PACKAGING DYNAMICS CORP - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 COMMISSION FILE NUMBER 000-49741
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PACKAGING DYNAMICS CORPORATION
(Exact name of registrant as specified in its charter)

DELAWARE 32-0009217
(State or other jurisdiction of (I.R.S. Employer
incorporation) Identification No.)

3900 WEST 43RD STREET 60632
CHICAGO, ILLINOIS (Zip Code)
(Address of Principal Executive Office)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(773) 843-8000

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]

The aggregate market value of the voting and non-voting common stock held
by non-affiliates of the Registrant as of June 30, 2004 was $70.4 million, based
on the closing price of $13.85 per share.

At March 31, 2005, 10,542,505 shares of Common Stock, par value of $0.01,
were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company's Proxy Statement, which will be filed within 120 days
after the close of
the Company's fiscal year in connection with the 2005 Annual Meeting of
Stockholders, are
incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III of this
Form 10-K

TABLE OF CONTENTS

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PART I

ITEM 1. BUSINESS

ORGANIZATION AND STRUCTURE

Packaging Dynamics Corporation (the "Company" or "Packaging Dynamics") is a
Delaware corporation established as a holding company to own all of the interest
in Packaging Dynamics Operating Company ("PDOC"). PDOC is a Delaware corporation
which is the holding company for all our current operating subsidiaries. In this
annual report, except where the context requires otherwise, the terms "we," "us"
and "our" refer to Packaging Holdings, L.L.C. ("Packaging Holdings" or "PHLLC")
and its subsidiaries for the periods as of and prior to the July 1, 2002
contribution of all of the Packaging Holdings limited liability company
interests to Packaging Dynamics, and to Packaging Dynamics and its subsidiaries
for the periods thereafter.

OVERVIEW

Packaging Dynamics Corporation was formed in 1998 to create a premier
flexible packaging company providing value-added specialty packaging products
for markets with attractive margins and growth rates. Since then, we have become
a leading supplier of specialty converted paper, foil and film based products
for use in a variety of end use markets. In 2004 we had net sales of $305
million. We operate nine manufacturing plants in eight states and employ
approximately 1,350 people. We have two operating segments: Food Packaging and
Specialty Laminations.

In September 2004, we acquired Papercon, Inc. ("Papercon"), a manufacturer
and marketer of a broad range of paper and foil based specialty packaging
products for foodservice, supermarket, quick service restaurant and packer
processor customers. Papercon has manufacturing facilities in Atlanta, Georgia
and near Dallas, Texas and Los Angeles, California. Papercon had net sales of
approximately $85 million during 2003, the most recent fiscal year prior to its
acquisition by the Company. The acquisition of Papercon significantly broadened
the product line, customer base and geographic presence of the Food Packaging
segment.

PRODUCTS AND MARKETS

FOOD PACKAGING

The Food Packaging segment converts paper, film and foil into a variety of
specialty value-added food packaging products including specialty bags,
specialty sheets and wraps, interfolded tissue, pan liners as well as a line of
butcher, freezer and locker paper products. Our product line includes a broad
range of products which are customized to meet the specific performance
requirements of individual customers. We also produce a broad range of standard
"stock products" for use across a range of customers and markets. Key markets
served by the Food Packaging segment include foodservice distribution,
restaurant (quick-service/QSR and fast-casual), supermarket, bakery, retail and
packer processor. We believe that, within our key markets, we have the most
comprehensive product line of any major competitor and have leading positions in
many of our key products. The Food Packaging segment operates using the
BagcraftPapercon trade name.

SPECIALTY LAMINATIONS

The Specialty Laminations segment produces laminated foil-paper structures
which are engineered and manufactured to meet the requirements of specific
customer applications. Our products are typically multi-layer laminated
structures which include a variety of substrates (foil, paper, paperboard and
film), adhesives and coatings. Our products are typically delivered in roll
stock form for use by our customers to manufacture end products for sale to
their customers. Representative products include base stock materials for the
production of labels, bags, pouches, composite cans, lidding and blister
packaging for use in food, consumer, medical and industrial packaging
applications. In addition, we produce specialized facing material used by North
American and European building materials manufacturers for the production of
foam insulation. We

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also produce foil sandwich wraps for a limited number of quick-service
restaurant customers. The Specialty Laminations segment operates using the
International Converter trade name.

BUSINESS STRATEGY

Our principal objective is to build on the original premise of Packaging
Dynamics to create a premier flexible packaging company providing value-added
specialty packaging products for markets with attractive margins and growth
rates. Our strategy to achieve this objective is to grow sales and profits by
expanding product capabilities, market participation and geographical presence.
We expect to achieve long-term growth rates above industry norms by leveraging
our broad product line, strong product development capabilities and national
geographic presence. We believe that these characteristics provide us with an
opportunity to expand our long-term customer relationships and presence in key
markets -- many of which are experiencing long-term consolidation trends. An
important part of our strategy is to continue making investments in new
manufacturing technology to upgrade product capabilities, improve productivity
and reduce overall product cost. Strategic acquisitions have been, and will
continue to be, an important complement to our internal growth strategy. Since
2002 we have invested approximately $83 million to acquire 3 businesses which
have significantly enhanced our product line, market participation and
geographic presence.

NEW PRODUCT DESIGN AND DEVELOPMENT

An important element of our growth strategy is to develop new value-added
products and product line extensions which meet or exceed the requirements of
our customers. We have significant resources dedicated to product development in
both our Food Packaging and Specialty Laminations segments. We have a strong
reputation in the markets we serve for creativity, new product innovation and
responsiveness to our customers. Our development programs are both customer
driven and market driven. We seek to work closely with our customers to develop
products which meet the needs of their specific application. We also seek to
identify unfilled market needs and develop unique products to satisfy those
needs. Our product development personnel have many years of experience in the
field, and we believe we have the broadest product development capability within
the markets in which we compete. A key component of our value proposition is to
provide "Innovative Solutions" for our customers.

CONVERTING CAPABILITIES

We operate nine converting facilities in the United States including six
facilities in the Food Packaging segment (one each in Illinois, Iowa, Kansas,
Georgia, Texas, and California) and three in the Specialty Laminations segment
(two in Ohio and one in Mississippi). Our national manufacturing and
distribution platform allows us to produce nearly all of our products at
multiple facilities and to efficiently serve the needs of customers on a local,
regional and national scale. We believe that our national manufacturing presence
provides us a unique competitive advantage with larger customers who value
multi-plant production and national coverage as many of our competitors lack
these capabilities.

The manufacturing of our products typically involves the conversion of
substrates such as paper, foil and film into the products we sell to customers.
Other raw materials used in our production processes include various types of
inks, adhesives, coatings and wax. Our converting capabilities include extensive
expertise in laminating, bag making, interfolding, waxing, slitting, sheeting,
die cutting, tin tie as well as flexographic and gravure printing using water
and solvent based inks. We have continued to invest to improve productivity,
quality and overall product cost. During 2003 and 2004, we installed five new
bag machines which deliver improved capabilities and product quality while
operating at significantly higher speeds. We expect to continue to make
investments to upgrade the capabilities of our converting assets to provide a
long-term competitive advantage. We believe that new manufacturing technology
will continue to offer attractive investment opportunities in each of our
business segments.

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COMPETITION

We operate in markets that are highly competitive with substantial
competition in each of our product lines from numerous competitors of various
sizes. Many of our competitors are significantly smaller privately-held
companies which tend to have lower fixed costs and greater operating
flexibility. A few of our competitors are smaller divisions or individual plants
within larger companies with more extensive financial and other resources
compared to Packaging Dynamics. We also face competition from alternative
products including plastic-, board-, paper- and foil-based converted products
which we do not currently produce or sell. In addition to price, competition is
based on product quality, breadth of product offering, product innovation,
supplier response time and complete order fulfillment.

EMPLOYEES

As of December 31, 2004, we employed approximately 1,350 people, 376 of
whom are covered by collective bargaining agreements. Of our 376 unionized
employees as of December 31, 2004, 66 employees are based in Belpre, Ohio and
are represented by the United Steelworkers of America under a contract that
expires in May 2005; 282 employees are based in Chicago, Illinois and are
represented by the International Brotherhood of Teamsters Local 743 under a
contract scheduled to expire in December 2005; and 28 employees are based in
Iuka, Mississippi and are represented by the United Steelworkers of America
under a contract that expires in August 2007. There have been no interruptions
or curtailments of our operations due to labor disputes since our inception, and
we believe that relations with our employees are good; however, as these labor
contracts expire, there can be no assurances that there will be no strikes, work
stoppages or other labor disputes as we negotiate such contracts.

RAW MATERIALS

Paper and aluminum foil have historically represented the largest portion
of our raw materials. Generally, these raw materials are readily available from
a wide variety of suppliers. Costs for all of the significant raw materials used
by us tend to fluctuate with various economic factors which generally affect us
and our competitors. During 2003, the Company made a strategic decision to shut
down the Detroit paper mill, which had provided approximately 45-50% of the
paper we consumed. The Company has entered into supply arrangements that provide
for both a secure supply of paper and the opportunity to continue to work to
lower the cost of paper through lower basis weights, consolidation of grades and
product development. The Company contracts to buy aluminum ingot, attempting to
match purchases to contracted sales volume where possible. The Company locks in
the cost of converting ingot to foil on an annual basis. The Company believes
that its scale of purchases of both foil and paper provides it with a
competitive advantage in the markets in which each competes. Prices and lead
times for aluminum foil and paper fluctuate with changes in market conditions,
in some instances adversely to us. The availability of raw materials was
adequate during 2004.

INTELLECTUAL PROPERTY

We own a number of U.S. patents and trademarks that collectively are
important to our business, but no single one of which is material to us. We
believe that our intellectual property rights and licensing rights are adequate
for our business and have an active program to maintain these rights.

CUSTOMERS, SALES AND BACKLOG

We have relationships with numerous customers in each of our product
categories. Although we do not currently have a single customer that accounts
for 10% or more of our net sales, the loss of one or more of our largest
customers, while not anticipated, could have a material adverse effect on our
financial condition or results of operations. In general, we believe that the
backlog of orders is not material to an understanding of our business.

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ENVIRONMENTAL MATTERS AND GOVERNMENT REGULATION

Since many of our packaging products are used in the food industry, we are
subject to the manufacturing standards of the U.S. Food and Drug Administration.
Historically, compliance with the standards of the food industry has not had a
material effect on our earnings, capital expenditures or competitive position.
There can be no assurance, however, that compliance with those standards will
not have a material adverse effect on our future operating results or financial
condition.

Our 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 our properties or any associated offsite disposal
location, or if contamination from prior activities is discovered at any of our
properties, we may be held liable. From time to time, we are involved in
regulatory proceedings and inquiries relating to compliance with environmental
laws, permits and other environmental matters. We believe that we are in
material compliance with applicable environmental regulations and do not believe
that costs of compliance, if any, will have a material adverse effect on our
financial condition, results of operation, or liquidity. In 2005 we will have
additional costs related to our ongoing program to clear the site, recover
assets and dispose of the Detroit property, although the total amount of such
costs are not currently estimable. There can be no assurance, however, that
items will not require additional expenditures beyond those that are anticipated
and that additional expenditures, if any, would not have a material adverse
effect on our operating results or financial condition.

FINANCIAL INFORMATION ABOUT SEGMENTS AND GEOGRAPHIC AREAS

We operate within, and sell to customers throughout, the U.S., Canada and
Europe in two operating segments -- Food Packaging and Specialty Laminations.
The Food Packaging segment converts paper, film and foil into a variety of
specialty value-added food packaging products. The Specialty Laminations segment
produces multi-layer laminated structures from a variety of substrates (foil,
paper, paperboard and film), adhesives and coatings for use in various food,
consumer, medical and industrial packaging applications as well as the
production of insulation for the building materials market. See Note 7 to the
Company's annual consolidated financial statements for further information.

MERGER AND DISTRIBUTION

On March 18, 2002, the board of directors of Ivex Packaging Corporation
("Ivex") approved a merger agreement providing for the merger of Ivex with a
wholly-owned subsidiary of Alcoa Inc. ("Alcoa"). 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 of Packaging Dynamics; 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;

5

(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. In the preceding discussion, dollar amounts are stated in
thousands.

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 September 2003, in conjunction with the refinancing of our senior credit
facility, we merged Packaging Holdings with Packaging Dynamics, L.L.C., a
Delaware limited liability company and parent company of all our operating
subsidiaries and of which Packaging Holdings was a sole member, and converted
the surviving limited liability company into a Delaware corporation which we
named Packaging Dynamics Operating Company.

Our principal executive offices are located at 3900 West 43rd Street,
Chicago, Illinois 60632, and our telephone number is (773) 843-8000. Our home
page on the Internet is www.pkdy.com. We make our web site content available for
informational purposes only. It should not be relied upon for investment
purposes, nor is it incorporated by reference into this Form 10-K. Packaging
Dynamics makes available free through its website its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 via a direct link to the Securities
and Exchange Commission's Internet site at www.sec.gov.

ITEM 2. PROPERTIES

Our principal properties consist of our manufacturing locations. Shown
below are the locations of the principal properties which we own or lease. We
believe our facilities are suitable and adequate for the purposes for which they
are used and are adequately maintained.

OWNED FACILITIES

LEASED FACILITIES

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(1) Lease expires in 2026, subject to termination at our election in 2006, and
from time to time thereafter, upon specified notice.

(2) Lease expires in 2009, subject to our right to extend the lease for two
successive five-year periods upon our written notice to the lessor.

(3) Sublease expires in 2005, subject to our right to extend the lease for 54
consecutive annual renewal terms of one (1) year each through September 30,
2058 and one (1) final automatic renewal term of nine (9) years ending
September 30, 2067.

(4) Lease expires in 2009, subject to our right to extend the lease for three
successive five-year periods upon our written notice to the lessor.

(5) Sublease expires in 2006, subject to our right to extend the lease for one
successive five-year period upon our written notice to the sublessor.

(6) Lease expires in 2008, subject to our right to extend the lease for one
successive five-year period upon our written notice to the lessor.

ITEM 3. LEGAL PROCEEDINGS

We are currently a party to various legal proceedings in various federal
and state jurisdictions arising out of the operations of our business. The
amount of alleged liability, if any, from these proceedings cannot be determined
with certainty; however, we believe that our 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, taking into
account established accruals for estimated liabilities, should not be material
to our financial condition or results of operations.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the security holders during the
fourth quarter of fiscal year 2004.

EXECUTIVE OFFICERS OF THE COMPANY

Set forth below are the name, age, positions and offices held (as of the
date hereof) and a brief account of the business experience for each executive
officer of the Company.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the NASDAQ Stock Market, under the ticker
symbol PKDY. The high and low sales prices for the common stock by quarter
during 2003 and 2004 as reported by the NASDAQ Stock Market are shown below.

