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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

Commission File Number 0-20646

Caraustar Industries, Inc.

(770) 948-3101
(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 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 o

Indicate the number of shares outstanding of each of issuer’s classes of common stock, as of the latest practicable date, October 28, 2002.

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FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2002

CARAUSTAR INDUSTRIES, INC.

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CARAUSTAR INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

The accompanying notes are an integral part of these financial statements.

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CARAUSTAR INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

The accompanying notes are an integral part of these financial statements.

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CARAUSTAR INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

The accompanying notes are an integral part of these financial statements.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The financial information included herein is unaudited; however, such information reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the interim periods. Certain notes and other information have been condensed or omitted from the interim financial statements; therefore, these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001. The results of operations for the nine months ended September 30, 2002 are not necessarily indicative of the results to be expected for the full year.

Note 2. Acquisitions

		Each of the following acquisitions are being accounted for under the purchase method of accounting, applying the provisions of Statements of Financial Accounting Standards No. 141 and, as a result, the Company recorded the assets and liabilities of the acquired company at their estimated fair values with the excess of the purchase price over these amounts being recorded as goodwill. Actual allocation of goodwill and other identifiable assets will be based on further studies and may change during the allocation period, generally one year following the date of the acquisition. The financial statements for the nine months ended September 30, 2002 reflect the operations of the acquired businesses for the periods after their respective dates of acquisition.
		In April 2002, the Company acquired the remaining 51 percent of the outstanding stock of Design Tubes Company Limited (“Design Tubes”), Toronto, Ontario, Canada in exchange for shares of a subsidiary of the Company convertible at the holder’s option (for no additional consideration) into approximately 141,000 shares of the Company’s common stock, valued at $1,472,000. The Company originally acquired its minority interest in Design Tubes in November 1998 and accounted for its 49 percent ownership using the equity method. Design Tubes manufactures paperboard tubes and also produces paper tube manufacturing equipment for companies throughout North America. Goodwill in the amount of $1,000,000 was recorded in the connection with the Design Tubes acquisition.
		On September 30, 2002, the Company acquired certain operating assets (excluding accounts receivable) of the Smurfit Industrial Packaging Group, a business unit of Jefferson Smurfit Corporation (U.S.), for approximately $67,100,000, and assumed $1,700,000 of indebtedness outstanding under certain industrial revenue bonds. The acquisition was funded by $38,000,000 of borrowings under Caraustar’s revolving credit facility and $29,100,000 of cash on hand. The purchase agreement includes a purchase price working capital adjustment which will be finalized in the fourth quarter. Goodwill and intangible assets of approximately $38,600,000 were recorded in conjunction with the Smurfit Industrial Packaging Group acquisition.
		The Company also entered into operating lease agreements with a third party to lease machinery and equipment at these locations. The terms of the agreements are six years. The future minimum rental payments required under these leases are approximately $1,700,000 each year in 2002 through 2007 and $1,300,000 in 2008. The Company will recognize operating lease expense of approximately $480,000 in 2002, $2,000,000 each year in 2003 through 2007 and $1,400,000 in 2008.
		Smurfit Industrial Packaging Group operations included seventeen paper tube and core plants, three uncoated recycled paperboard mills and three partition manufacturing plants. These facilities are located in 16 states across the U.S. and in Canada. The Company believes that these assets enhance the Company’s capabilities in its tube, core and composite container market and position the Company as a prominent producer in this market. In conjunction with the acquisition, the Company is evaluating its existing and acquired locations to determine which locations should be closed or consolidated to achieve economies of scale and other efficiencies.

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The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The Company is in the process of obtaining third-party valuations of the acquired assets including certain intangible assets; thus, the allocation of the purchase price is preliminary.

The following unaudited pro forma financial data (in thousands, except per share amounts) gives effect to the acquisition of Smurfit Industrial Packaging Group as if it had occurred on the first day of each period presented. The pro forma financial data is provided for comparative purposes only and is not necessarily indicative of the results which would have been obtained if the Smurfit Industrial Packaging Group acquisition had been effected at that date.

Note 3. Inventory

		Inventories are carried at the lower of cost or market. Cost includes materials, labor and overhead. Market, with respect to all inventories, is replacement cost or net realizable value. All inventories are valued using the first-in, first-out method.
		Inventories at September 30, 2002 and December 31, 2001 were as follows (in thousands):

Note 4. Comprehensive Income or Loss

Total comprehensive income or loss, consisting of net income or loss plus changes in foreign currency translation adjustment for the three months ended September 30, 2002 and 2001 was a loss of $4,563,000 and

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income of $1,041,000, respectively. For the nine months ended September 30, 2002 and 2001 total comprehensive loss was $4,409,000 and $9,533,000, respectively.

