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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2005
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _________________ to ____________________
COMMISSION FILE NUMBER: 0-49741
PACKAGING DYNAMICS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 32-0009217
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
3900 WEST 43RD STREET
CHICAGO, ILLINOIS 60632
(Address of Principal Executive Office) (Zip Code)
(773) 843-8000
(Registrant's Telephone Number, Including Area Code)
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
At May 6, 2005, there were 10,542,505 shares of common stock, par value
$0.01 per share, outstanding.
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1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PACKAGING DYNAMICS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
March 31, December 31,
2005 2004
----------- ------------
ASSETS (unaudited)
Current Assets:
Cash and cash equivalents.................................................... $ 380 $ 1,175
Accounts receivable trade (net of allowance for doubtful accounts of $828 and
$825, respectively).......................................................... 31,014 31,174
Inventories.................................................................. 40,591 36,506
Prepaid expenses and other................................................... 6,259 5,962
----------- ------------
Total current assets.................................................... 78,244 74,817
----------- ------------
Property, Plant and Equipment:
Property, plant and equipment................................................ 81,733 80,978
Less - accumulated depreciation.............................................. (31,077) (29,284)
----------- ------------
Total property, plant and equipment..................................... 50,656 51,694
----------- ------------
Other Assets:
Goodwill..................................................................... 81,263 81,263
Intangibles and other assets, net of accumulated amortization................ 20,513 20,893
----------- ------------
Total other assets...................................................... 101,776 102,156
----------- ------------
Total Assets...................................................................... $ 230,676 $ 228,667
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt......................................... $ 6,343 $ 6,093
Cash overdraft............................................................... 3,706 6,339
Accounts payable............................................................. 24,643 20,793
Accrued salary and wages..................................................... 3,087 3,420
Other accrued liabilities.................................................... 8,572 8,207
----------- ------------
Total current liabilities............................................... 46,351 44,852
Long-Term Debt.................................................................... 109,876 110,386
Other Liabilities................................................................. 5,675 7,592
Deferred Income Taxes............................................................. 16,960 15,975
----------- ------------
Total Liabilities................................................................. 178,862 178,805
----------- ------------
Commitments and Contingencies (Note 10)........................................... -- --
Stockholders' Equity:
Common stock, $.01 par value--40,000,000 shares authorized; (10,542,505 and
10,514,837 shares issued and outstanding at March 31, 2005 and December 31,
2004, respectively).......................................................... 106 105
Preferred stock, $.01 par value--5,000,000 shares authorized; (no shares
issued or outstanding)....................................................... -- --
Paid in capital in excess of par value....................................... 57,826 57,570
Accumulated other comprehensive income....................................... 844 486
Accumulated deficit.......................................................... (6,962) (8,299)
----------- ------------
Total stockholders' equity ............................................. 51,814 49,862
----------- ------------
Total Liabilities and Stockholders' Equity ....................................... $ 230,676 $ 228,667
=========== ============
The accompanying notes are an integral part of this statement.
2
PACKAGING DYNAMICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
(UNAUDITED)
For the Three Months Ended,
March 31, March 31,
2005 2004
------------ -----------
Net sales............................................ $ 86,784 $ 68,534
Cost of goods sold................................... 74,108 59,474
------------ -----------
Gross profit......................................... 12,676 9,060
------------ -----------
Operating expenses:
Selling, general and administrative............ 6,433 4,552
Depreciation and amortization.................. 504 216
------------ -----------
Total operating expenses............................. 6,937 4,768
------------ -----------
Income from operations............................... 5,739 4,292
Interest expense..................................... 2,088 1,200
------------ -----------
Income before income taxes........................... 3,651 3,092
Income tax provision................................. 1,406 1,221
------------ -----------
Income from continuing operations.................... 2,245 1,871
Loss from discontinued operations, net of tax benefit (223) (389)
------------ -----------
Net income........................................... $ 2,022 $ 1,482
============ ===========
Income (loss) per share:
Basic:
Continuing operations....................... $ 0.21 $ 0.19
Discontinued operations..................... (0.02) (0.04)
------------ -----------
Net income.................................. $ 0.19 $ 0.15
============ ===========
Diluted:
Continuing operations.................. $ 0.21 $ 0.19
Discontinued operations................ (0.02) (0.04)
------------ -----------
Net income............................. $ 0.19 $ 0.15
============ ===========
Cash dividend declared per share:.................... $ 0.065 $ 0.05
============ ===========
Weighted average shares outstanding:
Basic....................................... 10,525,653 9,681,504
============ ===========
Diluted..................................... 10,924,037 9,970,277
============ ===========
The accompanying notes are an integral part of this statement.