The approximate number of shareholders of record of our common stock as of
March 16, 2005 was 428 holders. On January 4, 2005 the Company paid a $0.065
cash dividend per share of common stock to shareholders of record as of December
15, 2004. Any payment of cash dividends in the future will be at the discretion
of our Board of Directors and will depend upon the financial condition, capital
requirements and our earnings as well as other factors that our Board of
Directors may deem relevant.

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ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated statement of operations data for each of the
three years ended December 31, 2004, 2003 and 2002 and consolidated balance
sheet data as of December 31, 2004 and 2003 for Packaging Dynamics Corporation
have been derived from audited consolidated financial statements included
elsewhere in this annual report. The selected consolidated statement of
operations data for the years ended December 31, 2001 and 2000 and the selected
consolidated balance sheet data as of December 31, 2002, 2001, and 2000 for
Packaging Dynamics Corporation have been derived from audited consolidated
financial statements not included in this annual report.

The selected financial data set forth below related to periods prior to
July 1, 2002, do not reflect the many changes that occurred in our operations,
capitalization and tax status in connection with and as a result of our new
corporate holding company structure. The selected financial data are not
necessarily indicative of what our results of operations or financial position
would have been had we operated as an independent public company during the
periods presented, nor is it necessarily indicative of our future results of
operations or financial position. The selected financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the audited consolidated financial statements and
related notes included elsewhere in this annual report.

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(1) The financial data of Packaging Dynamics Corporation include the acquisition
of the capital stock of Papercon, as of September 14, 2004, the net assets
of the Iuka Lamination Division of Ormet Corporation ("Iuka"), as of
December 4, 2003 and the common stock of Wolf Packaging, Inc. ("Wolf"), as
of October 23, 2002.

(2) Prior to July 1, 2002, for income tax purposes, Packaging Holdings' federal
and state taxable income, other than income generated by International
Converter, Inc. ("ICI"), was reported by its members on their income tax
returns as if the company were a partnership.

(3) 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 2002, 2001 or 2000.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

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 interests in Packaging Dynamics Operating Company ("PDOC"), a Delaware
corporation which is the parent company of all our current operating companies.

The following discussion including the Summary and Outlook should be read
in conjunction with our financial statements and accompanying notes thereto, and
the other financial information included elsewhere in this annual report. This
discussion contains forward-looking statements. Please see "Special Note
Regarding Forward-Looking Statements" for a discussion of the uncertainties,
risks and assumptions associated with these statements. In the discussion that
follows, dollar amounts other than per share data are stated in thousands.

SUMMARY AND OUTLOOK

The business is generally experiencing solid performance in each operating
segment. Over the next few quarters, the Company's primary focus will be on
integrating the acquisition of Papercon into the Food Packaging segment. Other
priorities include expanding sales of new and existing products, improving
manufacturing productivity and reducing overall product costs. The Company is
evaluating a number of specific capital investment opportunities to expand
product capabilities and reduce production costs. If approved, these investments
could result in total capital expenditures of approximately $10,000 in 2005
compared to $6,081 in 2004 and an estimated normalized range of $7,000 to $8,000
including Papercon. The Company is also continuing its efforts to identify and
pursue acquisition candidates which have the potential to expand the Company's
product capabilities, market participation and geographical presence.

The Company's results are typically weakest in the first quarter of the
year due, in part, to seasonal factors impacting certain markets served by the
Company's Food Packaging operating segment. In addition, the first quarter of
2005 will be impacted by weakness in sales by the Company's Specialty
Laminations operating segment. This is primarily the result of a combination of
global shortages of a key raw material used by the Company's building products
customers in the production of their products and a strategic decision by the
Company to focus its resources on a narrower set of building products customers
in an effort to maximize long-term sales growth.

FINANCIAL PERFORMANCE

Our continuing operations are comprised of two operating segments -- Food
Packaging and Specialty Laminations. The Food Packaging segment converts paper,
film and foil into a variety of specialty value-added food packaging products.
The Specialty Laminations segment produces multi-layer laminated structures from
a variety of substrates (foil, paper, paperboard and film), adhesives and
coatings for use in various food, consumer, medical and industrial packaging
applications as well as the production of insulation for the building materials
market. Our discontinued operation is the Specialty Paper segment which we
exited during 2003 in connection with our decision to shut down the Detroit
Paper mill.

The Company's management reporting system measures segment operating
performance based on Segment Operating Income. Certain items, such as asset
sales and disposals and the 2002 long-term incentive compensation charge are
excluded from Segment Operating Income. Corporate administrative expenses are
allocated to the segments on a direct basis where appropriate with the remainder
being allocated based on revenues. See Note 7 to the Company's annual
consolidated financial statements for further information.

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FOOD PACKAGING

Net sales increased $40,171, or 23.2%, during 2004 compared to 2003.
Papercon, which was acquired on September 14, 2004, contributed $31,736 of net
sales in 2004. Excluding Papercon, the net sales increase in the period was
attributable to a combination of unit volume growth in key end markets as well
as the impact of raw material related pricing actions. Net sales increased
$2,732, or 1.6%, during 2003 compared to 2002. The increase was primarily due to
incremental sales volume related to the Wolf acquisition, partially offset by
the impact of lower pricing resulting from shifts from foil to paper products by
several customers in our foodservice markets and the strategic exit of certain
products and customers in our distribution and retail markets.

Segment Operating Income increased $2,481, or 20.5%, in 2004 compared to
2003 and Segment Operating Income margin decreased to 6.8% from 7.0% during 2004
compared to 2003. The increase in operating income was primarily due to
incremental operating income related to the Papercon acquisition as the impact
of increased sales and cost initiatives in our base business were generally
offset by increased raw material and employee related costs. In addition, 2004
results were negatively impacted by a lower margin on the inventory acquired in
the Papercon acquisition, which, as a result of acquisition purchase accounting,
was $234 higher than their manufactured cost.

Segment Operating Income increased $944, or 8.5%, in 2003 compared to 2002
and Segment Operating Income margin increased to 7.0% from 6.6% during 2003
compared to 2002. The increase was primarily due to increased sales as a result
of the Wolf acquisition. The improved margin reflected the ongoing impact of our
productivity investments in converting equipment; lower manufacturing overhead
due to reduced overall staffing levels; and improving product mix as we exited
unprofitable products and customers.

SPECIALTY LAMINATIONS

Net sales increased $21,734, or 29.5%, during 2004 compared to 2003.
Approximately 85% of the 2004 sales growth is due to the Iuka plant which the
Company acquired in December 2003. The remaining increase was attributable to a
combination of unit volume growth in key end markets and raw material related
pricing actions. Net sales increased $433, or 0.6%, during 2003 compared to
2002. The increase was primarily due to increased sales of products to building
materials customers partially offset by reduced sales of food packaging
products.

Segment Operating Income increased $1,394, or 21.4%, in 2004 compared to
2003 and Segment Operating Income Margin decreased to 8.3% from 8.8% during 2004
compared to 2003. The increase in operating income was due to the contribution
of the Iuka plant acquired in 2003, the positive impact of volume increases, raw
material related pricing actions and cost and productivity gains partially
offset by raw material and other operating cost increases. Segment Operating
Income increased $1,521, or 30.5%, in 2003 compared to 2002 and Segment
Operating Income Margin increased to 8.8% from 6.8% during 2003 compared to
2002. This increase was primarily due to increased sales volume, improved sales
mix and manufacturing cost and productivity improvements.

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ASSET SALES AND DISPOSALS AND 2002 LONG TERM MANAGEMENT INCENTIVE CHARGE

We continue our efforts to upgrade the capabilities of our manufacturing
operations and dispose of assets which are not needed to execute our business
strategy. During 2004, we sold a parcel of unused property near one of our
plants and recorded a gain of $55. During 2003 and 2002, we idled certain
converting equipment in our Chicago, Illinois and Baxter Springs, Kansas
manufacturing facilities due to the purchase of five new bag machines in 2003.
The new bag machines have improved productivity on several product categories.
These manufacturing improvements and certain other productivity improvements
resulted in a loss in 2003 and 2002 of $813 and $1,510, respectively, on the
sale or disposal of the equipment. Also, as discussed further in Note 10 to the
Company's annual consolidated financial statements, we recorded a non-cash
long-term incentive compensation charge of $2,667 during 2002.

INTEREST EXPENSE

Interest expense was $5,900 in 2004 compared to $5,674 in 2003. The
increase in interest expense was primarily due to increased average outstanding
indebtedness of approximately $56,000 as a result of the third quarter 2004
acquisition of Papercon, partially offset by overall lower average borrowing
rates. The average interest rate on borrowings in 2004 was approximately 4.82%
compared to 6.21% in 2003. In the third quarter of 2004, the Company expensed
$150 of costs incurred in connection with amending the terms of its term debt to
provide for the Papercon acquisition. In 2003, the Company expensed $1,146 of
unamortized bank fees ($906 in continuing operations and $240 in discontinued
operations) resulting from the Company's credit facility refinancing.

Interest expense during 2003 was $5,674 compared to $5,982 during the same
period in 2002. The decrease in interest expense in 2003 compared to 2002
resulted primarily from decreased average outstanding indebtedness as a result
of reductions in working capital and the forgiveness of the 12% Promissory Note
payable to Ivex. The average interest rates on borrowings in 2003 was
approximately 6.21% compared to 7.60% in 2002.

INCOME TAXES

The income tax provision for continuing operations was $6,566, $4,736, and
$2,521 for 2004, 2003 and 2002, respectively. The Company's effective tax rate
on income from continuing operations was 39.5%, 39.1% and 42.2% for 2004, 2003
and 2002, respectively. During 2004, due to the losses incurred related to the
shutdown of the Detroit paper mill in 2003, we paid cash taxes only for U.S.
alternative minimum tax, state taxes and U.S. income taxes on Papercon earnings
for approximately one month following the acquisition date until Papercon became
part of the Company's consolidated filing group.

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 of
Packaging Holdings reported federal and state taxable income on their income tax
returns as if it were a partnership. ICI has remained a taxable C-corporation
from the time we acquired it in July 1999 through the date of the distribution.

INCOME FROM CONTINUING OPERATIONS

Income from continuing operations was $10,056, $7,369 and $3,447 for 2004,
2003 and 2002, respectively. The 2004 increase resulted primarily from the
following factors discussed above: incremental earnings from the Papercon and
Iuka acquisitions; positive impacts from sales volume increases, raw material
related pricing actions and manufacturing productivity initiatives in our base
business; raw material and other cost increases; and a $55 gain on asset
disposals in 2004 versus a loss on asset disposals of $813 in 2003. The 2003
increase was primarily due to the following factors discussed above: non-cash
long-term incentive compensation expense of $2,667 recorded in 2002; a $697
reduction in loss on asset disposals; the impact of sales changes; and
manufacturing cost and productivity initiatives.

14

DISCONTINUED OPERATIONS

Loss from discontinued operations in 2004 was $1,278 compared to a loss of
$22,089 in 2003 and a loss of $2,516 in 2002. The net loss for 2004 represents
the following: $2,317 ($1,401 after tax) of administrative expense associated
with the ongoing program to clear the site, recover assets and dispose of the
Detroit property; $398 ($241 after tax) of expense due to additional withdrawal
liability from a multi-employer pension plan; and $602 ($364 after tax) of
proceeds from the liquidation of equipment. In the third quarter of 2003, the
Company recorded a $22,094 ($13,367 after tax) asset impairment charge and a
$2,800 ($1,694 after tax) severance charge. In the fourth quarter of 2003, the
Company recorded an additional charge of $1,965 ($1,189 after tax) primarily
related to the write-down of parts and supplies inventories, the write-down of
other current assets and for employee outplacement services, and a charge of
$816 ($495 after tax) for withdrawal liability from a multi-employer pension
plan. The remaining loss from discontinued operations during 2003 was the result
of operating losses. In 2005 we will have additional costs related to our
ongoing program to clear the site, recover assets and dispose of the Detroit
property, although the total amount of such costs are not currently estimable.
There can be no assurance, however, that items will not require additional
expenditures beyond those that are anticipated and that additional expenditures,
if any, would not have a material adverse effect on our operating results or
financial condition.

DISCLOSURE ABOUT CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with GAAP requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses and related disclosures of contingent
liabilities. A summary of the Company's significant accounting policies is
included in Note 2 to the Company's annual consolidated financial statements.
Certain of the Company's accounting policies are considered critical, as these
policies are the most important to the depiction of the Company's financial
statements and require significant, difficult or complex judgments by
management, often employing the use of estimates about the effects of matters
that are inherently uncertain. Estimation methodologies are applied consistently
from year to year in material respects. The following is a summary of accounting
policies management considers critical to the Company's consolidated financial
statements. Management has discussed the development and selection of these
critical accounting estimates with the Audit Committee of the Board of Directors
and the Audit Committee has reviewed our disclosures relating to it in this
Management's Discussion and Analysis.

REVENUE RECOGNITION

The Company recognizes revenue 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. 104, "Revenue Recognition
in Financial Statements." Shipping and handling costs are included as a
component of cost of goods sold. Rebates and discounts expenses directly related
to the sale are recorded as a reduction to net sales. The rebates and discounts
accruals require the use of management estimates and the consideration of
contractual arrangements subject to interpretation. Customer sales that reach
certain award levels can affect the amount of such estimates, and actual results
could differ from these estimates. Future market conditions may require
increased incentive offerings, possibly resulting in an incremental reduction in
net sales at the time the incentive is offered.

INVENTORIES

The Company states 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. Please refer to Schedule II --

15

Valuation and Qualifying Accounts in this Form 10-K for activity in the
obsolescence reserve over the past three years.

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.

We record an allowance for doubtful accounts as an estimate of the
inability of our customers to make their required payments. We determine the
amount of our allowance for doubtful accounts by looking at a variety of
factors. First we examine an aging of the accounts receivable. The aging lists
past due amounts according to invoice terms. In addition, we consider the
current economic environment, the credit rating of the customers and general
overall market conditions.

If we determine that a customer is unlikely to pay, we record a charge to
bad debt expense in the income statement and an increase to the allowance for
doubtful accounts. Please refer to Schedule II -- Valuation and Qualifying
Accounts in this Form 10-K for activity in the allowance for doubtful accounts
over the past three years.

We believe our allowance for doubtful accounts is adequate to cover any
future non-payments of our customers. However, if economic conditions
deteriorate significantly or one of our large customers was to declare
bankruptcy, a larger allowance for doubtful accounts might be necessary.

LONG-LIVED ASSETS

Long-lived assets, including property, plant and equipment and finite-lived
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) are less than the carrying amount of the asset, an impairment
loss is recognized in accordance with SFAS 144. In addition, the remaining
amortization period for the impaired asset would be reassessed and revised if
necessary.

