PACKAGING DYNAMICS CORP - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED JUNE 30, 2003 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 July 15, 2003, there were 9,681,504 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)

The accompanying notes are an integral part of this statement.

2

PACKAGING DYNAMICS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)
(UNAUDITED)

The accompanying notes are an integral part of this statement.

3

PACKAGING DYNAMICS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)

The accompanying notes are an integral part of this statement.

4

PACKAGING DYNAMICS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
OTHER COMPREHENSIVE INCOME (LOSS)
(DOLLARS IN THOUSANDS)

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--ORGANIZATION

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
consolidated 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 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.

NOTE 2--BASIS OF PRESENTATION

GENERAL

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 30, 2003 and June 29, 2002 and the financial position at June 30, 2003. 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, 2002. The consolidated
balance sheet as of December 31, 2002 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

RECENTLY ISSUED ACCOUNTING STANDARDS

On July 30, 2002, the FASB issued Statement of Financial Accounting
Standards No. 146 (SFAS 146), "Accounting for Costs Associated with Exit or
Disposal Activities." SFAS 146 requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than as of the
date of a commitment to an exit or disposal plan. Examples of costs covered by
SAFS 146 included lease termination costs and certain employee severance costs
that are associated with a restructuring, discontinued operation, plant closing
or other exit or disposal activity. SFAS 146 also supercedes, in its entirety,
previous accounting guidance that was provided by Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Terminations
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." SFAS 146 is effective for exit or disposal activities that
are initiated after December 31, 2002. The Company will apply the provisions of
SFAS 146 prospectively to exit or disposal activities in 2003.

In November of 2002, the FASB issued FASB Interpretation No. 45 (FIN
45), "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, an interpretation of
FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34."
FIN 45 clarifies the requirements of FASB Statement No. 5, "Accounting for
Contingencies," relating to the guarantor's accounting for, and disclosure of,
the issuance of certain types of guarantees. The disclosure requirements of FIN
45 are effective for financial statements of interim or annual periods that end
after December 15, 2002.. The provisions for initial recognition and measurement
are effective on a prospective basis for guarantees that are issued or modified
after December 31, 2002, irrespective of the guarantor's year-end. FIN 45
requires that upon issuance of a guarantee, the entity must recognize a
liability for the fair value of the obligation it assumes under that guarantee.
There was no material effect resulting from the adoption of the Statement.

In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure". This standard provides
alternative methods of transition to the fair value method of accounting for
stock-based employee compensation under SFAS No. 123, "Accounting for
Stock-Based Compensation," but does not require the Company to use the fair
value method. This standard also amends certain disclosure requirements related
to stock-based employee compensation. The Company adopted the disclosure portion
of this standard as of December 31, 2002.

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities". This interpretation of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements", addresses
consolidation of variable interest entities. FIN 46 requires certain variable
interest entities ("VIE's") to be consolidated by the primary beneficiary if the
entity does not effectively disperse risks among the parties involved. The
provisions of FIN 46 are effective immediately for those variable interest
entities created after January 31, 2003. The provisions are effective for the
first period beginning after June 15, 2003 for those variable interests held
prior to February 1, 2003. There was no material effect resulting from the
adoption of the Statement.

7

PACKAGING DYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
(UNAUDITED)

NOTE 3--STOCK BASED COMPENSATION

At June 30, 2003, the Company has a stock-based compensation plan. The
company accounts for this plan under the recognition and measurement provisions
of Accounting Principles Board Opinion (APBO) No. 25 "Accounting for Stock
Issued to Employees," and related interpretations. Stock-based employee
compensation cost is reflected in earnings to the extent that option grants
under those plans had an exercise price below the market value of the underlying
common stock on the date of grant.

On a pro forma basis, had compensation cost for the Company's stock
option plan been determined based on the fair value provisions of FAS 123
"Accounting for Stock-Based Compensation" as amended by FAS 148 "Accounting for
Stock-Based Compensation-Transition and Disclosure," the Company's net income
and earnings per share for the three and six months ended June 30, 2003 would
have been as follows:

The fair value of the options granted was estimated on the date earned
using the Black-Scholes option-pricing model and utilized the following
assumptions: dividend yield--0%; volatility--35%; risk-free interest
rate--2.42%; and expected lives--5 years.