3
PACKAGING DYNAMICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
For the Three Months Ended,
March 31, March 31,
2005 2004
--------- ---------
Cash flows from operating activities:
Net income............................................................................ $ 2,022 $ 1,482
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization.................................................... 2,043 1,484
Amortization of deferred financing costs......................................... 154 86
Provision for doubtful accounts and.allowances................................... 3 94
Deferred income taxes............................................................ 924 114
Changes in assets and liabilities:
Accounts receivable........................................................... 157 (1,445)
Inventories................................................................... (4,085) (663)
Other assets.................................................................. 158 (648)
Accounts payable and accrued liabilities...................................... 2,093 1,226
--------- ---------
Net cash from continuing operating activities........................... 3,469 1,730
Net cash used by discontinued operating activities...................... (90) (1,232)
--------- ---------
Net cash from operating activities...................................... 3,379 498
--------- ---------
Cash flows used by investing activities:
Additions to property, plant and equipment........................................ (755) (1,544)
--------- ---------
Net cash used by continuing investing activities........................ (755) (1,544)
Net cash from discontinued investing activities......................... -- 152
--------- ---------
Net cash used by investing activities................................... (755) (1,392)
--------- ---------
Cash flows from (used by) financing activities:
Principal payments for loan obligations.......................................... (1,460) (1,250)
Proceeds under revolving line of credit.......................................... 19,700 14,600
Repayments under revolving line of credit........................................ (18,500) (14,700)
Payment of dividends............................................................. (685) (484)
Change in cash overdraft......................................................... (2,633) 2,703
Other, net....................................................................... 159 (4)
--------- ---------
Net cash from (used by) financing activities............................ (3,419) 865
--------- ---------
Net decrease in cash and cash equivalents.................................................. (795) (29)
Cash and cash equivalents at beginning of period .......................................... 1,175 453
--------- ---------
Cash and cash equivalents at end of period ................................................ $ 380 $ 424
========= =========
The accompanying notes are an integral part of this statement.
4
PACKAGING DYNAMICS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND OTHER COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS)
(UNAUDITED)
Retained Accumulated
Common Stock Earnings Other
------------------ Paid In (Accumulated Comprehensive Stockholde's Comprehensive
Shares Amount Capital Deficit) Income Equity Income
---------- ------ -------- ----------- ------------- ------------ -------------
Balance at December 31, 2003 9,681,504 $ 97 $ 46,003 $ (14,900) $ 190 $ 31,390
Net income 8,778 8,778 8,778
Issuance of common stock 833,333 8 11,567 11,575
Other comprehensive income:
Net change in fair value of derivative
instruments, net of income taxes of
$193 296 296 296
-------------
Comprehensive income $ 9,074
=============
Cash dividend ($.22 per share) (2,177) (2,177)
---------- ------ -------- ----------- ------------- ------------
Balance at December 31, 2004 10,514,837 $ 105 $ 57,570 $ (8,299) $ 486 $ 49,862
Net income 2,022 2,022 2,022
Issuance of common stock 27,668 1 256 257
Other comprehensive income:
Net change in fair value of derivative
instruments, net of income taxes
of $224 358 358 358
-------------
Comprehensive income $ 2,380
=============
Cash dividend ($.07 per share) (685) (685)
---------- ------ -------- ----------- ------------- ------------
Balance at March 31, 2005 10,542,505 $ 106 $ 57,826 $ (6,962) $ 844 $ 51,814
========== ====== ======== =========== ============= ============
The accompanying notes are an integral part of this statement.