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, 7 to 20 years for machinery and
equipment and 3 to 5 years for computer software. The Company amortizes
intangible assets with definitive lives over varying periods. Deferred financing
fees are amortized using the effective interest method over the lives of the
respective debt agreements. Customer contracts and customer relationships are
amortized using the straight-line method over the estimated lives of the
contracts and relationships. Covenants not to compete are amortized using the
straight-line method over the lives of the agreements.

IMPAIRMENT OF GOODWILL

In accordance with SFAS 142, we evaluate our goodwill for impairment on an
annual basis or whenever indicators of impairment exist. SFAS 142 requires that
if the carrying value of a reporting unit for which goodwill exists exceeds its
fair value, an impairment loss is recognized to the extent that the carrying
value of the reporting unit goodwill exceeds the "implied fair value" of
reporting unit goodwill.

As discussed in the notes to the financial statements, we have evaluated
our goodwill for impairment and have determined that the fair value of our
reporting units exceeds their carrying value, so we did not recognize an
impairment of goodwill. Our reporting units are consistent with our operating
segments. Goodwill of approximately $81,263 is shown on our balance sheet as of
December 31, 2004.

We believe that the accounting estimate related to determining the fair
value of our reporting units is a critical accounting estimate because: (1) it
is highly susceptible to change from period to period because it requires
company management to make assumptions about the future cash flows for each
reporting unit over

16

several years in the future, and (2) the impact that recognizing an impairment
would have on the assets reported on our balance sheet as well as our results of
operations could be material. Management's assumptions about future cash flows
for the reporting units require significant judgment and actual cash flows in
the future may differ significantly from those forecasted today.

In estimating future cash flows, we use internally generated projections
reviewed by management. We develop our projections based upon recent sales
trends, discussions with our customers, planned timing of new product launches,
forecasted capital expenditure needs, working capital needs, costing factors and
many other variables. From these internally generated projections, a projection
of cash flows is made based upon expected sales growth rates and capital and
working capital requirements.

We believe our assumptions used in discounting future cash flows are
appropriately conservative. Any increase in estimated cash flows would have no
impact on the reported carrying amount of goodwill. However, if our current
estimates of discounted cash flow had been approximately 40% lower for our Food
Packaging reporting unit and approximately 65% lower for our Specialty
Laminations reporting unit, the fair value of the reporting unit would have been
lower than the carrying value thus requiring us to perform an impairment test to
determine the "implied value" of goodwill.

STOCK-BASED COMPENSATION

As of December 31, 2004, we followed APB No. 25, "Accounting for Stock
Issued to Employees," ("APB No. 25") and the related Interpretations in
accounting for our stock option plans. SFAS No. 123, "Accounting for Stock-Based
Compensation," ("SFAS No. 123") issued subsequent to APB No. 25, defines a "fair
value based method" of accounting for employee stock options but allows
companies to continue to measure compensation cost for employee stock options
using the "intrinsic value based method" prescribed in APB No. 25.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS 123R"), which replaces SFAS No. 123, "Accounting for Stock-Based
Compensation," ("SFAS 123") and supercedes APB Opinion No. 25, "Accounting for
Stock Issued to Employees." SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
financial statements based on their fair values beginning with the first interim
or annual period after June 15, 2005, with early adoption encouraged. The pro
forma disclosures previously permitted under SFAS 123 no longer will be an
alternative to financial statement recognition. Under SFAS 123R, we must
determine the appropriate fair value model to be used for valuing share-based
payments, the amortization method for compensation cost and the transition
method to be used at date of adoption. The transition methods include
prospective and retroactive adoption options. Under the retroactive option,
prior periods may be restated either as of the beginning of the year of adoption
or for all periods presented. The prospective method requires that beginning
with the first quarter of adoption of SFAS 123R compensation expense will be
recorded for stock options and restricted stock as such items vest, while the
retroactive methods would record compensation expense for all stock options and
restricted stock as they vest beginning with the first period restated. See Note
2 to the Company's annual consolidated financial statements for assumptions used
in calculating the fair values of employee stock option plans.

We have not yet determined the method of adoption or the effect of adopting
SFAS 123R, and have not determined whether the adoption will result in amounts
that are similar to the current pro forma disclosures under SFAS 123. However,
in accordance with SFAS No. 123, we have been disclosing in the Notes to the
Consolidated Financial Statements the impact on our net income and earnings per
share had we adopted the fair value based method. If we had adopted the fair
value based method in 2004, our net income would have been $266 lower than
reported or approximately $.02 diluted earnings per share lower than reported.
If we had applied the fair value based method and recorded the additional
after-tax expense of $266, it would not have had a significant impact on our
liquidity and capital resources because the expense is non-cash. Further, "non-
cash expenses relating to the granting of options" are excluded as an expense in
determining EBITDA for purposes of our debt covenants.

17

INCOME TAXES

In the normal course of business, the Company is regularly audited by
federal and state authorities, and is periodically challenged regarding the
amount of taxes due. These challenges include questions regarding the timing and
amount of deductions and the allocation of income among various tax
jurisdictions. Management believes the Company's tax positions comply with
applicable tax law and intends to defend its positions. In evaluating the
exposure associated with various tax filing positions, the Company records
reserves for uncertain tax positions, and management believes these reserves are
adequate. The Company's effective tax rate in a given financial statement period
could be impacted if the Company prevailed in matters for which reserves have
been established, or was required to pay amounts in excess of established
reserves.

In determining whether a valuation allowance is warranted, management
evaluates factors such as prior earnings history, expected future earnings,
carry-back and carry-forward periods, and tax strategies that could potentially
enhance the likelihood of realization of a deferred tax asset. No valuation
allowance is considered necessary as of December 31, 2004.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2004, we had cash and cash equivalents of $1,175, and
$46,561 was available under the revolving portion of our credit facility (the
"Senior Credit Facility"), after taking into account $2,539 in letters of credit
outstanding and $900 of revolver borrowings. Our working capital at December 31,
2004 was $29,965 compared to $16,410 at December 31, 2003 due primarily to the
acquisition of Papercon.

Our primary short-term and long-term operating cash requirements are for
debt service, working capital, capital expenditures and dividends. We expect to
rely on cash generated from operations supplemented by revolver borrowings under
the Senior Credit Facility to fund short-term and long-term cash requirements.

During the third quarter of 2004, the Company amended the Senior Credit
Facility to provide for an additional $45,000 of Term B loans and an increase in
the revolving credit facility to $50,000, up to $8,000 of which may be in the
form of letters of credit. The revolving credit facility is due in 2008. As of
December 31, 2004, the Term A Loan had an outstanding balance of $24,750 and
will mature in 2008. The required aggregate annual payments, payable in
quarterly installments, total $5,250 $6,250, $7,250 and $6,000 in 2005, 2006,
2007 and 2008, respectively. As of December 31, 2004, the Term B Loan had a
outstanding balance of $83,829 and will mature in 2009. The aggregate annual
payments, payable in equal quarterly installments, total $843 in years 2005
through 2008 and $80,459 in 2009. The revolver had a balance of $900 as of
December 31, 2004.

The Company generated $17,327, $14,989 and $21,503 of cash from operating
activities during 2004, 2003 and 2002, respectively. The increase from 2004
compared to 2003 was primarily due to incremental cash from operating activities
from Papercon partially offset by a decrease in cash from discontinued operating
activities. The decrease in cash from operating activities from 2003 compared to
2002 was primarily related to an increased investment in working capital.

Cash used by discontinued operating activities was $1,952 during 2004
compared with cash from discontinued operations of $2,532 and $4,356 during 2003
and 2002, respectively. The cash generated and used by discontinued operating
activities is a result of ongoing efforts to clear the site and dispose of the
Detroit property. Such costs are expected to continue until the property is
sold.

Cash used by investing activities was $50,378, $12,321 and $13,909 during
2004, 2003 and 2002, respectively. The increase in cash used in continuing
operations investing activities during 2004 was primarily associated with the
Papercon acquisition. Cash used for additions to property, plant and equipment
was $6,081, $6,272 and $2,265 in 2004, 2003 and 2002, respectively. Major
capital expenditures in 2004 were for information technology upgrades,
manufacturing equipment upgrades as well as building and office improvements. In
2003 capital expenditures included $2,842 of investment in new bag making
equipment in our Food Packaging operating segment, increased investment in
information technology infrastructure and upgrades to our manufacturing
facilities.

18

Financing activities generated cash of $33,773 during 2004 compared to a
use of $4,079 and $6,771 during 2003 and 2002, respectively. The cash generated
in the current year was primarily related to the Senior Credit Facility
borrowings in connection with the acquisition of Papercon. In October 2004, the
Company reduced the revolver balance by $22,600 primarily by using the cash
acquired in the Papercon acquisition. During 2004, the Company paid cash
dividends of $1,978 compared with zero during 2003 and 2002. In addition, in
December 2004, the Company announced a cash dividend of $0.065 per common share,
$683 in the aggregate, which was paid on January 4, 2005 to shareholders of
record on December 15, 2004.

Loans under the Senior Credit Facility are designated from time to time, at
our election, either (1) as Eurodollar Rate 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 Rate Loans is equal to LIBOR plus an applicable percentage that
varies with the leverage ratio of the Company 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% or (2) the prime rate, plus
an applicable percentage that varies with the leverage ratio of the Company and
its consolidated subsidiaries.

Accordingly, Term A Loans and revolving loans bear interest at rates of up
to 2.0% plus the base rate, in the case of Base Rate Loans, and up to 3.0% plus
LIBOR, in the case of Eurodollar Loans. Term B Loans bear interest at rates of
2.0% plus the base rate, in the case of Base Rate Loans, and 3.0% plus LIBOR, in
the case of Eurodollar Loans.

At December 31, 2004, the interest rates on borrowings under the Term A
Loan and the Term B Loan were 3.0% plus LIBOR (1.98%) and 3.0% plus LIBOR
(1.98%), respectively, compared with 3.0% plus LIBOR (1.15%) and 3.5% plus LIBOR
(1.15%), respectively, at December 31, 2003. 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".

Borrowings are collateralized by substantially all of the stock and assets
of our operating subsidiaries. The revolving credit facility and Term A Loan
will terminate on September 29, 2008 and the Term B Loan will terminate on
September 29, 2009.

Under the Senior Credit Facility, as amended, we are 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, the ratio of total funded debt of the Company and its
consolidated subsidiaries to consolidated EBITDA of the Company and its
consolidated subsidiaries for the 12-month period then ended must not
exceed specified levels, decreasing from 4.5 to 1 at December 31, 2004 to
4 to 1;

- under the senior secured leverage ratio covenant, as of the last day of
each fiscal quarter, the ratio of total secured funded debt of the
Company and its consolidated subsidiaries to consolidated EBITDA of the
Company and its consolidated subsidiaries for the 12-month period then
ended must not exceed specified levels, decreasing from 3.75 to 1 at
December 31, 2004 to 3 to 1;

- under the fixed charge coverage ratio covenant, as of the last day of
each fiscal quarter, for the 12-month period then ended, the ratio of
consolidated EBITDA less capital expenditures and cash tax payments of
the Company and its consolidated subsidiaries to cash interest expense
and scheduled funded debt payments (excluding the $7,000 seller note
issued in connection with the Papercon acquisition) of the Company and
its consolidated subsidiaries must be equal to or greater than certain
specified levels, increasing from 1.1 to 1 at December 31, 2004 to 1.2 to
1; and

- under the net worth covenant, Packaging Dynamics' consolidated net worth
as of the last day of each fiscal quarter must be equal to or greater
than 80% of the net worth as of September 30, 2003 increased on a
cumulative basis by (1) as of the last day of each fiscal quarter, 50% of
the consolidated net income of Packaging Dynamics (to the extent
positive) for the fiscal quarter then ended, (2) 75% of the net cash
proceeds from any equity issuance by Packaging Dynamics or any subsidiary
of Packaging

19

Dynamics, and (3) 75% of the amount added to the equity of Packaging
Dynamics in accordance with GAAP in connection with the Papercon
acquisition.

For purposes of the Senior Credit Facility, as amended, consolidated
EBITDA, calculated on a consolidated basis for Packaging Dynamics and its
subsidiaries, consists of (1) net income from continuing operations, excluding
the effect of any extraordinary or other non-recurring gains or losses or
non-cash gains or losses (in each case, other than in connection with the sale
and/or closure of the Detroit paper mill), plus (2) an amount which, in the
determination of net income, has been deducted for interest expense, taxes,
depreciation and amortization, non-cash expenses relating to the granting of
options, cash and non-cash charges and/or losses with respect to the sale and/or
closure of the Detroit paper mill, and charges related to the Papercon owner
bonus program prior to the date of acquisition by the Company, minus (3) cash
expenditures related to non-cash charges previously added back to net income in
determining EBITDA (other than in connection with the closure of the Detroit
paper mill), plus (4) the write-off of capitalized financing costs existing as
of the closing of the Senior Credit Facility.

The Senior Credit Facility also contains various negative covenants that,
among other things, require Packaging Dynamics and its subsidiaries to limit
future borrowings and payments to related parties and restricts Packaging
Dynamics' ability and the ability of its subsidiaries to merge or consolidate.
In addition, the Senior Credit Facility prohibits changes in the nature of
business conducted by the Company and its subsidiaries. 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.

The Senior Credit Facility includes 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. The Senior Credit Facility requires PDOC to maintain specified
financial ratios and levels of tangible net worth as discussed above. PDOC was
in compliance with those covenants as of December 31, 2004, the latest
measurement date. The occurrence of any default of these covenants could result
in acceleration of our obligations under the Senior Credit Facility ($109,479 as
of December 31, 2004) and foreclosure on the collateral securing those
obligations.

On October 23, 2002, the Company acquired the outstanding common stock of
Wolf for the issuance of 166,667 shares of our common stock with a market value
of $984 and cash of $9,275 (including the repayment of certain indebtedness and
payment of costs related to the acquisition). 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 generated annual revenues
of approximately $23,000 during 2002. The acquisition was funded substantially
with cash flows from operations.

On December 4, 2003, the Company acquired the net assets of the Iuka
Lamination Division of Ormet Corporation. The Iuka Lamination Division consists
of a single converting plant located in Iuka, Mississippi which produces
laminated foil products for the insulation, food packaging and label stock
markets. The business generated net sales of approximately $18,000 during 2003
and the purchase price was approximately $4,296. The acquisition is not
considered significant and thus no pro forma financial information has been
presented.

On September 14, 2004, the Company acquired Papercon, a manufacturer and
marketer of a broad range of paper and foil based specialty packaging products
for foodservice, supermarket, quick service restaurant and food processing
customers, Papercon is headquartered at its Atlanta, Georgia manufacturing
facility and also has manufacturing facilities near Dallas, Texas and Los
Angeles, California. The acquisition of Papercon significantly broadens the
Company's product line, customer base and geographic presence. The business
generated net sales of approximately $85,480 during 2003 and the aggregate
purchase price was approximately $66,421 comprised of $44,148 of cash (net of
cash acquired), $11,575 of Packaging Dynamics common stock and a $7,000 note
payable to the seller. The cash portion of the acquisition was funded with an
increase in the borrowings under the Senior Credit Facility.