NOTE 4--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 30, 2003 and December 31,
2002 consist of the following:

NOTE 5--LONG-TERM DEBT

Long-term debt at June 30, 2003 and December 31, 2002 consists of the
following:

8

PACKAGING DYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
(UNAUDITED)

NOTE 6--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. No amounts have been recorded in the financial statements related to
such proceedings as the amounts can not be estimated. 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 adverse 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.

9

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITIONS AND
RESULTS 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 JUNE 30, 2003 AND
JUNE 29, 2002

Net Sales

Net sales remained relatively flat in the second quarter of 2003 over
our net sales during the corresponding period in 2002. A 3.5% increase in volume
in the food packaging operation, primarily resulting from the acquisition of
Wolf Packaging, Inc., was offset by a 26.3% decrease in volume in our specialty
paper operation. The decrease was also impacted by a shift in product mix in our
food packaging business.

Gross Profit

Gross profit increased 5.9% during the second quarter of 2003 compared
to the corresponding period in 2002 primarily due to our continued efforts to
improve productivity in our converting operation. This increase was partially
offset by an increase in raw material costs and reduced profitability in our
specialty paper operation. The gross profit margin was 12.7% which was 0.7%
higher than the same period in 2002. The current period gross profit margin was
favorably impacted by the productivity improvements.

Operating Expenses

Selling and administrative expenses remained relatively unchanged
during the second quarter of 2003 compared to the corresponding period in 2002.
The increase due to the acquisition of Wolf Packaging, Inc. ("Wolf") was offset
by the long-term incentive compensation expense of $219 and loss on sale of
equipment of $118 recorded in the second quarter of 2002.

On July 1, 2002, Packaging Dynamics granted to management, for
incentive purposes and in consideration of their waiver of cash payments under
the 2001 Long Term Incentive Plan ("LTIP"), stock options for the purchase of an
aggregate of 815,089 shares of its common stock under the 2002 LTIP.
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 730,924 options,
although fully vested, are not exercisable for three years after the grant date.
Consequently, for such options we have the right to repurchase an executive's
options if he terminates employment before the end of the three-year period. For
the three months ended June 30, 2002, the Company recorded a non-cash
compensation charge of $219. After December 31, 2002, no compensation expense
will be recorded for this plan.

Income from Operations

Income from operations and operating margins were $4,158 and 6.4%,
respectively, during the second quarter of 2003 compared to income from
operations and operating margin of $3,680 and 5.6%, respectively, during the
second quarter of 2002. The increase was primarily a result of improved
productivity in our converting operations. Our paper mill had a $873 loss from
operations in the second quarter of 2003 due to significant increases in raw
material and energy costs. Given the significant operating losses in our
specialty paper operations, the Company is currently evaluating all of its
strategic options to reduce these losses.

10

Interest Expense

Interest expense during the second quarter 2003 was $1,654 compared to
$2,280 during the same period in 2002. The decrease in interest expense in 2003
compared to 2002 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 7.04%; which is 1.35% less than the same
period in 2002. The paid-in-kind interest accruing on the 12% Promissory Note
was zero and $558 during the second quarter of 2003 and 2002, respectively. The
note was cancelled on 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 second quarter of 2003 was $989 as compared to $293 in the second quarter of
2002. The increase in income tax provision was associated with our change in
filing status and an increase in pre-tax income.

Net Income

Net income increased to $1,515 during the second quarter of 2003 from
$1,107 in the prior year. The increase was primarily attributable to improved
productivity in our converting operations and a decrease in interest expense
related to the cancellation of the 12% Promissory Note payable to Ivex.