5
PACKAGING DYNAMICS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)
(UNAUDITED)
NOTE 1 -- BASIS OF PRESENTATION
GENERAL
In the opinion of management, the information in the accompanying
unaudited consolidated financial statements reflects all adjustments necessary
to present fairly the results of operations, cash flows and stockholders' equity
for the three months ended March 31, 2005 and March 31, 2004 and the financial
position at March 31, 2005. The interim results are not necessarily indicative
of results for a full year and do not contain information included in the
Company's annual consolidated financial statements and notes for the year ended
December 31, 2004. The consolidated balance sheet as of December 31, 2004 was
derived from audited financial statements, but does not include all disclosures
required by generally accepted accounting principles. These interim financial
statements should be read in conjunction with our audited annual consolidated
financial statements and notes thereto included with the Company's filings with
the Securities and Exchange Commission.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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.
The following table details the calculation of basic and diluted earnings
per share from continuing operations:
FOR THE THREE MONTHS ENDED
MARCH 31,
---------
2005 2004
------------- -------------
Income from continuing operations................................. $ 2,245 $ 1,871
============= =============
Weighted average shares used to determine basic earnings per
share from continuing operations................................ 10,525,653 9,681,504
Common stock equivalents.......................................... 398,384 288,773
------------- -------------
Weighted average shares used to determine diluted earnings
per share from continuing operations............................ 10,924,037 9,970,277
============= =============
Basic earnings per share from continuing operations............... $ 0.21 $ 0.19
============= =============
Diluted earnings per share from continuing operations............. $ 0.21 $ 0.19
============= =============
6
DERIVATIVES AND OTHER COMPREHENSIVE INCOME
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. Such instruments are recorded at fair value, and at March 31, 2005 and
December 31, 2004, the fair value approximates an asset of $1,022 and $471,
respectively, which is included in other current assets 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 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
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. 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." The Company has
adopted the FSP 109-1 in the first quarter of 2005 which resulted in a decrease
in the effective tax rate of approximately one percentage point. FSP 109-2 has
no impact on the Company.
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. In April
2005, the SEC issued a ruling that FAS 123R will be effective for public
companies beginning with the first 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.
7
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 $1,022 and $471 at March 31, 2005 and
December 31, 2004, respectively. At March 31, 2005, the fair value of the
remaining amounts payable under a non-compete agreement (ten quarterly payments
totaling $3,333) was estimated to be $3,119 determined by discounting the
payments using a 5% discount rate. Also at March 31, 2005, 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.
PAPERCON ACQUISITION
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.
The purchase price allocation is 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 this year.
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 the 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.
The following table details selected income statement information for the
Specialty Paper operation.
THREE MONTHS ENDED
MARCH 31,
---------------------
2005 2004
----------- --------
(Loss) income from operations..... $ (362) $ (643)
Interest expense.................. - -
--------- --------
Loss before income taxes.......... (362) (643)
Income tax benefit................ 139 254
--------- --------
Net loss.......................... $ (223) $ (389)
========= ========
8
The net loss for the first quarter of 2005 represents approximately $362
of pretax administrative costs associated with the ongoing program to maintain
and dispose of the Detroit property. The Company is working towards a resolution
of the Detroit property this year.
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.