20

Disclosures about contractual obligations and commercial commitments are
included in various parts of this Report, including Note 6 -- Long Term Debt and
Note 11 -- Commitments and Contingencies to the consolidated financial
statements. A summary of significant contractual obligations as of December 31,
2004 is as follows:

The Company does not have long-term supply agreements or capital
commitments in addition to those discussed above.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

NEW ACCOUNTING PRONOUNCEMENTS

In November 2004, the FASB released FASB Statement No. 151, "Inventory
Costs -- an amendment of ARB No. 43, Chapter 4" (which we refer to as "SFAS
151"). SFAS 151 is the result of the FASB's efforts to converge U.S. accounting
standards for inventories with International Accounting Standards. SFAS 151
requires abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage) to be recognized as current-period charges. It also
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. SFAS
151 is effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. We are currently evaluating the effect that the adoption of
SFAS 151 will have on our consolidated results of operations and financial
condition but do not expect SFAS 151 to have a material impact.

In December 2004, the FASB issued two FASB Staff Positions (FSP's) that
provide accounting guidance on how companies should account for the effects of
the American Jobs Creation Act of 2004 (the Act) that was signed into law on
October 22, 2004. The Act could affect how companies report their deferred
income tax balances. The first FSP is FSP FAS 109-1 (FAS 109-1); the second is
FSP FAS 109-2 (FAS 109-2). In FAS 109-1, the FASB concludes that the tax relief
(special tax deduction for domestic manufacturing) from the Act should be
accounted for as a "special deduction" instead of a tax rate reduction. As a
domestic manufacturer the Company will assess early in 2005 whether the Company
is eligible for any tax deductions under this Act. FAS 109-2 gives a company
additional time to evaluate the effects of the Act on any plan for reinvestment
or repatriation of foreign earnings for purposes of applying FASB Statement No.
109, "Accounting for Income Taxes." We expect FAS 109-2 to have no impact.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS 123R"), which replaces SFAS No. 123, "Accounting for Stock-Based
Compensation," ("SFAS 123") and supercedes APB Opinion No. 25, "Accounting for
Stock Issued to Employees." SFAS 123R and the expected related impact on the
Company's financial statements is discussed more fully under the heading
"Disclosures about Critical Accounting Policies -- Stock Based Compensation".

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We use interest rate swaps, collars and caps 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

21

consists of floating rate debt instruments that are benchmarked to LIBOR. As of
December 31, 2004, we had interest rate instruments in effect with banks having
notional amounts totaling $75,000 and varying maturity dates through December
31, 2007. We had an interest rate swap agreement with a notional value of
$25,000 which became effective on December 31, 2003 and matures on December 29,
2006. This swap fixes our LIBOR rate for $25,000 of our Senior Credit Facility
indebtedness at a rate of 2.91%. We also entered into an interest rate collar
agreement with a notional amount of $20,000 which became effective on December
31, 2004 and matures on December 31, 2007. This collar will result in our paying
market LIBOR rates for $20,000 of our Senior Credit Facility indebtedness from a
floor of 3.08% to a cap of 5.00%. In addition to these two instruments, we had
two interest rate caps of $15,000 each which became effective on December 31,
2004 for a cap premium of $376. These caps limit our LIBOR rate for $30,000 of
our Senior Credit Facility indebtedness at a maximum rate of 4.00%. 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 $471 asset as
of December 31, 2004 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
changes in the fair market value of our derivative instruments, net of income
tax, was recorded in other comprehensive income (loss).

Substantially all of our sales, including export sales, are denominated in
United States Dollars in order to reduce our exposure to changes in foreign
currency exchange rates.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements included in this annual report, including without
limitation, "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Summary and Outlook, -- Financial
Performance, -- 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 its 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 Packaging Dynamics and its
subsidiaries.

22

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm is included on page
24.

(a)(1) The following financial statements of Packaging Dynamics are
included on pages 25 to 52.

- Consolidated Balance Sheets at December 31, 2004 and 2003

- Consolidated Statements of Operations for the Years ended December 31,
2004, 2003 and 2002

- Consolidated Statements of Stockholders' Equity/Members' Equity and Other
Comprehensive Income (Loss) for the Years ended December 31, 2004, 2003
and 2002

- Consolidated Statements of Cash Flows for the Years ended December 31,
2004, 2003 and 2002

- Notes to the Consolidated Financial Statements

23

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Packaging Dynamics Corporation

In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Packaging Dynamics Corporation and its subsidiaries (the "Company")
at December 31, 2004 and 2003, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2004 in
conformity with accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

- -s- PricewaterhouseCoopers LLP
PRICEWATERHOUSECOOPERS LLP

Chicago, Illinois
March 30, 2005

24

PACKAGING DYNAMICS CORPORATION

CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)

The accompanying notes are an integral part of this statement.
25

PACKAGING DYNAMICS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)

The accompanying notes are an integral part of this statement.
26

PACKAGING DYNAMICS CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY/MEMBERS' EQUITY AND
OTHER COMPREHENSIVE INCOME (LOSS)
(DOLLARS IN THOUSANDS)

The accompanying notes are an integral part of this statement.

27

PACKAGING DYNAMICS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(DOLLARS IN THOUSANDS)

The accompanying notes are an integral part of this statement.
28

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)

NOTE 1 -- ORGANIZATION AND BASIS OF PRESENTATION

Packaging Dynamics Corporation the ("Company" or "Packaging Dynamics") is a
Delaware corporation established as a holding company to own all of the interest
in Packaging Dynamics Operating Company ("PDOC"). PDOC is a Delaware corporation
which is the holding company for all our current 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. ("Alcoa"). 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, L.L.C ("Packaging Holdings" or "PHLLC"). 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 of Packaging Dynamics; 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/Members' 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 September 2003, in conjunction with the refinancing of the Senior Credit
Facility, Packaging Holdings merged with Packaging Dynamics, L.L.C., a Delaware
limited liability company which was the parent company of all the operating
subsidiaries and of which Packaging Holdings was a sole member, and converted
the surviving limited liability company into a Delaware corporation which was
named Packaging Dynamics Operating Company.

The Company is a flexible packaging converter, supplying specialty
converted paper, foil and film based products for use in a variety of end use
markets. Our continuing operations operate within, and sell to customers
throughout, the U.S., Canada and Europe in two operating segments -- Food
Packaging and Specialty Laminations. The Food Packaging segment converts paper,
film and foil into a variety of specialty value-added food packaging products.
The Specialty Laminations segment produces multi-layer laminated structures from
a variety of substrates (foil, paper, paperboard and film), adhesives and
coatings for use in various food, consumer, medical and industrial packaging
applications as well as the production of insulation

29

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

for the building materials market. Our discontinued operation is the Specialty
Paper segment which we exited during 2003 in connection with our decision to
shut down the Detroit Paper mill.

NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Packaging
Dynamics Corporation and its wholly-owned subsidiaries. Intercompany balances
and transactions have been eliminated.

CASH AND CASH EQUIVALENTS

The Company considers any highly liquid instruments purchased with an
original maturity date of three months or less to be cash equivalents.

REVENUE RECOGNITION

The Company recognizes revenue at the time title transfers to the customer
(generally upon shipment of products) in accordance with Staff Accounting
Bulletin No. 104, "Revenue Recognition in Financial Statements." Shipping and
handling costs are included as a component of cost of goods sold. Rebates and
discounts expenses directly related to the sale are recorded as a reduction to
net sales. The rebates and discounts accruals require the use of management
estimates and the consideration of contractual arrangements subject to
interpretation. Customer sales that reach certain award levels can affect the
amount of such estimates, and actual results could differ from these estimates.

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 December 31, 2004 and 2003
consisted of the following:

PROPERTY, PLANT AND EQUIPMENT

The Company capitalizes expenditures for additions and major improvements
at cost and charges to operating expenses the cost of maintenance and repairs.
Provisions for depreciation have been computed principally on the straight-line
method, over the following estimated useful lives: generally 31 years for
buildings, 15 to 31 years for improvements, 7 to 20 years for machinery and
equipment and 3 to 5 years for computer software. During the second quarter of
2004, the Company changed the estimate of useful lives for certain major
converting machinery and equipment from 12 years to 20 years resulting in a net
reduction of annual depreciation expense of $110. Assets recorded under capital
leases are amortized over the shorter of the life of the lease or useful life.
Depreciation expense was $5,901, $6,709, and $7,543 for the year ended December
31, 2004, 2003 and 2002, respectively.

30

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 and finite-lived
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) are less than the carrying amount of the asset, an impairment
loss is recognized. Finite-lived intangibles, consisting of deferred financing
costs, non-compete agreements and customer contracts, are capitalized and
amortized over their useful lives which range from one to nine years.

The Company amortizes intangible assets with definitive lives over varying
periods. Deferred financing fees are amortized using the effective interest
method over the lives of the respective debt agreements. Customer contracts and
customer relationships are amortized using the straight-line method over the
estimated lives of the contracts and relationships. Covenants not to compete are
amortized using the straight-line method over the lives of the agreements.

GOODWILL AND INDEFINITE-LIVED INTANGIBLE ASSETS

The Company records goodwill and intangible assets in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets." This statement eliminates the requirement for goodwill
and intangible assets with indefinite lives to be amortized to expense over time
but requires instead that such assets be tested for impairment at least
annually, or as circumstances dictate.

Trademarks and trade names are considered to have indefinite lives.
Goodwill, along with other indefinite lived intangibles, are reviewed annually
during the fourth quarter for impairment or when events or circumstances
indicate that an impairment exists. See Note 5 to the financial statements for
additional information.

STOCK BASED COMPENSATION

At December 31, 2004, the Company has a stock-based compensation plan,
which is described more fully in Note 10, "Employee Benefit Plans." The Company
accounts for this plan under the recognition and measurement provisions of
Accounting Principles Board Opinion ("APB") 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. SFAS No. 123, "Accounting for Stock-Based Compensation,"
("SFAS No. 123") issued subsequent to APB No. 25 and amended by SFAS No. 148,
"Accounting for Stock-Based Compensation -- Transition and Disclosure," ("SFAS
No. 148") defines a fair value based method of accounting for employees stock
options but allows companies to continue to measure compensation cost for
employee stock options using the intrinsic value based method described in APB
No. 25.

31

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123 as amended by SFAS No. 148, to stock-based employee compensation.

The determination of compensation expense for the pro forma information was
based upon the estimated fair value of the options on the date of grant using
the Black-Scholes option pricing model with the following assumptions:

The weighted average fair values of options granted during 2004 and 2003
were $3.60 and $2.67 per share, respectively.

These costs may not be representative of the total effects on pro forma
reported net income (loss) for future years. Factors that may impact disclosures
in future years include the attribution of the awards to the service period, the
vesting of stock options, timing of additional grants of stock option awards and
number of shares granted for future awards.

EARNINGS PER SHARE

Basic earnings per share excludes dilution and is computed by dividing net
income by the weighted average number of common shares outstanding during each
period. Diluted earnings per share reflects the potential dilution that could
occur if common stock options are exercised and is computed by dividing net
income by the weighted average number of common shares outstanding, including
common stock equivalent shares, issuable upon exercise of outstanding stock
options, to the extent that they would have a dilutive effect on the per share
amounts. Dilution of the Company's weighted average shares outstanding results
from common stock issuable upon exercise of outstanding stock options.

In accordance with SFAS 128, "Earnings per Share," the denominator used in
the diluted earnings per share calculation is based on the control number
concept, which requires that the same number of potentially dilutive securities
applied in computing diluted earnings per share from continuing operations be
applied to all other categories of income or loss, regardless of their
anti-dilutive effect on such categories.

32

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table details the calculation of basic and diluted earnings
per share for continuing operations:

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.

DERIVATIVES AND OTHER COMPREHENSIVE INCOME (LOSS)

The Company maintains interest rate derivative instruments (typically swaps
or collars) 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. The
Company recognizes all derivative instruments which are cash flow hedges as
assets or liabilities at fair value, with the related gain or loss reflected
within stockholders' equity through accumulated other comprehensive income
(loss). Such instruments are recorded at fair value, and at December 31, 2004
and 2003, the net fair value approximates a $471 asset and a $394 liability,
respectively. Net assets are included in other current assets and net
liabilities are included in accrued liabilities within the accompanying
consolidated balance sheet. Changes in fair value, based upon the amount at
which the instrument could be settled with a third party, are recorded in other
comprehensive income (loss) only to the extent of effectiveness. Any
ineffectiveness on the instrument would be recognized in the consolidated
statement of operations. The differentials to be received or paid under the
instrument are recognized in income over the life of the contract as adjustments
to interest expense.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

NEW ACCOUNTING PRONOUNCEMENTS

In November 2004, the FASB released FASB Statement No. 151, "Inventory
Costs -- an amendment of ARB No. 43, Chapter 4" (which we refer to as "SFAS
151"). SFAS 151 is the result of the FASB's efforts to converge U.S. accounting
standards for inventories with International Accounting Standards. SFAS 151
requires abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage) to be recognized as current-period charges. It also
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. SFAS
151 is effective for inventory costs incurred during fiscal years beginning
after June 15, 2005. We are currently evaluating the effect that the adoption of
SFAS 151 will have on our consolidated results of operations and financial
condition but do not expect SFAS 151 to have a material impact.

In December 2004, the FASB issued two FASB Staff Positions (FSP's) that
provide accounting guidance on how companies should account for the effects of
the American Jobs Creation Act of 2004 (the Act) that was signed into law on
October 22, 2004. The Act could affect how companies report their deferred
income tax balances. The first FSP is FSP FAS 109-1 (FAS 109-1); the second is
FSP FAS 109-2 (FAS 109-2). In FAS 109-1, the FASB concludes that the tax relief
(special tax deduction for domestic

33

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

manufacturing) from the Act should be accounted for as a "special deduction"
instead of a tax rate reduction. As a domestic manufacturer the Company will
assess early in 2005 whether the Company is eligible for any tax deductions
under this Act. FAS 109-2 gives a company additional time to evaluate the
effects of the Act on any plan for reinvestment or repatriation of foreign
earnings for purposes of applying FASB Statement No. 109, "Accounting for Income
Taxes." We expect FAS 109-2 to have no impact.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based
Payment" ("SFAS 123R"), which replaces SFAS No. 123, "Accounting for Stock-Based
Compensation," ("SFAS 123") and supercedes APB Opinion No. 25, "Accounting for
Stock Issued to Employees." SFAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
financial statements based on their fair values beginning with the first interim
or annual period after June 15, 2005, with early adoption encouraged. The pro
forma disclosures previously permitted under SFAS 123 no longer will be an
alternative to financial statement recognition. Under SFAS 123R, we must
determine the appropriate fair value model to be used for valuing share-based
payments, the amortization method for compensation cost and the transition
method to be used at date of adoption. The transition methods include
prospective and retroactive adoption options. Under the retroactive option,
prior periods may be restated either as of the beginning of the year of adoption
or for all periods presented. The prospective method requires that beginning
with the first quarter of adoption of SFAS 123R compensation expense will be
recorded for stock options and restricted stock as such items vest, while the
retroactive methods would record compensation expense for all stock options and
restricted stock as they vest beginning with the first period restated. We have
not yet determined the method of adoption or the effect of adopting SFAS 123R,
and have not determined whether the adoption will result in amounts that are
similar to the current pro forma disclosures under SFAS 123.

