the "Company," "Packaging Dynamics", "we" or
"our") which is a Delaware corporation established as a holding company to own
all of the limited liability company interests in Packaging Holdings, L.L.C.
("Packaging Holdings"), a Delaware limited liability company. Packaging Holdings
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 SEPTEMBER 28, 2002 AND
SEPTEMBER 29, 2001
Net Sales
Net sales increased by 2.8% during the third quarter of 2002 over our net
sales during the corresponding period in 2001. The increase resulted primarily
from additional volumes associated with promotional business of higher sales
price foil-based sandwich wrap products with major quick service restaurants
partially offset by lower sales price and volume of specialty paper products.
Overall, net sales of foodservice products increased $4,832 during the three
months ended September 28, 2002 compared to the prior year. Outside sales volume
of specialty paper decreased due to an increased mix of intercompany products
and increased competitive pricing in the marketplace.
Gross Profit
Gross profit increased 1.6% during the third 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 12.9% which was .1% lower than the
same period in 2001. The current period gross profit margin was unfavorably
impacted by increased competitive pricing in the marketplace primarily for
specialty paper, partially offset by reduced energy costs.
Operating Expenses
Selling and administrative expenses increased $1,577, or 45.2%, during the
third quarter of 2002 compared to the corresponding period in 2001. As a
percentage of net sales, selling and administrative expenses increased to 7.9%
during 2002 compared to 5.6% in 2001. The increase resulted primarily from
long-term incentive compensation expense discussed below, higher selling
expenses associated with the sales and marketing efforts and increased insurance
costs.
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, 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 certain 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, which 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, we have the right to
repurchase an executive's options if he terminates employment before the end of
the three-year period. We recorded a non-cash compensation charge of $1,372 for
the third quarter ended September 28, 2002 related to these management incentive
plans. For the three months ended September 29, 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
12
assets effective January 1, 2002. The application of this statement resulted in
the reduction of goodwill amortization of $230 for the three months ended
September 28, 2002 compared to the corresponding period in 2001.
Income from Operations
Income from operations and operating margins were $3,181 and 5.0%,
respectively, during the third quarter of 2002 compared to income from
operations and operating margin of $4,414 and 7.1%, respectively, during the
third quarter of 2001. The decrease in operating income resulted primarily from
the increased operating expenses including the long-term incentive compensation
charge partially offset by the elimination of amortization of goodwill. The
decrease in operating margin during the third quarter of 2002 compared to 2001
resulted primarily from increased operating expenses.
Other Income (Expense)
Other expense of $233 during the third 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 equipment.
Interest Expense
Interest expense during 2002 was $1,501 compared to $2,700 during the same
period in 2001. The decrease in interest expense in 2002 compared to 2001
resulted primarily from decreased average outstanding indebtedness, the
forgiveness of the 12% Promissory Note payable to Ivex and reduced interest
rates. The average interest rates on borrowings on our senior credit facility
were approximately 2.48% less during 2002 compared to 2001. The paid-in-kind
interest accruing on the 12% Promissory Note was zero and $517 during the third
quarter of 2002 and 2001, respectively, reflecting the cancellation of the 12%
Promissory Note payable to Ivex as of July 1, 2002.
Income Taxes
To facilitate the distribution on July 1, 2002, a new holding company
structure was created by contributing all of the limited liability company
interests of Packaging Holdings to Packaging Dynamics, a C-corporation for
income tax purposes, in exchange for the common stock. Prior to the
distribution, the members reported federal and state taxable income on their
income tax returns. International Converter, Inc. ("ICI"), a wholly owned
subsidiary, had remained a taxable C-corporation from the time we acquired it
in July, 1999 through the date of the distribution. The income tax provision for
the third quarter of 2002 was $572 as compared to $180 in the third quarter of
2001. The increase in income tax provision was primarily associated with our
change in filing status.
Net Income
Net income decreased to $875 during the third quarter of 2002 compared to
net income of $1,521 in the prior year. The decrease was primarily attributable
to the long-term incentive compensation charge and increased tax expense,
partially offset by the elimination of amortization of goodwill and reduced
interest.
RESULTS OF OPERATIONS - FOR THE NINE MONTHS ENDED SEPTEMBER 28, 2002 AND
SEPTEMBER 29, 2001
Net Sales
Net sales increased by 6.1% during the first nine months of 2002 over our
net sales during the corresponding period in 2001. The increase resulted
primarily from additional volume associated with promotional business of higher
sales price foil-based sandwich wrap products with major quick service
restaurants. Overall, net sales of foodservice products increased $15,556 during
the nine months ended September 28, 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.