MARCH 31, DECEMBER 31,
2005 2004
---------- ------------
Accounts receivable trade (net of allowance for doubtful
accounts of $45 and $45, respectively)..................... $ 4 $ 4
Other current assets......................................... 100 138
---------- ------------
Total assets of discontinued operations...................... 104 142
---------- ------------
Accounts payable............................................. 24 156
Accrued liabilities.......................................... 1,454 1,388
---------- ------------
Total liabilities of discontinued operations................. 1,478 1,544
---------- ------------
Net liabilities of discontinued operations................... $ (1,374) $ (1,402)
========== ============
A summary of the changes in the reserves related to the severance and
pension charges in connection with the Company's exit from the Specialty Paper
operation is as follows:
SEVERANCE PENSION
PAY CHARGE TOTAL
--------- ------- -------
Balance at December 31, 2003...... $ 951 $ 816 $ 1,767
Charges to expense.............. 228 398 626
Cash Payments................... (1,064) -- (1,064)
--------- ------- -------
Balance at December 31, 2004...... $ 115 $ 1,214 $ 1,329
--------- ------- -------
Charges to expense.............. 147 -- 147
Cash Payments................... (116) (7) (123)
---------- ------- -------
Balance at March 31, 2005......... $ 146 $ 1,207 $ 1,353
========= ======= =======
NOTE 4--GOODWILL AND INTANGIBLE ASSETS
Goodwill and intangible assets at March 31, 2005 consist of the following:
Weighted
Life Average Carrying Accumulated
(Years) Amount Amortization Net
------------ -------- ------------ ---------
Intangible assets subject to amortization
Customer contracts and relationships............... 19.4 $ 10,880 $ 664 $ 10,216
Covenants not to compete........................... 9.6 4,014 442 3,572
-------- ------------ ---------
$ 14,894 $ 1,106 $ 13,788
Intangible assets not subject to amortization
Trademarks and trade names......................... $ 4,800 $ -- $ 4,800
Goodwill........................................... 81,263 -- 81,263
-------- ------------ ---------
$ 86,063 $ -- $ 86,063
-------- ------------ ---------
Total intangible assets and goodwill $100,957 $ 1,106 $ 99,851
======== ============ =========
Changes in the carrying value of goodwill during 2005 are as follows:
Balance at December 31, 2004: $ 81,263
Adjustments - purchase accounting.........
--
Additions................................. --
----------
Balance at March 31, 2005................... $ 81,263
==========
9
Amortization expense for intangible assets subject to amortization was
$249 and $82 for the three months ended March 31, 2005 and 2004, respectively.
Amortization expense for the remaining year of 2005 and years 2006, 2007, 2008
and 2009 is estimated to be $657, $906, $906, $906, $904 and $904, respectively.
NOTE 5 -- STOCK BASED COMPENSATION
At March 31, 2005, the Company has a stock-based compensation plan. The
Company accounts for this plan under the recognition and measurement provisions
of Accounting Principles Board Opinion ("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. The Company's stock-based compensation plans are
accounted for under the intrinsic value based method. No compensation expense is
reflected in net income in the three months ended March 31, 2005 and March 31,
2004, as all options granted under the plan had an exercise price that was equal
to the market price on the date of grant.
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.
Three Months Ended Three Months Ended
March 31, 2005 March 31, 2004
------------------ ------------------
Net Income ........................................ $ 2,022 $ 1,482
Deduct: Stock-based employee compensation expense
determined under fair value based method, net of
tax ............................................ (68) (70)
------------------ ------------------
Pro forma net income .............................. $ 1,954 $ 1,412
================== ==================
Income per share:
Basic - as reported............................. $ 0.19 $ 0.15
================== ==================
Basic - pro forma .............................. $ 0.19 $ 0.15
================== ==================
Diluted - as reported .......................... $ 0.19 $ 0.15
================== ==================
Diluted - pro forma ............................ $ 0.18 $ 0.14
================== ==================
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:
March 31, 2005 March 31, 5004
-------------- --------------
Expected option life (years) 5 5
Risk-free weighted average interest rate 3.71% 2.92%
Stock price volatility 27.5% 27.5%
Dividend yield 1.8% 1.9%
10
NOTE 6 -- 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 March 31, 2005 and December 31,
2004 consist of the following:
March 31, December 31,
2005 2004
------------- ------------
Raw materials $ 22,096 $ 18,609
Work-in-process 3,294 3,580
Finished goods 15,488 14,608
------------- ------------
40,878 36,797
Obsolescence Reserve (287) (291)
------------- ------------
$ 40,591 $ 36,506
============= ============
NOTE 7 -- LONG-TERM DEBT
Long-term debt at March 31, 2005 and December 31, 2004 consists of the
following:
March 31, December 31,
2005 2004
---------- ------------
Senior Credit Facility:
Term A Loan $ 23,500 $ 24,750
Term B Loan 83,619 83,829
Revolving credit loan 2,100 900
Seller note payable 7,000 7,000
---------- ------------
Subtotal 116,219 116,479
Current maturities of long term debt (6,343) (6,093)
---------- ------------
Long-term debt $ 109,876 $ 110,386
========== ============
SENIOR CREDIT FACILITY
During the third quarter of 2003, we refinanced our existing credit
facility with a new credit facility (the "Senior Credit Facility") that provided
for a Term A 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.