CONCENTRATION OF CREDIT RISK

The Company performs ongoing credit evaluations of its customers and does
not generally require collateral. The Company maintains allowances for potential
credit losses based upon expected collectibility of all accounts receivable.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts of financial instruments including cash and cash
equivalents, accounts receivable, accounts payable and variable rate debt
approximates their estimated fair value based either on the short-term maturity
of these instruments or on market prices for the same or similar type of
financial instruments. The fair market value and carrying value of the Company's
interest rate swaps were a net gain of $471 and a net loss of $394 at December
31, 2004 and 2003, respectively. At December 31, 2004, the fair value of amounts
payable under a non-compete agreement (twelve quarterly payments totaling
$4,000) was estimated to be $3,698 determined by discounting the payments using
a 5% discount rate. Also at December 31, 2004, the fair value of a $7,000 note
payable on September 14, 2006 and bearing a 5% annual interest rate payable
quarterly, was estimated to be $7,000.

INCOME TAXES

The Company provides for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes." SFAS No. 109 requires the asset and liability
approach in accounting for income taxes. Deferred income tax assets and
liabilities are recorded based on the differences between the financial
statement and tax base of assets and liabilities using enacted tax rates.
Valuation allowances are provided against deferred tax assets, which are not
likely to be realized.

34

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

RECLASSIFICATION

Certain prior year amounts have been reclassified to conform to the current
year's presentation.

NOTE 3 -- DISCONTINUED OPERATIONS

During the fourth quarter of 2003, the Company shut down its paper mill,
located in Detroit, Michigan, and exited its Specialty Paper operation. In
accordance with SFAS 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" which establishes accounting and reporting standards for the
impairment and disposal of long-lived assets and discontinued operations, the
Specialty Paper operation is classified as a discontinued operation. The
financial information presented for all prior periods has been reclassified to
reflect the Specialty Paper operation as a discontinued operation in the
Consolidated Statement of Operations.

Loss from discontinued operations in 2004 was $1,278 compared to a loss of
$22,089 in 2003. The net loss for 2004 represents approximately $2,317 ($1,402
after tax) of administrative costs associated with the ongoing program to clear
the site, recover assets and dispose of the Detroit property and additional
withdrawal liability from a multi-employer pension plan recorded in the fourth
quarter of 2004 of $398 ($241 after tax), offset by approximately $602 ($364
after tax) of proceeds from the liquidation of equipment. In the third quarter
of 2003, the Company recorded a $22,094 ($13,367 after tax) asset impairment
charge and a $2,800 ($1,694 after tax) severance charge based on SFAS No. 112,
"Employers' Accounting for Postemployment Benefits." In the fourth quarter of
2003, the Company recorded an additional charge of $1,965 ($1,189 after tax)
primarily related to the write-down of parts and supplies inventories, the
write-down of other current assets and for employee outplacement services, and a
charge of $816 ($495 after tax) for withdrawal liability from a multi-employer
pension plan. The remaining loss from discontinued operations during 2003 was
the result of operating losses. In 2005 we will have additional costs related to
our ongoing program to clear the site, recover assets and dispose of the Detroit
property, although the total amount of such costs are not currently estimable.
There can be no assurance, however, that items will not require additional
expenditures beyond those that are anticipated and that additional expenditures,
if any, would not have a material adverse effect on our operating results or
financial condition.

35

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table details selected income statement information for the
Specialty Paper operation. Interest expense was allocated to the Specialty Paper
operation based on the ratio of net assets over total debt plus equity.

The assets and liabilities associated with the Specialty Paper operation
are included in the Consolidated Balance Sheet. The following table details
selected balance sheet information for the Specialty Paper operation.

A summary of the changes in the reserves related to the severance and
pension charges recorded in 2004 in connection with the Company's exit from the
Specialty Paper operation is as follows:

36

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 4 -- ACQUISITION

PAPERCON

On September 14, 2004, the Company completed the acquisition of 100% of the
issued and outstanding shares of capital stock of 3141276 Canada Inc. from the
sole shareholder (the "Seller") pursuant to an acquisition agreement dated
August 6, 2004. 3141276 Canada Inc. is a Canadian corporation and the ultimate
parent holding company of Papercon, Inc. (Papercon, Inc. and 3141276 Canada Inc.
are collectively referred to as "Papercon"), a Georgia corporation, which
conducts all of Papercon's business operations.

Papercon, a manufacturer and marketer of a broad range of paper and foil
based specialty packaging products for foodservice, supermarket, quick service
restaurant and food processor customers, is headquartered at its Atlanta,
Georgia manufacturing facility and also has manufacturing facilities near
Dallas, Texas and Los Angeles, California. The acquisition of Papercon
significantly broadens the Company's product line, customer base and geographic
presence.

Packaging Dynamics acquired Papercon for aggregate consideration of
approximately $66,421, net of $22,650 of cash acquired and subject to
adjustment, comprised of $44,148 of cash consideration (net of cash acquired), a
$7,000 two year note with interest payable quarterly at a 5% annual interest
rate, 833,333 shares of Packaging Dynamics common stock valued at $11,575 based
upon the price of the Company's stock price near the August 6, 2004 acquisition
announcement date, and approximately $3,698 representing the present value of
amounts payable pursuant to a ten year non-competition agreement between the
Company and Seller. In addition, the Company incurred $1,680 in other direct
costs related to the acquisition, primarily accounting and legal expenses
incurred in the second half of 2004.

The following table summarizes the allocation of the purchase price.

Current assets (net of $22,650 cash acquired)............... $ 17,985
Property, plant and equipment............................... 8,314
Intangible assets........................................... 18,998
Goodwill.................................................... 38,669
--------
Total assets acquired (net of $22,650 cash acquired)...... 83,966
--------
Current liabilities......................................... (7,881)
Deferred taxes.............................................. (7,984)
--------
Total liabilities assumed................................. (15,865)
--------
Net assets acquired (net of $22,650 cash acquired).......... $ 68,101
========

The Company considered the intangible assets that should be recognized
apart from goodwill. The Company performed an internal review and retained the
services of an outside appraisal firm to value intangibles. Intangible assets,
as reflected above, are comprised of non-contractual customer relationships of
$10,500 (20 year weighted average life), trade name of $4,800 (indefinite life),
and a non-compete agreement of $3,698 (twelve quarterly payments totaling $4,000
discounted at a 5% annual interest rate). The non-compete agreement is
deductible for tax purposes over a 15 year period. The remaining intangible
assets and goodwill are not deductible for income tax purposes.

In addition, the purchase price allocation reflected in the table above is
also subject to change based on the receipt of additional information with
respect to the fair value of certain assets and obligations and the resolution
of the net asset purchase price adjustment provision contained in the
acquisition agreement. The final valuation of assets and liabilities and the
associated purchase price allocation is expected to be completed as soon as
possible. The purchase price adjustment process is ongoing and is expected to be
resolved in 2005.

37

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's financial statements include the results of operations and
cash flows of Papercon from September 14, 2004, the effective date of
acquisition. The following table summarizes certain supplemental unaudited pro
forma financial information of the Company which was prepared as if the
acquisition by the Company had occurred as of the beginning of the periods
presented. The unaudited pro-forma financial information was prepared for
comparative purposes only and does not purport to be indicative of what would
have occurred had the acquisition been made at that time or of results which may
occur in the future.

IUKA

On December 4, 2003, the Company acquired the net assets of the Iuka
Lamination Division ("Iuka") of Ormet Corporation ("Ormet") for $4,296 comprised
of $5,000 in cash paid at closing less $704 received during the second quarter
of 2004 pursuant to a settlement agreement with Ormet, as approved by the United
States Bankruptcy court presiding over Ormet's bankruptcy case, with respect to
the working capital adjustment mechanism contained in the agreement of sale. In
addition, the Company incurred $218 in other direct costs related to the
acquisition. The acquisition is not considered significant and thus no pro forma
financial information has been presented.

The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition.

Current assets.............................................. $ 5,233
Property, plant and equipment............................... 1,258
Intangible assets........................................... --
Goodwill.................................................... --
-------
Total assets acquired..................................... 6,491
-------
Current liabilities......................................... (1,977)
-------
Total liabilities assumed................................. (1,977)
-------
Net operating assets acquired............................... 4,514
Debt assumed.............................................. --
-------
Net assets acquired......................................... $ 4,514
=======

WOLF

On October 23, 2002, the Company acquired the outstanding common stock of
Wolf Packaging, Inc. ("Wolf") for the issuance of 166,667 shares of the
Company's common stock with a fair market value on the

38

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

date of acquisition of $984 and cash of $9,275 (including the repayment of
certain indebtedness and payment of costs related to the acquisition). 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. The
acquisition is not considered significant and thus no pro forma financial
information has been presented.

The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition of Wolf.

The intangible assets are comprised of customer contracts of $380 (1.4 year
weighted average life) and non-compete agreements of $100 (9.5 year weighted
average life). Goodwill was not deductible for income tax purposes.

NOTE 5 -- GOODWILL AND INTANGIBLE ASSETS

Goodwill and intangible assets at December 31, 2004 consist of the
following:

39

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Goodwill and intangible assets at December 31, 2003 consist of the
following:

Goodwill for 2004, 2003, and 2002 is as follow:

Amortization expense for intangible assets subject to amortization was
$347, $354, and $120 for the year ended December 31, 2004, 2003 and 2002,
respectively. Amortization expense for the years 2005, 2006, 2007, 2008 and 2009
is estimated to be $906, $906, $906, $904 and $904, respectively.

NOTE 6 -- LONG-TERM DEBT

Long-term debt at December 31, 2004 and 2003 consists of the following:

SENIOR CREDIT FACILITY

During the third quarter of 2003, PDOC entered into a new credit facility
(the "Senior Credit Facility") that provided for a Term A Loan and Term B Loan
totaling $70,000 and a $40,000 revolving credit facility, up to $5,000 of which
could be in the form of letters of credit.

40

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

During the third quarter of 2004, PDOC amended the Senior Credit Facility
to provide for an additional $45,000 of Term B Loans, providing for a total of
Term A and Term B Loans of $115,000 and an increase in the revolving credit
facility to $50,000, up to $8,000 of which may be in the form of letters of
credit. As of December 31, 2004, the Term A Loan had a balance of $24,750 and
will mature in 2008. The required aggregate annual payments, payable in
quarterly installments, total $5,250 $6,250, $7,250 and $6,000 in years 2005
through 2008, respectively. As of December 31, 2004, the Term B Loan had a
balance of $83,829 and will mature in 2009. The aggregate annual payments,
payable in equal quarterly installments, total $843 in years 2005 through 2008
and $80,459 in 2009. The revolver had a balance of $900 as of December 31, 2004.
The revolving credit facility is due in 2008.

Loans under the Senior Credit Facility are designated from time to time, at
our election, either (1) as Eurodollar Rate 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 Rate Loans is equal to LIBOR plus an applicable percentage that
varies with the leverage ratio of the Company 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% or (2) the prime rate, plus
an applicable percentage that varies with the leverage ratio of the Company and
its consolidated subsidiaries.

Accordingly, Term A Loans and revolving loans bear interest at rates of up
to 2.0% plus the base rate, in the case of Base Rate Loans, and up to 3.0% plus
LIBOR, in the case of Eurodollar Loans. Term B Loans bear interest at rates of
2.0% plus the base rate, in the case of Base Rate Loans, and 3.0% plus LIBOR, in
the case of Eurodollar Loans.

At December 31, 2004, the interest rates on borrowings under the Term A
Loan and the Term B Loan were 3.0% plus LIBOR (1.98%) and 3.0% plus LIBOR
(1.98%), respectively, compared with 3.0% plus LIBOR (1.15%) and 3.5% plus LIBOR
(1.15%), respectively, at December 31, 2003. As of December 31, 2004, we had
interest rate derivative agreements with a group of banks having notional
amounts totaling $75,000 and varying maturity dates through December 31, 2007.
The interest rate swap agreements effectively fix our LIBOR rate for $25,000 of
our Senior Credit Facility indebtedness at a rates of 2.91%. During 2004, the
Company entered into an interest rate collar agreement with a notional amount of
$20,000 which became effective on December 31, 2004 and matures on December 31,
2007. This collar will result in our paying market LIBOR rates for $20,000 of
our Senior Credit Facility indebtedness from a floor of 3.08% to a cap of 5.00%.
Additionally, the Company entered into two interest rate caps of $15,000 each
that are effective December 31, 2004 for a cap premium of $376. These caps
effectively limit LIBOR rate for $30,000 of our Senior Credit Facility
indebtedness at a maximum rate of 4.00%.

Borrowings are collateralized by substantially all of the stock and assets
of our operating subsidiaries. The revolving credit facility and Term A Loan
will terminate on September 29, 2008 and the Term B Loan will terminate on
September 29, 2009.

Under the Senior Credit Facility, as amended, we are 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, the ratio of total funded debt of the Company and its
consolidated subsidiaries to consolidated EBITDA of the Company and its
consolidated subsidiaries for the 12-month period then ended must not
exceed specified levels, decreasing from 4.5 to 1 at December 31, 2004 to
4 to 1;

- under the senior secured leverage ratio covenant, as of the last day of
each fiscal quarter, the ratio of total secured funded debt of the
Company and its consolidated subsidiaries to consolidated EBITDA of the
Company and its consolidated subsidiaries for the 12-month period then
ended must not exceed specified levels, decreasing from 3.75 to 1 at
December 31, 2004 to 3 to 1;
41

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

- under the fixed charge coverage ratio covenant, as of the last day of
each fiscal quarter, for the 12-month period then ended, the ratio of
consolidated EBITDA less capital expenditures and cash tax payments of
the Company and its consolidated subsidiaries to cash interest expense
and scheduled funded debt payments (excluding the $7,000 seller note
issued in connection with the Papercon acquisition) of the Company and
its consolidated subsidiaries must be equal to or greater than certain
specified levels, increasing from 1.1 to 1 at December 31, 2004 to 1.2 to
1; and

- under the net worth covenant, Packaging Dynamics' consolidated net worth
as of the last day of each fiscal quarter must be equal to or greater
than 80% of the net worth as of September 30, 2003 increased on a
cumulative basis by (1) as of the last day of each fiscal quarter, 50% of
the consolidated net income of Packaging Dynamics (to the extent
positive) for the fiscal quarter then ended, (2) 75% of the net cash
proceeds from any equity issuance by Packaging Dynamics or any subsidiary
of Packaging Dynamics, and (3) 75% of the amount added to the equity of
Packaging Dynamics in accordance with GAAP in connection with the
Papercon acquisition.