Adjusted EBITDA

In addition to financial results determined in accordance with
generally accepted accounting principles ("GAAP"), Packaging Dynamics utilizes
non-GAAP financial measures (within the meaning of Regulation G promulgated by
the Securities and Exchange Commission). For purposes of Regulation G, a
non-GAAP financial measure is a numerical measure of a registrant's historical
or future financial performance, financial position or cash flows that excludes
amounts, or is subject to adjustments that have the effect of excluding amounts,
that are included in the most directly comparable measure calculated and
presented in accordance with GAAP in the statement of income, balance sheet or
statement of cash flows (or equivalent statements) of the issuer; or includes
amounts, or is subject to adjustments that have the effect of including amounts,
that are excluded from the most directly comparable measure so calculated and
presented. These measures should be considered in addition to results prepared
in accordance with GAAP, but are not a substitute for or superior to GAAP
results. Non-GAAP financial measures are used because management believes this
information provides investors useful information in evaluating the results of
the continuing operations and believes that this information provides the users
of the financial statements a valuable insight into the operating results given
the restructuring of Packaging Dynamics and distribution by Ivex Packaging
Corporation of its ownership interest in Packaging Dynamics last year. The
non-GAAP measure of adjusted EBITDA is presented to supplement the consolidated
financial statements in accordance with GAAP. Specifically, management believes
that adjusted EBITDA is of interest to its investors and lenders in relation to
its debt covenants, as certain of its debt covenants include this adjusted
EBITDA as a performance measure. Refer to Liquidity and Capital Resources for
additional disclosure of these debt covenants.

Packaging Dynamics defines adjusted EBITDA as earnings from operations
(excluding items deemed by management as non-recurring) plus depreciation and
amortization. Adjusted 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 adjusted EBITDA.

11

Adjusted EBITDA for the three months ended June 30, 2003 and June 29,
2002 is computed as follows:

In the three months ended June 30, 2003 adjusted EBITDA and adjusted
EBITDA margins were $6,165 and 9.4%, respectively, as compared to $5,880 and
8.9%, respectively, in the three months ended June 29, 2002.

RESULTS OF OPERATIONS - FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND JUNE 29, 2002

Net Sales

Net sales increased by 3.2% during the first six months of 2003 over
our net sales during the corresponding period in 2002. A 7.0% increase in volume
in the food packaging operation, primarily resulting from the acquisition of
Wolf Packaging, Inc., was partially offset by a 14.5% decrease in volume in our
specialty paper operation. The decrease was also impacted by a shift in product
mix in our food packaging business.

Gross Profit

Gross profit increased 9.9% during the first six months of 2003
compared to the corresponding period in 2002 primarily due to our continued
efforts to improve productivity in our converting operation. This increase was
partially offset by reduced profitability in our specialty paper operations. The
gross profit margin was 12.6% which was 0.8% higher than the same period in
2002. The current period gross profit margin was favorably impacted by the
productivity improvements.

Operating Expenses

Selling and administrative expenses remained relatively unchanged
during the first six months of 2003 compared to the corresponding period in
2002. An increase due to the Wolf acquisition and the incremental expense
associated with operating as a public company were offset by the long-term
incentive compensation expense of $1,295 recorded in the six months ended June
29, 2002.

On July 1, 2002, Packaging Dynamics granted to management, for
incentive purposes and in consideration of their waiver of cash payments under
the 2001 Long Term Incentive Plan ("LTIP"), stock options for the purchase of an
aggregate of 815,089 shares of its common stock under the 2002 LTIP.
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 730,924 options,
although fully vested, are not exercisable for three years after the grant date.
Consequently, for such options we have the right to

12

repurchase an executive's options if he terminates employment before the end of
the three-year period. For the six months ended June 30, 2002, the Company
recorded a non-cash compensation charge of $1,295. After December 31, 2002, no
compensation expense will be recorded for this plan.

Income from Operations

Income from operations and operating margins were $7,382 and 5.7%,
respectively, during the first six months of 2003 compared to income from
operations and operating margin of $5,884 and 4.7%, respectively, during the
first six months of 2002. The increase was primarily a result of improved
productivity in our converting operations and the long-term incentive
compensation expense of $1,295 recorded in the six months ended June 29, 2002.
Given the significant operating losses in our specialty paper operations, the
Company is currently evaluating all of its strategic options to reduce these
losses.