During the third quarter of 2004, we amended the Senior Credit Facility to
provide for an additional $45,000 of Term B Loan, 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
March 31, 2005, the Term A Loan had a balance of $23,500 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,
of which $1,250 was paid during the three months ended March 31, 2005. As of
March 31, 2005, the Term B Loan had a balance of $83,619 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 of which $210 was paid
during the three months ended March 31, 2005. The revolver had a balance of
$2,100 as of March 31, 2005. 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.
11
At March 31, 2005, the Term A Loan and revolving loans were bearing
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. The Term B
Loan was bearing 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.
On April 12, 2005, we entered into another amendment to our Senior Credit
Facility. This amendment provides for an overall decrease in the interest rates
of the Term A and Term B Loans. The Term A Loan and revolving loans bear
interest at rates of up to 1.25%, decreased from 2.0%, plus the base rate, in
the case of the Base Rate Loans, and up to 2.25%, decreased from 3.0%, plus
LIBOR, in the case of Eurodollar Loans. The Term B Loan bears interest at a rate
of 1.25%, decreased from 2.0%, plus the base rate, in the case of the Base Rate
Loans, and 2.25%, decreased from 3.0%, plus LIBOR, in the case of Eurodollar
Loans. In addition, the applicable percentage rates of certain of the fees that
may be incurred by us under the Senior Credit Facility were decreased.
At March 31, 2005, the interest rates on borrowings under the Term A Loan
and the Term B Loan were 3.0% plus LIBOR (2.56%) and 3.0% plus LIBOR (2.56%),
respectively, compared with 3.0% plus LIBOR (1.11%) and 3.5% plus LIBOR (1.11%),
respectively, at March 31, 2004. As of March 31, 2005, we had interest rate
instruments in effect with banks having notional amounts totaling $75,000 and
varying maturity dates through December 31, 2007. We have 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 have
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
results 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, we
have two interest rate caps of $15,000 each which became effective on December
31, 2004 and mature on December 31, 2007. We purchased these caps for a cap
premium of $376 of which $31 was amortized during the first quarter of 2005.
These caps limit our 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 the Company's 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, the Company is required to
comply on a quarterly basis with the following four financial covenants:
- under the leverage ratio covenant, as of the last day of each fiscal
quarter, 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 March
31, 2005 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 March 31, 2005 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 March 31, 2005 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
12
(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 March 31, 2005, the
latest measurement date. The occurrence of any default of these covenants could
result in acceleration of our obligations under the Senior Credit Facility
($109,219 as of March 31, 2005) 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 Packaging Dynamics 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 former
owner of Papercon in connection with the acquisition of Papercon. The note
matures on September 14, 2006 and bears an annual interest rate of 5% payable
quarterly. This note is unsecured and subordinated to the Senior Credit
Facility.
NOTE 8 -- 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.