13
Gross Profit
Gross profit increased 6.4% during the first nine 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 12.2% which was .1% higher
than 2001. The current period gross profit margin was favorably impacted by the
product mix as well as lower raw material and energy costs partially offset by
increased competitive pricing in the marketplace, primarily for specialty paper.
Operating Expenses
Selling and administrative expenses increased $3,867 or 38.3% during the
nine months ended September 28, 2002 compared to the corresponding period in
2001. As a percentage of net sales, selling and administrative expenses
increased to 7.4% during 2002 compared to 5.6% in 2001. The increase resulted
primarily from long-term incentive compensation expense discussed below, higher
selling expenses associated with the sales and marketing efforts and increased
insurance costs.
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, 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 certain 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, which 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, we have the right to
repurchase an executive's options if he terminates employment before the end of
the three-year period. We recorded a non-cash compensation charge of $2,667 for
the nine months ended September 28, 2002 related to these management incentive
plans. For the nine months ended September 29, 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
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. 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 $697 for the
nine months ended September 28, 2002 compared to the corresponding period in
2001.
Income from Operations
Income from operations and operating margins were $9,078 and 4.8%,
respectively, during the first nine months of 2002 compared to income from
operations and operating margin of $10,910 and 6.1%, respectively, during the
same period of 2001. The decrease in operating income resulted primarily from
the increased operating expenses including the long-term incentive compensation
charge partially offset by the elimination of amortization of goodwill. The
decrease in operating margin during the first nine months of 2002 compared to
2001 resulted primarily from increased operating expenses. These unfavorable
factors were partially offset by the increased sales volume and gross profit.
Other Income (Expense)
Other expense of $246 during 2002 was comprised of losses on the sale of
converting equipment of $351 partially offset by a gain on the sale of a parcel
of land in Ohio recorded during the first quarter of 2002. 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 equipment.
14
Interest Expense
Interest expense during 2002 was $6,077 compared to $8,509 during the same
period in 2001. The decrease in interest expense in 2002 compared to 2001
resulted primarily from decreased interest rates and average outstanding
indebtedness as a result of reductions in working capital and the cancellation
of the 12% Promissory Note payable to Ivex. The average interest rates on
borrowings on our senior credit facility were approximately 2.23% less during
2002 compared to 2001. The paid-in-kind interest expense on the 12% Promissory
Note was $1,106 during the first nine months of 2002 compared with $1,503 during
the first nine months of 2001, reflecting the cancellation of the 12% Promissory
Note payable to Ivex as of July 1, 2002.
Income Taxes
To facilitate the distribution on July 1, 2002, a new holding company
structure was created by contributing all of the limited liability company
interests of Packaging Holdings to Packaging Dynamics, a C-corporation for
income tax purposes, in exchange for the common stock. Prior to the
distribution, the members reported federal and state taxable income on their
income tax returns. ICI had remained a taxable C-corporation from the time we
acquired it in July, 1999 through the date of the distribution. The income tax
provision for the first nine months of 2002 was $1,253 compared to $208 in the
third quarter of 2001. The increase in income tax provision was primarily
associated with our change in filing status.
Net Income
Net income was $1,502 during the first nine months of 2002 compared to net
income of $2,182 in the prior year. The decrease was primarily attributable to
the long-term incentive compensation charge and increased tax expense, partially
offset by the elimination of amortization of goodwill and reduced interest.
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 is 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.
15
EBITDA and Adjusted EBITDA for the quarter ended and nine months ended
September 28, 2002 and September 29, 2001 are computed as follows:
For the Three Months Ended, For the Nine Months Ended,
September 28, September 29, September 28, September 29,
2002 2001 2002 2001
---------------- ---------------- ----------------- ---------------
Income from operations, as reported $ 3,181 $ 4,414 $ 9,078 $ 10,910
Depreciation and amortization 1,781 2,041 5,721 6,086
-------- -------- --------- --------
EBITDA 4,962 6,455 14,799 16,996
Long-term incentive compensation expense 1,372 -- 2,667 --
-------- -------- --------- --------
Adjusted EBITDA $ 6,334 $ 6,455 $ 17,466 $ 16,996
======== ======== ========= ========
In the three months ended September 28, 2002, Adjusted EBITDA and Adjusted
EBITDA margins were $6,334 and 9.9%, respectively, as compared to $6,455 and
10.4%, respectively, in the three months ended September 29, 2001. Adjusted
EBITDA was slightly below the prior year despite the increase in net sales due
to increased competitive pricing in the market place, primarily for specialty
paper, and slightly higher selling and administrative costs.
In the nine months ended September 28, 2002, Adjusted EBITDA and Adjusted
EBITDA margins were $17,466 and 9.2%, respectively, as compared to $16,996 and
9.5%, respectively, in the nine months ended September 29, 2001. The decrease in
Adjusted EBITDA and EBITDA margin resulted from the increased sales volume and
gross profit, partially offset by higher operating expenses including increased
selling expenses associated with the sales and marketing efforts and increased
insurance cost.