Interest Expense

Interest expense during the first six months of 2003 was $3,123
compared to $4,576 during the same period in 2002. The decrease in interest
expense in 2003 compared to 2002 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 1.24% less during 2003 compared to
2002. The paid-in-kind interest accruing on the 12% Promissory Note was zero and
$1,106 during the first six months of 2003 and 2002, respectively. The note was
cancelled on 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 first six months of 2003 was $1,677 as compared to $681 in the first six
months of 2002. The increase in income tax provision was associated with an
increase in pre-tax income.

Net Income

Net income increased to $2,582 during the first six months of 2003 from
$627 in the prior year. The increase was primarily attributable to the $1,295
long-term incentive expense in the first six months of 2002 and a decrease in
interest expense related to the cancellation of the 12% Promissory Note payable
to Ivex.

Adjusted EBITDA

In addition to financial results determined in accordance with generally
accepted accounting principles ("GAAP"), Packaging Dynamics utilizes non-GAAP
financial measures (within the meaning of Regulation G promulgated by the
Securities and Exchange Commission). For purposes of Regulation G, a non-GAAP
financial measure is a numerical measure of a registrant's historical or future
financial performance, financial position or cash flows that excludes amounts,
or is subject to adjustments that have the effect of excluding amounts, that are
included in the most directly comparable measure calculated and presented in
accordance with GAAP in the statement of income, balance sheet or statement of
cash flows (or equivalent statements) of the issuer; or includes amounts, or is
subject to adjustments that have the effect of including amounts, that are
excluded from the most directly comparable measure so calculated and presented.
These measures should be considered in addition to results prepared in
accordance with GAAP, but are not a substitute for or superior to GAAP results.
Non-GAAP financial measures are used because management believes this
information provides investors useful information in evaluating the results of
the continuing operations and believes that this information provides the users
of the financial statements a valuable insight into the operating results given
the restructuring of Packaging Dynamics and distribution by Ivex Packaging
Corporation of its ownership interest in Packaging Dynamics last year. The
non-GAAP measure of adjusted EBITDA is presented to supplement the consolidated
financial statements in accordance

13

with GAAP. Specifically, management believes that adjusted EBITDA is of interest
to its investors and lenders in relation to its debt covenants, as certain of
its debt covenants include this adjusted EBITDA as a performance measure. Refer
to Liquidity and Capital Resources for additional disclosure of these debt
covenants.

Packaging Dynamics defines adjusted EBITDA as earnings from operations
(excluding deemed by management as non-recurring) plus depreciation and
amortization. Adjusted 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 adjusted EBITDA.

Adjusted EBITDA for the six months ended June 30, 2003 and June 29,
2002 is computed as follows:

In the six months ended June 30, 2003, adjusted EBITDA and adjusted
EBITDA margins were $11,479 and 8.8%, respectively, as compared to $11,119 and
8.8%, respectively, in the six months ended June 30, 2002.

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2003, we had cash and cash equivalents of $2,877, and
$23,400 was available under the revolving portion of the Senior Credit Facility.
Our working capital at June 30, 2003 was $3,259.

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 $67,370 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
$10,375 at June 30, 2003 and is required to be repaid in quarterly payments
totaling $6,000 in 2003 and $7,375 in 2004. The Term B Loan had a balance of
$56,995 at June 30, 2003 and is required to be repaid in quarterly payments
totaling $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

o a base rate equal to the greater of (1) the Federal Funds rate
plus 1/2 of 1% and (2) the prime rate, plus

o an applicable percentage that varies with the leverage ratio
of PDLLC and its consolidated subsidiaries.