13
The reconciliation of Segment Operating Income to the Company's consolidated
financial statements is as follows:
FOR THE THREE MONTHS ENDED
---------------------------
MARCH 31, MARCH 31,
2005 2004
--------- ---------
Net Sales:
Food Packaging.................................................... $ 67,409 $ 44,656
Specialty Laminations............................................. 20,143 24,590
Elimination of Specialty Laminations intercompany sales........... (768) (712)
--------- ---------
Total........................................................ $ 86,784 $ 68,534
========= =========
Segment Operating Income:
Food Packaging.................................................... $ 4,172 $ 2,128
Specialty Laminations............................................. 1,567 2,164
--------- ---------
Income From Operations.............................................. 5,739 4,292
Interest expense.................................................... (2,088) (1,200)
--------- ---------
Income before income taxes.......................................... $ 3,651 $ 3,092
========= =========
Depreciation and Amortization:
Food Packaging.................................................... $ 1,620 $ 1,023
Specialty Laminations............................................. 423 461
--------- ---------
Total........................................................ $ 2,043 $ 1,484
========= =========
FOR THE THREE MONTHS ENDED
------------------------------------------
JUNE 30, SEPTEMBER 30, DECEMBER 31,
2004 2004 2004
-------- ------------- ------------
Net Sales:
Food Packaging......................................... $ 45,851 $ 49,889 $ 72,657
Specialty Laminations.................................. 24,597 25,305 20,962
Elimination of Specialty Laminations intercompany sales (706) (880) (1,236)
-------- -------- ------------
Total............................................. $ 69,742 $ 74,314 $ 92,383
======== ======== ============
Segment Operating Income:
Food Packaging......................................... $ 3,310 $ 2,929 $ 6,205
Specialty Laminations.................................. 2,410 2,430 891
Asset sales and disposals................................ -- 1 54
-------- -------- ------------
Income From Operations................................... 5,720 5,360 7,150
Interest expense......................................... (1,158) (1,533) (2,009)
-------- -------- ------------
Income before income taxes............................... $ 4,562 $ 3,827 $ 5,141
======== ======== ============
Depreciation and Amortization:
Food Packaging......................................... $ 899 $ 1,111 $ 1,470
Specialty Laminations.................................. 436 417 427
-------- -------- ------------
Total............................................. $ 1,335 $ 1,528 $ 1,897
======== ======== ============
14
NOTE 9 -- COMPREHENSIVE INCOME
The components of comprehensive income, net of tax, were as follows:
Three Months Ended,
March 31, 2005 March 31, 2004
-------------- --------------
Net Income..................................................................... $ 2,022 $ 1,482
Net change in fair value of derivative instruments............................. 358 (174)
-------------- --------------
Comprehensive income........................................................... $ 2,380 $ 1,308
============== ==============
Accumulated other comprehensive income presented on the accompanying condensed
consolidated balance sheet consists entirely of unrecognized gains and losses on
derivatives.
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
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.
LEASE COMMITMENTS
The Company occupies certain facilities under lease arrangements and
leases certain machinery, automobiles, and equipments. Future minimum rental
commitments, including capital lease obligations, with noncancelable terms in
excess of one year are as follows:
Year ended December 31:
2005 (second through fourth quarter)................... 2,086
2006................................................... 2,358
2007................................................... 1,766
2008................................................... 1,546
2009................................................... 1,222
Thereafter............................................. 3,660
-----------
Total.................................................. $ 12,638
===========
Accumulated amortization on capital leases as of March 31, 2005 is $112.
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.
15
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 maintain 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 11 -- RELATED PARTY TRANSACTIONS
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.
16
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 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.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS)
The following discussion addresses the consolidated financial statements
of Packaging Dynamics Corporation (the "Company," "Packaging Dynamics", "we" or
"our") which is a Delaware corporation established as a holding company to own
all interests in Packaging Dynamics Operating Company ("PDOC"), a Delaware
corporation which is the parent company of all our current operating companies.
The following discussion should be read in conjunction with our interim
financial statements and accompanying notes thereto, and the other financial
information included elsewhere in this 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
During the balance of 2005, the Company will be focused on, among other
things, integrating the Papercon acquisition in the Food Packaging segment and
addressing the ongoing sales weakness in the Specialty Laminations segment.
Other priorities in each of the Company's operating segments 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. The
combination of projects which have been approved and others under consideration
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. 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.
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 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.
Food Packaging
FOR THE THREE MONTHS ENDED
---------------------------
MARCH 31, MARCH 31,
2005 2004
--------- --------
Net Sales................................................ $ 67,409 $ 44,656
Segment Operating Income................................. $ 4,172 $ 2,128
Segment Operating Income Margin.......................... 6.2% 4.8%
Depreciation and Amortization............................ $ 1,620 $ 1,023
Net sales increased $22,753, or 51.0%, during the first quarter of 2005
compared to the same period in 2004 primarily due to the September 14, 2004
acquisition of Papercon.