For purposes of the Senior Credit Facility, as amended, consolidated
EBITDA, calculated on a consolidated basis for Packaging Dynamics and its
subsidiaries, consists of (1) net income from continuing operations, excluding
the effect of any extraordinary or other non-recurring gains or losses or
non-cash gains or losses (in each case, other than in connection with the sale
and/or closure of the Detroit paper mill), plus (2) an amount which, in the
determination of net income, has been deducted for interest expense, taxes,
depreciation and amortization, non-cash expenses relating to the granting of
options, cash and non-cash charges and/or losses with respect to the sale and/or
closure of the Detroit paper mill, and charges related to the Papercon owner
bonus program prior to the date of acquisition by the Company, minus (3) cash
expenditures related to non-cash charges previously added back to net income in
determining EBITDA (other than in connection with the closure of the Detroit
paper mill), plus (4) the write-off of capitalized financing costs existing as
of the closing of the Senior Credit Facility.

The Senior Credit Facility also contains various negative covenants that,
among other things, require Packaging Dynamics and its subsidiaries to limit
future borrowings and payments to related parties and restricts Packaging
Dynamics' ability and the ability of its subsidiaries to merge or consolidate.
In addition, the Senior Credit Facility prohibits changes in the nature of
business conducted by the Company and its subsidiaries. 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.

The Senior Credit Facility includes 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. The Senior Credit Facility requires Packaging Dynamics Operating
Company ("PDOC") to maintain specified financial ratios and levels of tangible
net worth. PDOC was in compliance with those covenants as of December 31, 2004,
the latest measurement date. The occurrence of any default of these covenants
could result in acceleration of our obligations under the Senior Credit Facility
($109,479 as of December 31, 2004) and foreclosure on the collateral securing
those obligations.

The Senior Credit Facility limits and restricts the payment of dividends
and distribution or transfer of assets by PDC and its subsidiaries. Dividends to
shareholders may not exceed $4 million in any twelve month period. Additionally,
any redemption or repurchase of capital stock of the Company other than as
defined in the Senior Credit Facility is not permitted. As a result,
substantially all of PDOC's net assets are restricted.

SELLER NOTE PAYABLE

On September 14, 2004, the Company issued a $7,000 note to the seller in
connection with the acquisition of Papercon. The note matures on September 14,
2006 and bears an annual interest rate of 5%

42

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

payable quarterly. This note is unsecured and subordinated to the Senior Credit
Facility. See Note 8 to the Company's annual consolidated financial statements
for further information.

BAXTER SPRINGS FACILITY LOANS

At December 31, 2003 the Company had 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. This loan
was refinanced in the third quarter of 2003. The remaining unpaid principal of
$700, bearing interest at 1.21%, was paid off in full on the maturity date in
the third quarter of 2004.

MATURITIES

Maturities of long-term debt greater than one year outstanding at December
31, 2004 were:

Year ending December 31:
2005...................................................... $ 6,093
2006...................................................... 14,092
2007...................................................... 8,092
2008...................................................... 7,743
2009...................................................... 80,459
--------
$116,479
========

NOTE 7 -- OPERATING SEGMENT INFORMATION

Our continuing operations operate within, and sell to customers throughout,
the U.S., Canada and Europe in two operating segments -- Food Packaging and
Specialty Laminations. The Food Packaging segment converts paper, film and foil
into a variety of specialty value-added food packaging products. The Specialty
Laminations segment produces multi-layer laminated structures from a variety of
substrates (foil, paper, paperboard and film), adhesives and coatings for use in
various food, consumer, medical and industrial packaging applications as well as
the production of insulation for the building materials market. Corporate
administrative expenses are allocated to the segments on a direct basis where
appropriate with the remainder being allocated based on revenues. During 2004,
approximately 90.0% of the Company's sales were to United States customers, with
substantially all of the remaining 10% to customers in Europe.

43

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The reconciliation of Segment Operating Income to the Company's
consolidated financial statements is as follows:

44

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 8 -- RELATED PARTY TRANSACTIONS

As further discussed in Note 4 -- Acquisitions, pursuant to an acquisition
agreement (the "Acquisition Agreement") dated August 6, 2004, Packaging Dynamics
acquired 100% of the issued and outstanding shares of capital stock of 3141276
Canada Inc., the parent holding company of Papercon, Inc. ("Papercon"), from its
sole shareholder (the "Seller"). The acquisition closed on September 14, 2004.
Prior to the Papercon acquisition, the Seller was not affiliated with the
Company. Effective with the closing, the Seller became an officer of the
Company. In connection with the Papercon acquisition, the Company entered into
the Acquisition Agreement and several related agreements with the Seller.
Certain of these agreements obligate the Company to make payments to, or take
other action for the benefit, of the Seller as discussed below.

Pursuant to the Acquisition Agreement, Packaging Dynamics acquired Papercon
for aggregate consideration of approximately $66,421, net of $22,650 of cash
acquired. The purchase price is subject to adjustment to the extent that the net
assets of Papercon (as defined in the Acquisition Agreement) are less than
$33,500.

The Company issued a $7,000 two year Seller Note to the Seller which is due
and payable on September 14, 2006. The principal amount payable under the Seller
Note will accrue interest at a rate of 5% per year, which will be due and
payable in cash on a quarterly basis. The Company has the right to set-off
against its payment obligations under the Seller Note for the full amount of any
indemnification obligations required to be paid by the Seller under the
Acquisition Agreement. Events of default under the Seller Note would include the
Company's failure to make any payment that is not subject to a claim for
set-off, a material breach of any of the Company's representations and
warranties under the Seller Note that are not cured within 30 days of notice of
such breach and the bankruptcy or general insolvency of the Company. In
addition, a default by the Company under the Non-Competition Agreement would
constitute a cross-default under the Seller Note. In the event of a default and
upon written notice of the Seller (except in the case of default due to the
bankruptcy or general insolvency of the Company, in which case written notice is
not required), the balance of consideration due under the Seller Note would
become immediately due and payable and would also accrue interest at a rate of
12% per year until such time as the event of default is cured by the Company (or
waived by the Seller) or all amounts due are paid in full.

In connection with the Seller Note, the Seller entered into an
intercreditor agreement with Bank of America, the administrative agent for the
Company's credit facility, pursuant to which payments under the Seller Note are
subordinated to payments under the Company's senior credit facility, as amended.

The Company entered into a Non-Competition Agreement with the Seller which
provides, among other things, that for a period of ten years following the
closing of the Acquisition, the Seller may not own, operate, manage, control,
engage in, invest in or participate in any manner in, act as a consultant or
advisor to, or render services for any other person or entity in any similar or
competitive business as Packaging Dynamics and its subsidiaries (including
Papercon) anywhere in the United States and Canada. Also, during this period,
the Seller may not without the prior written consent of the Company, solicit or
advise any customer or vendor of the Company to patronize a competitive business
or curtail or withdraw their business with the Company or solicit for employment
any person employed by the Company. The Company is required to make twelve (12)
equal quarterly payments of $333 to the Seller under the Non-Competition
Agreement commencing in December 2004. The Company has the right to set-off
against its payment obligations under the Non-Competition Agreement the full
amount of any indemnification obligations required to be paid by the Seller
under the Acquisition Agreement. A failure by the Company to make any payment
under the Non-Competition Agreement that is not subject to a claim for set-off,
so long as the Seller has not breached the Non-Competition Agreement, would
constitute an event of default. Additionally, the failure to pay any amount of
principal or interest due under the Seller Note would constitute a cross-default
under the Non-Competition Agreement. In the event of a default and upon written
notice of the Seller, the balance of consideration due under the Non-Competition
Agreement would become immediately due and payable and

45

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

would also accrue interest at a rate of 12% per year until such time as the
event of default is cured by the Company (or waived by the Seller) or all
amounts due are paid in full.

The Company and the Seller entered into a registration rights agreement,
dated September 14, 2004 (the "Papercon Seller Registration Rights Agreement"),
between the Company, the Seller and Packaging Investors, L.P. ("Packaging
Investors"). The Company also amended its existing registration rights agreement
(the "Initial Registration Rights Agreement") with, among others, Packaging
Investors. Pursuant to the Papercon Seller Registration Rights Agreement, the
Seller has the right, under certain circumstances, to require the Company to
register his shares of Seller Common Stock for sale in the public markets. The
Seller also has piggyback registration rights to include his shares in any
registration statement which the Company files on its own behalf (other than for
employee benefit plans and business acquisitions or corporate restructurings) or
on behalf of other stockholders. The Company amended the Initial Registration
Rights Agreement to provide for the piggyback registration rights granted to the
Seller under the Papercon Seller Registration Rights Agreement. In addition,
under the Papercon Seller Registration Rights Agreement, until the date on which
the Seller ceases to own at least 5% of the outstanding shares of Seller Common
Stock, at each annual meeting of stockholders, the Company has agreed to
nominate or cause to be nominated the Seller for election to the board of
directors of the Company. The Seller and Packaging Investors have agreed that
until the date (a) on which Packaging Investors ceases to own at least 20% of
the outstanding shares of Seller Common Stock, the Seller will vote any shares
of Seller Common Stock then owned by him to nominate and elect the individual
designated by Packaging Investors for election to the board of directors of the
Company and (b) on which the Seller ceases to own at least 5% of the outstanding
shares of Seller Common Stock, Packaging Investors will vote any shares of
Seller Common Stock then owned by it to nominate and elect the Seller for
election to the board of directors of the Company.

In connection with the Papercon acquisition, Papercon entered into a new
lease (the "Lease") with respect to its Atlanta headquarters and facilities,
effective as of September 14, 2004, with GHGA Properties, L.P. (the "Landlord"),
a limited partnership wholly-owned and controlled by the Seller. The initial
term of the Lease is five years and has options to renew for three additional
five-year terms. The monthly rent for the initial and first renewal terms has
been fixed at $49 and $52, respectively, with the subsequent renewal terms to be
set at the market rate as agreed upon by the parties. The payment and
performance of the obligations arising under the Lease are guaranteed pursuant
to a separate guaranty by the Company in favor of Landlord. This arrangement was
amended during the fourth quarter of 2004 and is reflected in the accompanying
financial statements as an operating lease.

During 2004, the Company purchased paper from Valentine Paper, Inc.
("Valentine") in the normal course of its business. These purchases totaled
approximately $3 million, or approximately 9% of Valentine's 2004 gross revenue.
Certain of the Company's directors (Messrs. Bayly, Scotto and Tannura) and
executive officers (Messrs. Gentili, Lawrence and Wartner) own in the aggregate
approximately 20% of Valentine's outstanding ownership interests. Mr. Scotto and
Mr. Tannura serve as Valentine's board of directors and Mr. Tannura serves as an
officer of Valentine.

Pursuant to a consulting agreement, the Company paid Ivex an annual
consulting fee for management and administrative services rendered to the
Company by Ivex including financial, tax, accounting and legal services. During
2002 the Company recorded consulting fee expense of $250 related to this
agreement. On July 1, 2002, the consulting agreement was canceled.

46

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

NOTE 9 -- 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 Packaging Dynamics. Prior to
the distribution, the members of Packaging Holdings reported federal and state
taxable income on their income tax returns. 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 in 2002 related to the
change in tax status was approximately $9,200.

The components of the income tax provision on income from continuing
operations shown in the consolidated statements of operations were as follows:

The provision recognized for income taxes relating to continuing operations
differs from the amount determined by applying the U.S. federal income tax rate
of 35% due to the following:

47

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Deferred tax liabilities (assets) were comprised of the following:

Realization of deferred income tax assets is dependent upon generating
sufficient future taxable income in the periods in which the assets reverse or
the benefits expire. The Company has $1,213 in net operating loss carryforwards
that expire in 2023 and an AMT carryforward of $146. In the event of a change in
ownership of the Company, these net operating loss carryovers may be limited.
The Company has considered the weight of available evidence and concluded more
likely than not that it will realize its recorded deferred tax assets and
consequently no valuation allowance has been established.

On October 22, 2004 the President signed the American Jobs Creation Act of
2004 (the "Act"). The Act provides for a deduction for income from qualified
domestic production activities, which will be phased in from 2005 through 2010.
This provision also is subject to a number of limitations which effect the
effective tax rate in 2005 and later. The Company has not yet determined the
extent to which its effective rate will change.

NOTE 10 -- EMPLOYEE BENEFIT PLANS

The Company sponsors two 401(k) plans. All employees over twenty-one years
of age are covered by one of these plans. Eligibility varies from three to six
months following the date of hire. Matching contributions vary from 4% to 5%
depending on the plan. The vesting period ranges from three years to five years.
Company contributions were approximately $933, $823, and $784 for the years
ended December 31, 2004, 2003 and 2002, respectively.

The Company sponsors a nonqualified deferred compensation plan into which
eligible employees may elect to contribute a portion of their compensation. The
Company may, but is not obligated to, make matching or incentive contributions
to the plan. The plan was adopted on January 1, 2003 and Company contributions
to the plan during 2004 and 2003 were $32 and $13, respectively.

2001 Long-Term Incentive Compensation Plan -- 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

48

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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. The plan was terminated during 2002.

2002 Long-Term Incentive Stock Plan -- 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 814,787 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
730,622 options, although fully vested, are not exercisable for three years
after the grant date. Consequently, for such options 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
$2,667 during the year ended December 31, 2002 related to these management
incentive plans.

During 2002, 43,397 options were repurchased from former employees for
approximately $124. These payments reduced the $2,667 incentive liability
recorded in 2002. No options were repurchased in 2003 and 2004. Additional
information relating to the plans was as follows:

Options exercisable under the 2002 Long Term Incentive Stock Plan were
93,342, 0 and 62,739 at December 31, 2004, 2003 and 2002, respectively.

49

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes information about stock options outstanding
at December 31, 2004:

As of December 31, 2004, 2003 and 2002, there were 31,199, 357,867 and
599,563 shares available for grant, respectively. The weighted average fair
value at date of grant for options whose exercise price was less than the market
price of the stock on the date of grant during 2003 and 2002 was $2.08 and
$4.25, respectively. There were no options granted in 2004 for which the
exercise price is less than the market price on the date of grant during 2004.
The weighted average fair value at date of grant for options whose exercise
price was equal to the market price of the stock on the grant date during 2004
and 2003 was $3.60 and $2.93, respectively. There were no options granted in
2002 for which the exercise price was equal to the market price on the date of
grant. There were no options granted in 2004, 2003 or 2002 for which the
exercise price was greater than the market price on the date of grant. No
options were granted prior to July 1, 2002.