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 estimates of net realizable value are manufacturing schedules,
customer demand, possible alternative uses and ultimate realization of
potentially excess inventory.
16
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 with finite lives, 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.
LIQUIDITY AND CAPITAL RESOURCES
At September 28, 2002, we had cash and cash equivalents of $8,891, and
$23,675 was available under the revolving portion of the Senior Credit Facility.
Our working capital at September 28, 2002 was $25,535.
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
$14,625 at September 28, 2002 and is required to be repaid in quarterly payments
totaling $1,250 in 2002, $6,000 in 2003, and $7,375 in 2004. The Term B Loan had
a balance of $57,535 at September 28, 2002 and is required to be repaid in
quarterly payments totaling $180 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 September 28, 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 September 29, 2001. As of September 28, 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.
17
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.
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, although we are anticipating the need to
either obtain waivers under or amend or refinance the Senior Credit Facility as
early as the first part of 2003 in order to avoid noncompliance with certain of
the four financial covenants described above.
Packaging Holdings issued a 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. The note with an accreted value of
$19,238 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.
18
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 nine months ended September 28, 2002
and September 29, 2001 of $3,551 and $2,912, 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 September 28, 2002, we have capital projects ongoing at all locations. In
2002, capital expenditures are expected to approximate $5,000 to $5,500.
On October 23, 2002, the Company announced the acquisition of Wolf
Packaging, Inc. ("Wolf") for approximately $10,700 comprised of $6,700 in cash,
$1,000 of newly issued common stock and $3,000 of assumed debt. Wolf is a
manufacturer of foil and paper sandwich wraps located in Fort Madison, Iowa.
Wolf is a significant supplier to the quick-service restaurant industry and
expects to generate annual revenues of approximately $22,000 during 2002.
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 September 28, 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 ($72,160 as of September 28, 2002)
and foreclosure on the collateral securing those obligations. We are
anticipating the need to either obtain waivers under or amend or refinance the
Senior Credit Facility as early as the first part of 2003 in order to avoid
noncompliance with certain of the four financial covenants described above.
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.
19
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.
ITEM 3. 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 September 28, 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 $1,044 as of September 28, 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
income tax, was recorded in other comprehensive income (loss).
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. The Company's
Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the Company's disclosure controls and procedures (as such term
is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934, as amended (the "Exchange Act")) as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"). Based on such
evaluation, such officers have concluded that, as of the Evaluation Date, the
Company's disclosure controls and procedures are effective in alerting them on a
timely basis to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's periodic
filings under the Exchange Act.
(b) Changes in Internal Controls. Since the Evaluation Date, there have
not been any significant changes in the Company's internal controls or in other
factors that could significantly affect such controls.
SPECIAL NOTE REGARDING FORWARD - LOOKING STATEMENTS
Certain statements included in this form, including without
limitation, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Results of Operations - For the Three Months and Nine
Months Ended September 28, 2002 and September 29, 2001- Liquidity and Capital
Resources, -- Recently Issued Accounting Pronouncements, 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
20
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.
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 5. OTHER INFORMATION
On October 23, 2002, the Company announced the acquisition of Wolf
Packaging, Inc. ("Wolf") for approximately $10,700 comprised of $6,700 in cash,
$1,000 of newly issued common stock and $3,000 of assumed debt. Wolf is a
manufacturer of foil and paper sandwich wraps located in Fort Madison, Iowa.
Wolf is a significant supplier to the quick-service restaurant industry and
expects to generate annual revenues of approximately $22,000 during 2002.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description
----------- -----------
4 Amended and Restated Registration Rights
Agreement, dated as of October 23, 2002 by and
among Packaging Dynamics Corporation, Packaging
Investors, L.P., DCBS Investors, L.L.C., CB
Investors, L.L.C., and Mr. Tom Wolf.
99.1 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.
(b) Reports on Form 8-K
Form 8-K filed on October 24, 2002 and Amended Form 8-K filed
on October 29, 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
(Principal Financial Officer)
November 7, 2002
21
CERTIFICATION FOR
QUARTERLY REPORTS ON FORM 10-Q
I, Phillip D. Harris, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Packaging
Dynamics Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
November 7, 2002 /s/ PHILLIP D. HARRIS
---------------------------------------
PHILLIP D. HARRIS
President and Chief Executive Officer
22
CERTIFICATION FOR
QUARTERLY REPORTS ON FORM 10-Q
I, David E. Wartner, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Packaging
Dynamics Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
November 7, 2002 /s/ DAVID E. WARTNER
-------------------------------------------
DAVID E. WARTNER
Vice President and Chief Financial Officer
23