Note 5. Senior Credit Facility and Other Long-Term Debt

At September 30, 2002 and December 31, 2001, total long-term debt consisted of the following (in thousands):

		On March 29, 2001, the Company obtained a credit facility that provides for a revolving line of credit in the aggregate principal amount of $75,000,000 for a term of three years, including subfacilities of $10,000,000 for swingline loans and $15,000,000 for letters of credit, usage of which reduces availability under the facility. As of September 30, 2002 the Company borrowed $38,000,000 under the facility at an average interest rate of 4.28 percent, and an aggregate of $10,000,000 in letter of credit obligations were outstanding. The Company used the $38,000,000 to fund a portion of the acquisition price of the Smurfit Industrial Packaging Group (see Note 2). The Company intends to use the remaining balance of the facility for working capital, capital expenditures and other general corporate purposes. The Company’s obligations under the facility are unconditionally guaranteed, on a joint and several basis, by all of its existing and subsequently acquired wholly-owned domestic subsidiaries and are secured by a first priority security interest in the accounts receivable and inventory of the Company and all of its existing and subsequently acquired wholly-owned domestic subsidiaries (see discussion below of amendments to the senior credit facility).
		Borrowings under the facility bear interest at a rate equal to, at the Company’s option, either (1) the base rate (which is equal to the greater of the prime rate most recently announced by Bank of America, N.A., the administrative agent under the facility, or the federal funds rate plus one-half of one percent) or (2) the adjusted Eurodollar Interbank Offered Rate, in each case plus an applicable margin determined by reference to the Company’s leverage ratio (which is defined under the facility as the ratio of the Company’s total debt to its total capitalization). Based on the Company’s leverage ratio at September 30, 2002, the current margins are 2.75 percent for Eurodollar rate loans and 1.50 percent for base rate loans. Additionally, the undrawn portion of the facility is subject to a facility fee at an annual rate that is currently set at 0.55 percent based on the Company’s leverage ratio at September 30, 2002.
		The facility contains covenants that restrict, among other things, the Company’s ability and its subsidiaries’ ability to create liens, merge or consolidate, dispose of assets, incur indebtedness and guarantees, pay dividends, repurchase or redeem capital stock and indebtedness, make certain investments or acquisitions, enter into certain transactions with affiliates, make capital expenditures or change the nature of the Company’s business. The facility also contains several financial maintenance covenants, including covenants establishing a maximum leverage ratio (as described above), minimum tangible net worth and a minimum fixed charge coverage ratio.
		The facility contains events of default including, but not limited to, nonpayment of principal or interest, violation of covenants, incorrectness of representations and warranties, cross-default to other indebtedness, bankruptcy and other insolvency events, material judgments, certain ERISA events, actual or asserted invalidity of loan documentation and certain changes of control of the Company.