NOTE 11 -- COMMITMENTS AND CONTINGENCIES

LEGAL PROCEEDINGS

The Company is currently a party to various legal proceedings in various
federal and state jurisdictions arising out of the operations of our business.
The amount of alleged liability, if any, from these proceedings cannot be
determined with certainty; however, we believe that our 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, taking
into account established accruals for estimated liabilities, should not be
material to our financial condition or results of operations.

LEASE COMMITMENTS

The Company occupies certain facilities under lease arrangements and leases
certain machinery, automobiles, and equipment. Rental expense amounted to
$1,707, $1,704 and $1,531 for the year ended December 31, 2004, 2003 and 2002,
respectively.

50

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Future minimum rental commitments, including capital lease obligations,
with noncancelable terms in excess of one year are as follows:

Year ending December 31:
2005...................................................... $ 2,443
2006...................................................... 2,260
2007...................................................... 1,667
2008...................................................... 1,405
2009...................................................... 1,124
Thereafter................................................ 3,635
-------
$12,534
=======

Accumulated amortization on capital leases as of December 31, 2004, 2003
and 2002 was $94, $19 and $0, respectively.

ENVIRONMENTAL MATTERS AND GOVERNMENT REGULATION

Since many of our packaging products are used in the food industry, we are
subject to the manufacturing standards of the U.S. Food and Drug Administration.
Historically, compliance with the standards of the food industry has not had a
material effect on our earnings, capital expenditures or competitive position.
There can be no assurance, however, that compliance with those standards will
not have a material adverse effect on our future operating results or financial
condition.

Our 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 our properties or any associated offsite disposal
location, or if contamination from prior activities is discovered at any of our
properties, we may be held liable. From time to time, we are involved in
regulatory proceedings and inquiries relating to compliance with environmental
laws, permits and other environmental matters. We believe that we are in
material compliance with applicable environmental regulations and do not believe
that costs of compliance, if any, will have a material adverse effect on our
financial condition, results of operation, or liquidity. In 2005, we will have
additional costs related to our ongoing program to clear the site, recover
assets and dispose of the Detroit property, although the total amount of such
costs are not currently estimable. There can be no assurance, however, that
items will not require additional expenditures beyond those that are anticipated
and that additional expenditures, if any, would not have a material adverse
effect on our operating results or financial condition.

NOTE 12 -- ASSET SALES AND DISPOSALS

During 2004, we sold property within our Specialty Laminations operating
segment which resulted in a gain of $55. During 2003 and 2002, the Company idled
certain converting equipment in its Chicago, Illinois and Baxter Springs, Kansas
manufacturing facilities due to the purchase of five new bag machines in 2003.
These manufacturing improvements and certain other productivity improvements
resulted in a loss in 2003 and 2002 of $813 and $1,510, respectively, on the
sale or disposal of the equipment.

NOTE 13 -- RESTRUCTURING CHARGE

In January 2000, the Company commenced a restructuring plan, which resulted
in a reduction in work force of 32 people. The restructuring charge included
severance and other benefits related to this reduction in

51

PACKAGING DYNAMICS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

force of $1,250. At December 31, 2004, 2003 and 2002, there was $0, $18 and $54,
respectively, of severance and other benefits costs remaining to be paid in
future periods.

The restructuring reserve activity was as follows:

NOTE 14 -- UNAUDITED QUARTERLY RESULTS

Summarized unaudited quarterly data for the years ended December 31, 2004
and 2003 were as follows:

52

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES

None.

ITEM 9A. CONTROLS AND PROCEDURES

EVALUATION OF 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 the end of the period covered by this
report. Based on such evaluation, the Company's Chief Executive Officer and
Chief Financial Officer have concluded that the Company's disclosure controls
and procedures were not effective as of December 31, 2004 due to the restatement
of prior period information contained in Item 15(a)(2) Schedule I -- Condensed
Financial Information as discussed below. Subsequent to December 31, 2004, the
Company performed additional analysis and other post-closing procedures to
ensure our consolidated financial statements were prepared in accordance with
generally accepted accounting principles. Accordingly, management believes that
the financial statements included in this report fairly present in all material
respects our financial condition, results of operations and cash flows for the
periods presented.

Subsequent to December 31, 2004, the Company determined that a restatement
of the prior period (2002 and 2003) parent company only financial information
contained in Item 15(a)(2) Schedule I -- Condensed Financial Information was
necessary. As explained in Schedule I, Note 2 -- Restatement Adjustments, the
restatement included adjustments to reflect the appropriate allocation of tax
attributes between the parent and its wholly-owned subsidiaries and recording
the parent's equity in the underlying net assets of its wholly-owned
subsidiaries. The restatement had no impact on the Company's consolidated
financial statements included in Item 8. The determination to restate the prior
year information was made as a result of disclosure controls and procedures in
effect subsequent to December 31, 2004 during the preparation of Schedule I for
inclusion in the Company's 2004 annual report on Form 10-K.

In addition to our responsibilities with respect to an evaluation of our
disclosure controls and procedures, we, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, are in the process of performing the assessments required by
Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules adopted by
the SEC (collectively, the "Section 404 requirements"). In the event that we are
deemed an Accelerated Filer for 2005, we will be required to include a report on
management's assessment of the effectiveness of our internal control over
financial reporting in our Annual Report on Form 10-K for the year ending
December 31, 2005. Our independent auditor will also be required to attest to
and report on management's assessment of the effectiveness of our internal
control over financial reporting. We have been and are continuing to devote
significant resources to prepare for the Section 404 requirements. There can be
no assurances that once completed, management's assessment and the auditor's
attestation will not report any material weaknesses in our internal control over
financial reporting.

In connection with our response to the rules pertaining to the evaluation
of our disclosure controls and procedures, as well as our response to the
Section 404 requirements pertaining to the assessment of our internal controls
over financial reporting, we are reviewing, documenting and testing our
disclosure controls and procedures and our internal controls over financial
reporting, and may from time to time make changes aimed at enhancing their
effectiveness and to ensure that our systems evolve with our business. For
example, we are using internal resources and third party service providers to
assist us in evaluating, documenting and testing our key controls over financial
reporting in preparation for management's assessment under the Section 404
requirements. These efforts are likely to lead to changes in our internal
controls over financial reporting, including enhanced documentation of certain
of these internal controls.

53

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING.

Except as further described in the following paragraphs, there have not
been any changes in the Company's internal control 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.

On September 14, 2004, the Company acquired Papercon. The results of
Papercon's operations from the date of acquisition have been included in the
Company's 2004 financial results. Prior to its acquisition by the Company,
Papercon operated as an independent private company, was not subject to public
company reporting requirements and had a limited amount of resources available
for financial reporting and controls matters. The Company is conducting an
ongoing review of Papercon's internal control over financial reporting and
intends to make changes, where necessary, to conform Papercon's controls and
procedures to the Company's controls and procedures and to ensure that such
controls and procedures are effective and integrated appropriately.

During 2004, the Company implemented a new enterprise wide financial
accounting software system at each of its facilities except the Papercon
facilities acquired in September 2004. In the fourth quarter of 2004,
implementation occurred at four facilities. The Company expects to implement the
Company's financial and accounting software systems at Papercon during 2005.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information required by Item 10 of this Form 10-K is incorporated herein by
reference from the Company's definitive Proxy Statement for the May 11, 2005
Annual meeting of Stockholders under the captions "Code of Business Conduct and
Ethics," "Nomination and Election of Directors," "Principal Stockholders" and
"Section 16(a) Beneficial Ownership Reporting Compliance;" and in Part I, Item
4, of this Form 10-K under the caption "Executive Officers of the Company."

ITEM 11. EXECUTIVE COMPENSATION

Information required by Item 11 of this Form 10-K is incorporated herein by
reference to the Company's definitive Proxy Statement for the May 11, 2005
Annual Meeting of Stockholders under the captions "Executive Compensation" and
"Directors' Compensation for 2004."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

Information required by Item 12 of this Form, is incorporated herein by
reference to the Company's definitive Proxy Statement for the May 11, 2005
Annual Meeting of Stockholders under the captions "Principal Stockholders" and
"Directors' Compensation for 2004."

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information required by Item 13 of this Form is incorporated by reference
to the Company's definitive Proxy Statement for the May 11, 2005 Annual Meeting
of Stockholders under the caption "Certain Relationships and Related
Transactions."

54

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

Information required by Item 14 of this Form is incorporated herein by
reference to the Company's definitive Proxy Statement for the May 11, 2005
Annual Meeting of Stockholders under the caption "Fees Paid to Independent
Auditors."

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) Financial Statements

See Item 8 -- Financial Statements and Supplementary Data

(a)(2) Schedules

- Schedule I -- Condensed Financial Information

- Schedule II -- Valuation and Qualifying Accounts and Reserves

All other schedules of Packaging Dynamics for which provision is made in
the applicable accounting regulations of the Securities and Exchange Commission
are not required, are inapplicable or have been disclosed in the notes to the
consolidated financial statements and therefore have been omitted.

(a)(3) Exhibits

3.1*** Restated Certificate of Incorporation of Packaging Dynamics
Corporation
3.2** Bylaws of Packaging Dynamics Corporation
4.1 Reference is hereby made to Exhibit 3.1 and Exhibit 3.2.
4.2** Specimen Common Stock Certificate of Packaging Dynamics
Corporation
4.3 Registration Rights Agreement, dated July 1, 2002, by and
among Packaging Investors, L.P., DCBS Investors, L.L.C., CB
Investors, L.L.C. and Packaging Dynamics Corporation (filed
on August 9, 2002 as Exhibit 4.2 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002 and incorporated herein by reference).
4.4*** First Amended and Restated Registration Rights Agreement,
dated as of October 23, 2002, by and among Packaging
Investors, L.P., DCBS Investors, L.L.C., CB Investors,
L.L.C., Mr. Thomas Wolf and Packaging Dynamics Corporation.
4.5 Amendment, dated September 14, 2003, to the First Amended
and Restated Registration Rights Agreement, dated as of
October 23, 2002, by and among Packaging Investors, L.P.,
DCBS Investors, L.L.C., CB Investors, L.L.C., Mr. Thomas
Wolf and Packaging Dynamics Corporation (filed on September
20, 2004 as Exhibit 10.4 to the Registrant's Current Report
on Form 8-K and incorporated herein by reference).
4.6 Stockholders Agreement, dated July 1, 2002, by and among
Packaging Investors, L.P., DCBS Investors, L.L.C. and CB
Investors, L.L.C. (filed on August 9, 2002 as Exhibit 4.1 to
the Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002 and incorporated herein by
reference).
4.7 Termination of Stockholders Agreement with respect to DCBS
Investors, L.L.C. and CB Investors, L.L.C. dated January 15,
2004 (filed on March 25, 2004 as Exhibit 4.6 to the
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 2003 and incorporated herein by
reference).
4.8 Registration Rights Agreement, dated September 14, 2004, by
and among Mr. Gaby A. Ajram, Packaging Dynamics Corporation
and Packaging Investors, L.P. (filed on September 20, 2004
as Exhibit 10.3 to the Registrant's Current Report on Form
8-K and incorporated herein by reference).

55

10.1 Tax Sharing Agreement, dated July 1, 2002, by and between
Ivex Packaging Corporation and Packaging Dynamics
Corporation (filed on August 9, 2002 as Exhibit 10 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002 and incorporated herein by reference)
10.2 Amended and Restated Credit Agreement, dated September 29,
2003 among Packaging Dynamics Operating Company, Packaging
Dynamics Corporation, each of the subsidiaries of Packaging
Dynamics Operating Company, Bank of America, as
Administrative Agent and L/C Issuer, National City Bank, as
Syndication Agent, LaSalle Bank National Association, as
Documentation Agent, and the Lenders party hereto (filed on
November 14, 2003 as Exhibit 10.1 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003 and incorporated herein by reference).
10.3 First Amendment, dated August 6, 2004, to the Amended and
Restated Credit Agreement, dated September 29, 2003 among
Packaging Dynamics Operating Company, Packaging Dynamics
Corporation, each of the subsidiaries of Packaging Dynamics
Operating Company, Bank of America, as Administrative Agent
and L/C Issuer, National City Bank, as Syndication Agent,
LaSalle Bank National Association, as Documentation Agent,
and the Lenders party hereto (filed on September 20, 2004 as
Exhibit 10.7 to the Registrant's Current Report on Form 8-K
and incorporated herein by reference).
10.4 Deferred Compensation Agreement dated August 14, 2003 (filed
on November 14, 2003 as Exhibit 10.2 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003 and incorporated herein by reference).
10.5* Packaging Holdings, L.L.C. Subordinated Note, dated July
1999, payable to Lombard Investments, Inc.
10.6* Loan Agreement, dated December 27, 1993, by and between
Bagcraft Corporation of America and the City of Baxter
Springs, Kansas
10.7* Assignment and Assumption Agreement dated as of November 20,
1998 by and among Bagcraft Corporation of America, Packaging
Dynamics, L.L.C. and Bagcraft Acquisition, L.L.C.
10.8* Commercial Guaranty made as of November 20, 1998 by Bagcraft
Acquisition, L.L.C. in favor of the City of Baxter Springs,
Kansas.
10.9*** Lease, dated October 23, 2002, between the Company and
W.O.W., L.L.C.
10.10* Sublease, dated December 16, 1975, E.I. DuPont de Nemours
and Company and Bagcraft Corporation of America, with
amendment dated April 30, 1996
10.11* Lease, dated November 19, 1999, between 6501 Corporation and
Packaging Dynamics, L.L.C.
10.12* ISDA(R) Master Agreement, dated as of May 16, 2001, between
Bank of America, N.A. and Packaging Dynamics, L.L.C.
10.13* Interest Rate Swap Confirmation, dated May 30, 2001, from
Bank of America, N.A. to Packaging Dynamics, L.L.C.
10.14* Interest Rate Swap Confirmation, dated September 25, 2001,
from Bank of America, N.A. to Packaging Dynamics, L.L.C.
10.15* ISDA(R) Master Agreement, dated as of December 4, 1998,
between ABN AMRO Bank, N.V. and Packaging Dynamics, L.L.C.
10.16* Interest Rate Swap Confirmation, dated September 14, 2001,
from ABN AMRO Bank N.V., Chicago ranch, to Packaging
Dynamics, L.L.C.
10.17*** Severance Agreement, dated as of January 23, 2003, between
Packaging Dynamics Corporation and each of Mr. Phillip D.
Harris and Mr. Frank V. Tannura(1)
10.18 Amendment, dated October 1, 2004, to the Severance
Agreement, dated as of January 23, 2003, between Packaging
Dynamics Corporation and Mr. Frank V. Tannura(1) (filed on
October 7, 2004 as Exhibit 10.1 to the Registrant's Current
Report on Form 8-K and incorporated herein by reference).
10.19* Severance Agreement, dated August 1, 2000, between Packaging
Dynamics, L.L.C. and Jeremy S. Lawrence(1)