18
Segment Operating Income increased $2,044, or 96.1%, during the first
quarter of 2005 compared to the same period in 2004 and Segment Operating Income
margin increased to 6.2% from 4.8% during the first quarter of 2005 compared to
the same period in 2004. The increase in Segment Operating Income and Segment
Operating Income Margin was primarily due to incremental Segment Operating
Income from Papercon and other cost and productivity initiatives. In addition,
the first quarter of 2005 was negatively impacted by approximately $0.3 million
of management severance costs.
Specialty Laminations
FOR THE THREE MONTHS ENDED
--------------------------
MARCH 31, MARCH 31,
2005 2004
-------- ---------
Net Sales................................................ $ 20,143 $ 24,590
Segment Operating Income................................. $ 1,567 $ 2,164
Segment Operating Income Margin.......................... 7.8% 8.8%
Depreciation and Amortization............................ $ 423 $ 461
Net sales decreased $4,447, or 18.1%, during the first quarter of 2005
compared to the same period in 2004. The decrease was primarily due to volume
weakness for products sold into the building products market and for other
specialty lamination products. The weakness in sales of products into the
building products market is primarily the result of a combination of global
shortages of a key raw material (MDI, Methyl Diphenyl Diisocyanate) 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. The
Company expects the sales weakness to continue in the second quarter but
diminish in the second half of 2005 due, in part, to the addition of new
business unrelated to MDI with a building products customer. This new business
is expected to provide approximately $5,000 to $7,000 of annual revenue.
Segment Operating Income decreased $597, or 27.6%, during the first
quarter of 2005 compared to the same period in 2004 and Segment Operating Income
Margin decreased to 7.8% from 8.8% in the first quarter of 2005 compared to the
same period in 2004. The decline in Segment Operating Income and Segment
Operating Income Margin was primarily due to decreased sales volume.
INTEREST EXPENSE
Interest expense was $2,088 in the first quarter of 2005 compared $1,200
in same period of 2004. The increase in interest expense was primarily due to
increased average outstanding indebtedness of approximately $52,000 and the
non-compete liability related to of the Papercon acquisition and a higher
average borrowing rate. The average interest rate on borrowings in the first
quarter of 2005 was approximately 5.68% compared to 4.53% in the same period in
2004.
INCOME TAXES
The income tax provision for continuing operations was $1,406 and $1,221
for the first quarter of 2005 and 2004, respectively. The Company's effective
tax rate on income from continuing operations was 38.5% and 39.5%, for the first
quarter of 2005 and 2004, respectively. The decrease in the Company's effective
tax rate is due to the American Jobs Creation Act of 2004 (the "Act"). The Act
provides a deduction for income from qualified domestic production activities,
which will be phased in from 2005 through 2010.
INCOME FROM CONTINUING OPERATIONS
Income from continuing operations was $2,245 and $1,871 for the first
quarter of 2005 and 2004, respectively. The 2005 increase resulted primarily
from incremental earnings from the Papercon acquisition, partially offset by the
impact of decreased sales volume of specialty lamination products.
19
DISCONTINUED OPERATIONS
Loss from discontinued operations during the first quarter of 2005 was
$223 compared to a loss of $389 in the same period in 2004. The net loss for
first quarter of 2005 represents the administrative expense associated with the
ongoing program to maintain and dispose of the Detroit property. During the
balance of 2005, we will have additional costs related to our ongoing program to
maintain 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.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2005, we had cash and cash equivalents of $380, and $45,071
was available under the revolving portion of the Senior Credit Facility, after
taking into account $2,829 in letter of credits outstanding. Our working capital
at March 31, 2005 was $33,155 compared to $29,965 for the comparable period at
March 31, 2004.
Our primary short-term and long-term operating cash requirements are for
debt service, working capital and capital expenditures. We expect to rely on
cash generated from operations supplemented by revolving borrowings under the
Senior Credit Facility to fund short-term and long-term cash requirements.
The Company generated $3,379 of cash from operating activities in the
three months ended March 31, 2005 compared to $498 for the same period in 2004.