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		During the third and fourth quarters of 2001 and the first and third quarters of 2002, the Company completed four amendments to its senior credit facility agreement. The first amendment, dated September 10, 2001, allows the Company to acquire up to $30,000,000 of its senior subordinated notes so long as no default or event of default exists on the date of the transaction, or will result from the transaction.
		The second amendment, dated November 30, 2001, provides for the issuance of letters of credit under the senior credit facility having an original expiration date more than one year from the date of issuance, if required under related industrial revenue bond documents and agreed to by the issuing lender.
		The third amendment was completed on January 22, 2002 with an effective date of September 30, 2001. The Company obtained this amendment in order to avoid the occurrence of an event of default under its senior credit facility agreement resulting from a violation of the interest coverage ratio covenant contained in the agreement. This amendment modified the definitions of “Interest Expense,” “Premier Boxboard Interest Expense” and “Standard Gypsum Interest Expense” to include interest income and the benefit or expense derived from interest rate swap agreements or other interest hedge agreements. Additionally, the amendment lowered the minimum allowable interest coverage ratio for the fourth quarter of 2001 from 2.5:1.0 to 2.25:1.0, the first quarter of 2002 from 2.75:1.0 to 2.25:1.0, and the second quarter of 2002 from 2.75:1.0 to 2.50:1.0.
		In connection with the Company’s acquisition of the Smurfit Industrial Packaging Group, the Company entered into a fourth amendment to its senior credit facility in September 2002. The purpose of this amendment was to obtain the required lender consent under the senior credit facility for the consummation of the acquisition (and the incurrence of up to $60,000,000 in subordinated debt financing to refinance borrowings under the credit facility and restore cash used to fund a portion of the acquisition price), to lower the minimum allowable tangible net worth for all periods after the effective date of the amendment, and to increase the maximum permitted leverage ratio covenant to 70.0 percent for the fiscal quarters ending December 31, 2002, March 31, 2003 and June 30, 2003, and 67.5 percent for the fiscal quarter ending September 30, 2003. Additionally, the minimum interest coverage ratio covenant was replaced with a minimum fixed charge coverage ratio covenant beginning with the third quarter of 2002. These modifications, in addition to increasing the Company’s flexibility to finance the acquisition, were necessary to enable the Company to avoid violations of the leverage ratio and interest coverage ratio covenants for the third quarter of 2002 and violations of the leverage ratio covenant in future periods.
		In exchange for these modifications, the Company’s lenders required an increase in the applicable margin component of the interest rates applicable to borrowings under the facility and the facility fee rate applicable to the undrawn portion of the facility. The amendment also provides for a margin pricing increase of 0.25 percent effective November 15, 2002, if the Company has not issued at least $50,000,000 in senior subordinated notes by that date, and an increase of 0.25 percent every three months after that date until the first date on which the Company’s balance of cash and cash equivalents is at least $50,000,000 and the Company has no loans outstanding under the facility (subject to a maximum interest margin of 3.75 percent for Eurodollar rate loans and 2.50 percent for base rate loans). In addition, under the terms of the fourth amendment, the Company was required to enter into a security agreement under which the Company and its subsidiary guarantors under the senior credit facility granted a first priority security interest in their respective accounts receivable and inventory to secure their obligations under the credit facility and the Company’s obligations under its 50 percent guarantees of the credit facilities of Standard Gypsum and Premier Boxboard.
		On March 22, 2001, the Company obtained commitments and executed an agreement for the issuance of $285,000,000 of 9 7/8 percent senior subordinated notes due April 1, 2011 and $29,000,000 of 7 1/4 percent senior notes due May 1, 2010. These senior subordinated notes and senior notes were issued at a discount to yield effective interest rates of 10.5 percent and 9.4 percent, respectively. Under the terms of the agreement, the Company received aggregate proceeds, net of issuance costs, of approximately $291,200,000 on March 29, 2001. These proceeds were used to repay borrowings outstanding under the Company’s former senior credit facility and its 7.74 percent senior notes. In connection with the repayment of the 7.74 percent senior notes, the Company incurred a prepayment penalty of approximately $3,600,000. The Company recorded an extraordinary loss of $2,695,000, which included the prepayment penalty and unamortized issuance costs of $705,000, net of tax benefit of $1,610,000. The difference between issue price and principal amount at

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		maturity of the Company’s 7 1/4 percent senior and 9 7/8 percent senior subordinated notes will be accreted each year as interest expense in its financial statements. These notes are unsecured, but are guaranteed, on a joint and several basis, by all of the Company’s domestic subsidiaries, other than two that are not wholly-owned.
		During 1998, the Company registered with the Securities and Exchange Commission a total of $300,000,000 in public debt securities for issuance in one or more series and with such specific terms as to be determined from time to time. On June 1, 1999, the Company issued $200,000,000 in aggregate principal amount of its 7 3/8 percent notes due June 1, 2009. The 7 3/8 percent notes were issued at a discount to yield an effective interest rate of 7.473 percent and pay interest semiannually. The 7 3/8 percent notes are unsecured obligations of the Company.
		During the second and third quarters of 2001, the Company entered into four interest rate swap agreements in notional amounts totaling $285,000,000. The agreements, which have payment and expiration dates that correspond to the terms of the note obligations they cover, effectively converted $185,000,000 of the Company’s fixed rate 9 7/8 percent senior subordinated notes and $100,000,000 of the Company’s fixed rate 7 3/8 percent senior notes into variable rate obligations. The variable rates are based on the three-month LIBOR plus a fixed spread.
		The following table identifies the debt instrument hedged, the notional amount, the fixed spread and the three-month LIBOR at September 30, 2002 for each of the Company’s interest rate swaps. The September 30, 2002 three-month LIBOR is presented for informational purposes only and does not represent the Company’s actual effective rates in place at September 30, 2002.