56

10.20*** Severance Agreement, dated January 23, 2003, between
Packaging Dynamics Corporation and Mr. Randy L. Van
Antwerp(1)
10.21 Severance Agreement, dated October 1, 2004, between
Packaging Dynamics Corporation and Mr. Patrick T.
Chambliss(1) (filed on October 7, 2004 as Exhibit 10.3 to
the Registrant's Current Report on Form 8-K and incorporated
herein by reference).
10.22** Form of Packaging Dynamics 2002 Long Term Incentive Stock
Plan(1)
10.23* Packaging Dynamics, L.L.C. 2002 Incentive Compensation Plan
for Packaging Dynamics Executives(1)
10.24* Packaging Dynamics LLC Employee 401(k) Plan(1)
10.25 Form of Nonqualified Stock Option Agreement(1) (filed on
January 10, 2005 as Exhibit 10 to the Registrant's Current
Report on Form 8-K and incorporated herein by reference).
10.26 Promissory Note issued by Packaging Dynamics Corporation to
Mr. Gaby A. Ajram, dated September 14, 2004 (filed on
September 20, 2004 as Exhibit 10.1 to the Registrant's
Current Report on Form 8-K and incorporated herein by
reference).
10.27 Non-Competition Agreement, dated September 14, 2004, between
Mr. Gaby A. Ajram and Packaging Dynamics Corporation (filed
on September 20, 2004 as Exhibit 10.2 to the Registrant's
Current Report on Form 8-K and incorporated herein by
reference).
10.28 Lease, dated September 14, 2004, by and between GHGA
Properties, L.P. and Papercon, Inc. (filed on September 20,
2004 as Exhibit 10.5 to the Registrant's Current Report on
Form 8-K and incorporated herein by reference).
10.29 Guaranty of Packaging Dynamics Corporation, dated September
14, 2004, in the favor of GHGA Properties, L.P. (filed on
September 20, 2004 as Exhibit 10.6 to the Registrant's
Current Report on Form 8-K and incorporated herein by
reference).
21**** Subsidiaries of Packaging Dynamics Corporation
23**** Consent of PricewaterhouseCoopers LLP
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

- ---------------

* Incorporated by reference to the Registrant's Form 10 filed on April 19,
2002.

** Incorporated by reference to the Registrant's Form 10/A Amendment No. 1
filed on May 21, 2002.

*** Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2002.

**** Filed herewith.

(1) Management contract or compensatory plan or arrangement required to be filed
as an Exhibit to this Form 10-K pursuant to Item 15 (c) of this report.

57

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED ON MARCH 31, 2005.

PACKAGING DYNAMICS CORPORATION

By: /s/ FRANK V. TANNURA
------------------------------------
Name: Frank V. Tannura
Title: Chairman and Chief Executive
Officer

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT IN THE CAPACITIES INDICATED ON MARCH 31, 2005.

58

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

ON

FINANCIAL STATEMENT SCHEDULES

To the Board of Directors of Packaging Dynamics Corporation:

Our audits of the consolidated financial statements referred to in our
report dated March 30, 2005 appearing in the Packaging Dynamics Corporation
Annual Report on Form 10-K also included an audit of the financial statement
schedules listed in Item 15(a)(2) of this Form 10-K. In our opinion, these
financial statement schedules present fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements.

As discussed in Note 2 to Schedule I, Packaging Dynamics Corporation has
restated its Packaging Dynamics Corporation Condensed Financial Information
(Parent Company only) as of December 31, 2003 and for the years ended December
31, 2003 and 2002.

PricewaterhouseCoopers LLP
Chicago, Illinois

March 30, 2005

59

PACKAGING DYNAMICS CORPORATION

SCHEDULE I -- CONDENSED FINANCIAL INFORMATION
(PARENT COMPANY ONLY)

BALANCE SHEETS
(DOLLARS IN THOUSANDS)

See Notes to Condensed Financial Information.
60

PACKAGING DYNAMICS CORPORATION

SCHEDULE I -- CONDENSED FINANCIAL INFORMATION
(PARENT COMPANY ONLY)

STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS)

See Notes to Condensed Financial Information.
61

PACKAGING DYNAMICS CORPORATION

SCHEDULE I -- CONDENSED FINANCIAL INFORMATION
(PARENT COMPANY ONLY)

STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY/MEMBERS' EQUITY
AND OTHER COMPREHENSIVE INCOME(LOSS)
(DOLLARS IN THOUSANDS)

See Notes to Condensed Financial Information.

62

PACKAGING DYNAMICS CORPORATION

SCHEDULE I -- CONDENSED FINANCIAL INFORMATION
(PARENT COMPANY ONLY)

STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)

See Notes to Condensed Financial Information.
63

PACKAGING DYNAMICS CORPORATION

SCHEDULE I -- CONDENSED FINANCIAL INFORMATION
(PARENT COMPANY ONLY)
NOTES TO CONDENSED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)

NOTE 1 -- BASIS OF PRESENTATION

The condensed financial statements of Packaging Dynamics Corporation
(Parent Company only) (PDC) are presented herein because the restricted net
assets of the subsidiaries of PDC exceeded 25% of the consolidated net assets of
PDC at December 31, 2004. Packaging Dynamics Operating Company (PDOC) a wholly
owned subsidiary of PDC entered into a credit facility (as amended in August
2004) which limits and restricts the payment of dividends and distribution or
transfer of assets by PDOC to PDC. See Note 6 to the consolidated financial
statements of Packaging Dynamics Corporation for further information.

NOTE 2 -- RESTATEMENT ADJUSTMENTS

The prior period condensed financial information of PDC has been restated
to reflect the appropriate allocation of tax attributes between the parent and
its wholly-owned subsidiaries and recording the parent company's equity in the
underlying net assets of its wholly-owned subsidiaries. The restatement impacted
the 2003 and 2002 condensed financial statement as follows:

64

PACKAGING DYNAMICS CORPORATION

SCHEDULE I -- CONDENSED FINANCIAL INFORMATION -- (CONTINUED)
(PARENT COMPANY ONLY)
NOTES TO CONDENSED FINANCIAL INFORMATION
(DOLLARS IN THOUSANDS)

NOTE 3 -- OTHER INFORMATION

See the notes to the consolidated financial statements of Packaging
Dynamics Corporation in Item 8 for further information.

65

PACKAGING DYNAMICS CORPORATION

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(DOLLARS IN THOUSANDS)

66

EXHIBIT INDEX

3.1*** Restated Certificate of Incorporation of Packaging Dynamics
Corporation
3.2** Bylaws of Packaging Dynamics Corporation
4.1 Reference is hereby made to Exhibit 3.1 and Exhibit 3.2.
4.2** Specimen Common Stock Certificate of Packaging Dynamics
Corporation
4.3 Registration Rights Agreement, dated July 1, 2002, by and
among Packaging Investors, L.P., DCBS Investors, L.L.C., CB
Investors, L.L.C. and Packaging Dynamics Corporation (filed
on August 9, 2002 as Exhibit 4.2 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30,
2002 and incorporated herein by reference).
4.4*** First Amended and Restated Registration Rights Agreement,
dated as of October 23, 2002, by and among Packaging
Investors, L.P., DCBS Investors, L.L.C., CB Investors,
L.L.C., Mr. Thomas Wolf and Packaging Dynamics Corporation.
4.5 Amendment, dated September 14, 2003, to the First Amended
and Restated Registration Rights Agreement, dated as of
October 23, 2002, by and among Packaging Investors, L.P.,
DCBS Investors, L.L.C., CB Investors, L.L.C., Mr. Thomas
Wolf and Packaging Dynamics Corporation (filed on September
20, 2004 as Exhibit 10.4 to the Registrant's Current Report
on Form 8-K and incorporated herein by reference).
4.6 Stockholders Agreement, dated July 1, 2002, by and among
Packaging Investors, L.P., DCBS Investors, L.L.C. and CB
Investors, L.L.C. (filed on August 9, 2002 as Exhibit 4.1 to
the Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002 and incorporated herein by
reference).
4.7 Termination of Stockholders Agreement with respect to DCBS
Investors, L.L.C. and CB Investors, L.L.C. dated January 15,
2004 (filed on March 25, 2004 as Exhibit 4.6 to the
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 2003 and incorporated herein by
reference).
4.8 Registration Rights Agreement, dated September 14, 2004, by
and among Mr. Gaby A. Ajram, Packaging Dynamics Corporation
and Packaging Investors, L.P. (filed on September 20, 2004
as Exhibit 10.3 to the Registrant's Current Report on Form
8-K and incorporated herein by reference).
10.1 Tax Sharing Agreement, dated July 1, 2002, by and between
Ivex Packaging Corporation and Packaging Dynamics
Corporation (filed on August 9, 2002 as Exhibit 10 to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002 and incorporated herein by reference)
10.2 Amended and Restated Credit Agreement, dated September 29,
2003 among Packaging Dynamics Operating Company, Packaging
Dynamics Corporation, each of the subsidiaries of Packaging
Dynamics Operating Company, Bank of America, as
Administrative Agent and L/C Issuer, National City Bank, as
Syndication Agent, LaSalle Bank National Association, as
Documentation Agent, and the Lenders party hereto (filed on
November 14, 2003 as Exhibit 10.1 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003 and incorporated herein by reference).
10.3 First Amendment, dated August 6, 2004, to the Amended and
Restated Credit Agreement, dated September 29, 2003 among
Packaging Dynamics Operating Company, Packaging Dynamics
Corporation, each of the subsidiaries of Packaging Dynamics
Operating Company, Bank of America, as Administrative Agent
and L/C Issuer, National City Bank, as Syndication Agent,
LaSalle Bank National Association, as Documentation Agent,
and the Lenders party hereto (filed on September 20, 2004 as
Exhibit 10.7 to the Registrant's Current Report on Form 8-K
and incorporated herein by reference).
10.4 Deferred Compensation Agreement dated August 14, 2003 (filed
on November 14, 2003 as Exhibit 10.2 to the Registrant's
Quarterly Report on Form 10-Q for the quarter ended Septem-
ber 30, 2003 and incorporated herein by reference).
10.5* Packaging Holdings, L.L.C. Subordinated Note, dated July
1999, payable to Lombard Investments, Inc.

67

10.6* Loan Agreement, dated December 27, 1993, by and between
Bagcraft Corporation of America and the City of Baxter
Springs, Kansas
10.7* Assignment and Assumption Agreement dated as of November 20,
1998 by and among Bagcraft Corporation of America, Packaging
Dynamics, L.L.C. and Bagcraft Acquisition, L.L.C.
10.8* Commercial Guaranty made as of November 20, 1998 by Bagcraft
Acquisition, L.L.C. in favor of the City of Baxter Springs,
Kansas.
10.9*** Lease, dated October 23, 2002, between the Company and
W.O.W., L.L.C.
10.10* Sublease, dated December 16, 1975, E.I. DuPont de Nemours
and Company and Bagcraft Corporation of America, with
amendment dated April 30, 1996
10.11* Lease, dated November 19, 1999, between 6501 Corporation and
Packaging Dynamics, L.L.C.
10.12* ISDA(R) Master Agreement, dated as of May 16, 2001, between
Bank of America, N.A. and Packaging Dynamics, L.L.C.
10.13* Interest Rate Swap Confirmation, dated May 30, 2001, from
Bank of America, N.A. to Packaging Dynamics, L.L.C.
10.14* Interest Rate Swap Confirmation, dated September 25, 2001,
from Bank of America, N.A. to Packaging Dynamics, L.L.C.
10.15* ISDA(R) Master Agreement, dated as of December 4, 1998,
between ABN AMRO Bank, N.V. and Packaging Dynamics, L.L.C.
10.16* Interest Rate Swap Confirmation, dated September 14, 2001,
from ABN AMRO Bank N.V., Chicago ranch, to Packaging
Dynamics, L.L.C.
10.17*** Severance Agreement, dated as of January 23, 2003, between
Packaging Dynamics Corporation and each of Mr. Phillip D.
Harris and Mr. Frank V. Tannura(1)
10.18 Amendment, dated October 1, 2004, to the Severance
Agreement, dated as of January 23, 2003, between Packaging
Dynamics Corporation and Mr. Frank V. Tannura(1) (filed on
October 7, 2004 as Exhibit 10.1 to the Registrant's Current
Report on Form 8-K and incorporated herein by reference).
10.19* Severance Agreement, dated August 1, 2000, between Packaging
Dynamics, L.L.C. and Jeremy S. Lawrence(1)
10.20*** Severance Agreement, dated January 23, 2003, between
Packaging Dynamics Corporation and Mr. Randy L. Van
Antwerp(1)
10.21 Severance Agreement, dated October 1, 2004, between
Packaging Dynamics Corporation and Mr. Patrick T.
Chambliss(1) (filed on October 7, 2004 as Exhibit 10.3 to
the Registrant's Current Report on Form 8-K and incorporated
herein by reference).
10.22** Form of Packaging Dynamics 2002 Long Term Incentive Stock
Plan(1)
10.23* Packaging Dynamics, L.L.C. 2002 Incentive Compensation Plan
for Packaging Dynamics Executives(1)
10.24* Packaging Dynamics LLC Employee 401(k) Plan(1)
10.25 Form of Nonqualified Stock Option Agreement(1) (filed on
January 10, 2005 as Exhibit 10 to the Registrant's Current
Report on Form 8-K and incorporated herein by reference).
10.26 Promissory Note issued by Packaging Dynamics Corporation to
Mr. Gaby A. Ajram, dated September 14, 2004 (filed on
September 20, 2004 as Exhibit 10.1 to the Registrant's
Current Report on Form 8-K and incorporated herein by
reference).
10.27 Non-Competition Agreement, dated September 14, 2004, between
and Packaging Dynamics Corporation (filed on September 20,
2004 as Exhibit 10.2 to the Registrant's Current Report on
Form 8-K and incorporated herein by reference).
10.28 Lease, dated September 14, 2004, by and between GHGA
Properties, L.P. and Papercon, Inc. (filed on September 20,
2004 as Exhibit 10.5 to the Registrant's Current Report on
Form 8-K and incorporated herein by reference).
10.29 Guaranty of Packaging Dynamics Corporation, dated September
14, 2004, in the favor of GHGA Properties, L.P. (filed on
September 20, 2004 as Exhibit 10.6 to the Registrant's
Current Report on Form 8-K and incorporated herein by
reference).

68

21**** Subsidiaries of Packaging Dynamics Corporation
23**** Consent of PricewaterhouseCoopers
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