14

Accordingly, Tranche A Term Loans and revolving loans bear interest at
rates of up to 2.75% plus the base rate, in the case of Base Rate Loans, and up
to 3.75% 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 30, 2003, the interest rates on borrowings under the Tranche A
Term Loan and the Tranche B Term Loan were 3.0% plus LIBOR and 3.75% plus LIBOR,
respectively, compared with 2.75% plus LIBOR and 3.75% plus LIBOR, respectively,
at June 30, 2002. In addition, as of June 30, 2003, we had entered into interest
rate derivative instruments, which are discussed in Item 3 - "Quantitative and
Qualitative Disclosures About Market Risk." 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:

o 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 to 1 at present
to 2 to 1 from and after April 1, 2004;

o 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 3.25 to 1 at present
to 4 to 1 from and after July 1, 2004;

o 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 1.15 to 1; and

o 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 adjusted
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 42.5% 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 currently planning to
refinance the Senior Credit Facility by the end of 2003 in order to avoid
possible non-compliance with certain of the four financial covenants described
above

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

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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 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. The remaining unpaid principal of
these notes as of June 30, 2003 was $1,400 and bear interest at rates varying
from 6.53% 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 30, 2003 and
June 29, 2002 of $3,140 and $2,229, respectively. The increase in capital
expenditures during 2003 compared to 2002 resulted primarily from expenditures
incurred for two new bag machines. At June 30, 2003, we have capital projects
ongoing at all locations. In 2003, capital expenditures are expected to
approximate $5,500.

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 30, 2003, the latest measurement date. The occurrence
of any default of these covenants could result in acceleration of our
obligations under the Senior Credit Facility ($67,370 as of June 30, 2003) and
foreclosure on the collateral securing those obligations. We are anticipating
that we will refinance the Senior Credit Facility by the end of 2003.

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 June 30, 2003, we had interest rate swap agreements with a group of
banks having notional amounts totaling $55,000 and with various maturity dates
through December 10, 2003. These agreements effectively fix our LIBOR rate for
$40,000 and $15,000 of our Senior Credit Facility indebtedness at rates of 3.83%
and 1.61%, respectively. Beginning on December 10, 2003, we have a no-cost
collar agreement with a notional amount of $25,000 maturing on December 10,
2004. This collar agreement effectively fixes the LIBOR base rate for $25,000 of
our Senior Credit Facility indebtedness at a maximum of 3.97% and allows for us
to pay the market LIBOR from a floor of 2.34% to the maximum rate. If LIBOR
falls below 2.34%, we are required to pay the floor rate of 2.34%. 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 $840 as of June 30, 2003 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).

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ITEM 4. CONTROLS AND PROCEDURES

(a) Disclosure Controls and Procedures. The Company's management, with
the participation of the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company's disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of
period covered by this report. Based on such evaluation, the Company's Chief
Executive Officer and Chief Financial Officer have concluded that, as of the end
of such period, the Company's disclosure controls and procedures are effective
in recording, processing, summarizing and reporting, on a timely basis,
information required to be disclosed by the Company in the reports that it files
or submits under the Exchange Act.

(b) Internal Control Over Financial Reporting. There have not been any
changes in the Company's internal controls over financial reporting (as such
term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during
the fiscal quarter to which this report relates that have materially affected,
or are reasonably likely to materially affect, the Company's internal control
over financial reporting.

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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 and Six Months Ended June 30,
2003 and June 29, 2002- 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 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On May 14, 2003, the Corporation held its 2003 annual meeting of
stockholders, at which the stockholders elected five directors for a one-year
term and ratified the appointment of PricewaterhouseCoopers LLP as the
Corporation's independent accountants for 2003.

A total of 9,154,456 shares of common stock were voted in person or by
proxy at the annual meeting, representing approximately 94.8% of the voting
power of the Corporation entitled to vote at such meeting. Each share of common
stock was entitled to one vote on each matter before the meeting. The votes cast
applicable, were as follows:

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits
Exhibit No. Description
----------- -----------
31.1 Certification of Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.

32 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

Current Report, Form 8-K regarding Packaging Dynamics Corporation's
second quarter 2003 earnings release and conference call, filed on July
24, 2003.

SIGNATURE PAGE FOLLOWS

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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/ HENRY C. NEWELL
-------------------------------------------
HENRY C. NEWELL
Vice President and Chief Financial Officer
(Principal Financial Officer)

August 4, 2003

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