This increase was primarily related to an increase in cash generated from net
income and a reduction in cash used by discontinued operations, partially offset
by an increased investment in working capital. Cash used by discontinued
operating activities in the three months ended March 31, 2005 was $90 compared
to $1,232 for the comparable period ended March 31, 2004. The cash used by
discontinued operating activities is a result of ongoing efforts to maintain and
dispose of the Detroit property. Such costs are expected to continue until the
property is sold.
Cash used by investing activities was $755 for the three months ended
March 31, 2005 compared to $1,392 for the same period in 2004. This change was
primarily due to decreased capital expenditures. The Company has approved or is
evaluating a number of specific capital investment opportunities to expand
product capabilities and reduce production costs. In aggregate, these
investments could result in total capital expenditures of approximately $10,000
in 2005 versus an estimated normalized range of $7,000 to $8,000.
Cash used by financing activities was $3,419 for the three months ended
March 31, 2005 compared to $865 of cash generated for the same period in 2004.
The change was primarily due to higher repayment of debt and a lower cash
overdraft balance at March 31, 2005.
In December 2004, the Company announced a cash dividend of $0.065 per
common share, $685 in the aggregate, which was paid on January 4, 2005 to
shareholders of record as of December 15, 2004. In March 2005, the Company
announced a cash dividend of $0.065 per common share, $685 in the aggregate,
which was paid on April 5, 2005 to shareholders of record on March 15, 2005.
20
Disclosures about contractual obligations and commercial commitments are
included in various parts of this Report, including Note 7 - Long-Term Debt and
Note 10 - Commitments and Contingencies to the financial statements. A summary
of significant contractual obligations as of March 31, 2005 is included as
follows:
LONG-TERM
DEBT LEASE NON-COMPETE OTHER
MATURITIES COMMITMENTS AGREEMENT COMMITMENTS TOTAL
---------- ----------- ----------- ----------- --------
2005........ $ 4,633 $ 2,086 $ 1,000 $ 61 $ 7,780
2006........ 14,092 2,358 1,333 97 17,880
2007........ 8,092 1,766 1,000 103 10,961
2008........ 8,943 1,546 -- 110 10,599
2009........ 80,459 1,222 -- 117 81,798
Thereafter.. -- 3,660 -- 718 4,378
---------- ----------- ----------- ------------ --------
Total....... $ 116,219 $ 12,638 $ 3,333 $ 1,206 $133,396
========== =========== =========== ============ ========
RECENTLY ISSUED 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. 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." The Company has
adopted FSP 109-1 in the first quarter of 2005 which resulted in a decrease in
the effective tax rate of approximately one percentage point, based on current
earnings level. FSP 109-2 has no impact on the Company.
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 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.
21
ITEM 3. 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 consists of floating rate debt instruments that are benchmarked to
LIBOR. As of March 31, 2005, we had interest rate instruments in effect with
banks having notional amounts totaling $75,000 and varying maturity dates
through December 31, 2007. We have 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 have 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 results 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, we have two interest rate
caps of $15,000 each which became effective on December 31, 2004 and mature on
December 31, 2007. We purchased these caps for a cap premium of $376 of which
$31 was amortized during the first quarter of 2005. 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
$1,022 asset as of March 31, 2005 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 change 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.
ITEM 4. 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, as of the end of such period, the
Company's disclosure controls and procedures are effective.
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
22
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.
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 internal control 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.
In 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. The company expects to implement the
financial and accounting software systems at Papercon during the second quarter
of 2005.
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 -- 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.
23
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time Packaging Dynamics and its subsidiaries are involved in
various litigation matters arising in the ordinary course of business. Packaging
Dynamics believes that none of the matters which arose during the quarter,
either individually or in the aggregate is material to Packaging Dynamics.
ITEM 6. EXHIBITS
Exhibit No. Description
- ----------- -----------
31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
-
32 Certification of CEO and CFO pursuant to 18 U.S.C.,
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
SIGNATURE PAGE FOLLOWS
24
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PACKAGING DYNAMICS CORPORATION
By: /s/ PATRICK T. CHAMBLISS
------------------------
PATRICK T. CHAMBLISS
Vice President and Chief Financial Officer
(Principal Financial Officer)
May 6, 2005
25