		In October 2001, the Company unwound its $185,000,000 interest rate swap agreement related to the 9 7/8 percent senior subordinated notes and received $9,093,000 from the bank counter-party. Simultaneously, the Company executed a new swap agreement with a fixed spread that was 85 basis points higher than the original swap agreement. The new swap agreement is the same notional amount, has the same terms and covers the same notes as the original agreement. The $9,093,000 gain, which was classified as a component of debt, is accreted to interest expense over the life of the notes and partially offsets the increase in interest expense. The Company executed these transactions in order to take advantage of market conditions.
		In August 2002, the Company unwound its $185,000,000 interest rate swap agreement related to the 9 7/8 percent senior subordinated notes and received $5,500,000 million from the bank counter-party. Simultaneously, the Company executed a new swap agreement with a fixed spread that was 17 basis points higher than the original swap agreement. The new swap agreement is the same notional amount, has the same terms and covers the same notes as the original agreement. In September 2002, the Company repaid the $5,500,000 and entered into a new swap agreement that lowered the fixed spread by 7.5 basis points from the August 2002 swap.
		Under the provisions of SFAS No. 133, the Company has designated and accounted for its interest rate swap agreements as fair value hedges. The Company has assumed no ineffectiveness with regard to these agreements as they qualify for the short-cut method of accounting for fair value hedges of debt obligations, as prescribed by SFAS No. 133. At September 30, 2002 the aggregate fair value of the swap agreements is approximately $20,986,000 and is classified as a component of long-term assets and long-term debt in the accompanying balance sheet. The December 31, 2001 aggregate fair value of the swaps was $7,418,000 and is classified as a component of other long-term liabilities and long-term debt.

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Note 6. New Accounting Pronouncements

		SFAS No. 142 supercedes APB Opinion No. 17, “Intangible Assets.” This pronouncement prescribes the accounting practices for goodwill and other intangible assets. Under this pronouncement, goodwill will no longer be amortized to earnings, but instead is reviewed periodically (at least annually) for impairment. The Company has completed the required transitional impairment test as of January 1, 2002 and found no impairment of goodwill. On an ongoing basis (absent any impairment indicators), the Company expects to perform its impairment tests during the fourth quarter.
		In July 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS No. 143”). This pronouncement requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, the entity either settles the obligation for the amount recorded or incurs a gain or loss. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The Company is currently assessing the impact of SFAS No. 143 on its financial position and results of operations.
		In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”). This pronouncement addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company adopted SFAS No. 144 as of January 1, 2002. This pronouncement did not have a material impact on the Company’s consolidated financial statements upon adoption.
		In April 2002, the FASB issued SFAS No. 145 “Recission of FASB Statements No. 4, 44 and 46, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS No. 145”). This statement eliminates the current requirement that gains and losses on extinguishment of debt must be classified as extraordinary items in the statement of operations. Instead, the statement requires that gains and losses on extinguishment of debt be evaluated against the criteria in APB Opinion 30 to determine whether or not it should be classified as an extraordinary item. Additionally, the statement contains other corrections to authoritative accounting literature in SFAS No. 4, 44 and 46. The changes in SFAS No. 145 related to debt extinguishment become effective for the Company in fiscal 2003, and the other changes were effective for all financial statements issued on or after May 15, 2002.
		In June 2002, the FASB issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No. 146”). This pronouncement addresses accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 becomes effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not expect the adoption of this pronouncement to have a material impact on its consolidated financial statements.

Note 7. Segment Information

		The Company operates principally in three business segments based on its products. The paperboard segment consists of facilities that manufacture 100 percent recycled uncoated and clay-coated paperboard and facilities that collect recycled paper and broker recycled paper and other paper rolls. The tube, core, and composite container segment is principally made up of facilities that produce spiral and convolute-wound tubes, cores, and composite cans. The carton and custom packaging segment consists of facilities that produce printed and unprinted folding cartons and set-up boxes and facilities that provide contract manufacturing and contract packaging services. Intersegment sales are recorded at prices which approximate market prices.
		Operating income includes all costs and expenses directly related to the segment involved. Corporate expenses include corporate, general, administrative, and unallocated information systems expenses.

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The following table presents certain business segment information for the periods indicated (in thousands):