UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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

For the fiscal year ended: January 2, 2016

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 numbers: 333-82084-01

 

 

Registrant’s telephone number, including area code: (920) 734-9841

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  ☐    No  ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.     Yes  ☒    No  ☐

 

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 ☐   No  ☒

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes   ☒    No  ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☒

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one).

Large Accelerated filer  ☐    Accelerated filer  ☐    Non-accelerated filer  ☒    Smaller reporting company  ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    Yes  ☐    No  ☒

 

As of March 1, 2016,  6,757,865 shares of Paperweight Development Corp. common stock, $.01 par value, were outstanding. There is no trading market for the common stock of Paperweight Development Corp. No shares of Paperweight Development Corp were held by non-affiliates.

 

Documents incorporated by reference: None.

 

 

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INDEX 

 

 

 

 

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PART I

 

Unless stated to the contrary or the context requires otherwise, all references in this report to the Company refer to Paperweight Development Corp. (“PDC” or “Paperweight”) and its 100%-owned subsidiaries. It includes Appvion, Inc. and its 100%-owned subsidiaries (collectively “Appvion”).

 

Item 1.Business

Overview

 

The Company is a leading manufacturer of specialty, high value-added coated paper products, including carbonless, thermal and security papers. The Company creates product solutions for customers and end users through its development and use of coating formulations and applications as well as security technologies. Under U.S. generally accepted accounting principles (“GAAP”), the Company has two reportable segments: thermal papers and carbonless papers. The performance of these two segments is described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data.”

 

Company Background

 

PDC was incorporated in Wisconsin on December 28, 2000. Appvion was incorporated in Delaware in July 1965 and is the primary operating subsidiary of PDC.

 

Company History

 

Appleton Coated Paper Company, or ACPC, began operations in 1907 in Appleton, Wisconsin. In 1953, ACPC began working with NCR on the development and production of carbonless paper. In 1954, NCR began marketing its NCR PAPER* brand of carbonless paper, which ACPC manufactured.

 

In 1969, NCR acquired Combined Paper Mills, Inc., which then consisted of pulp and paper mills in Combined Locks, Wisconsin, and Roaring Spring, Pennsylvania. In 1970, NCR acquired ACPC. In 1971, NCR formed the Appleton Papers division by merging ACPC with Combined Paper Mills, Inc.

 

In 1978, Appleton, then a subsidiary of B.A.T Industries Limited, acquired the assets of the Appleton Papers division from NCR. In 1990, Appleton, together with The Wiggins Teape Group Ltd., was separated from B.A.T Industries to form Wiggins Teape Appleton p.l.c., a public company listed on the London Stock Exchange. Later that year, Wiggins Teape Appleton merged with Arjomari Prioux SA, a public French paper manufacturer and merchant. Shortly after the merger, the group changed its name to Arjo Wiggins Appleton p.l.c. Appleton operated as an indirect, 100%-owned subsidiary of Arjo Wiggins Appleton p.l.c. until 2001.

 

On November 9, 2001, Appleton employees purchased Appleton from Arjo Wiggins Appleton p.l.c. through the use of an employee stock ownership plan. On May 9, 2013, the Company changed its name from Appleton Papers Inc. to Appvion, Inc.

 

The KSOP and the ESOP

 

The Appvion Retirement Savings and Employee Stock Ownership Plan (the “KSOP” or the “plan”) includes a separate employee stock ownership plan component (the “ESOP” or the “Company Stock Fund”). The KSOP is a tax-qualified retirement plan that is available to U.S. employees. The ESOP component of the KSOP is a tax-qualified employee stock ownership plan that invests in PDC common stock.

 

In late 2001, approximately 90% of Appvion’s employees invested approximately $107 million in the ESOP. On November 9, 2001, the ESOP purchased 100% of the common stock of PDC. PDC simultaneously used all the proceeds from the sale of those shares of common stock, along with the proceeds of a senior credit facility, senior subordinated notes, a deferred payment obligation and its available cash, to finance the purchase of the acquisition described below. 

 

Acquisition from Arjo Wiggins

 

On November 9, 2001, PDC and a 100%-owned subsidiary acquired Appleton from Arjo Wiggins Appleton p.l.c., now known as Windward Prospects Ltd.  (formerly “AWA”), and two of its subsidiary holding companies, (the “sellers” or “affiliates of AWA”). Appvion is a 100%-owned subsidiary of PDC and the ESOP owns 100% of the shares of common stock of PDC. PDC does not conduct any business apart from undertaking matters incidental to its ownership of the stock of its subsidiaries, matters relating to the ESOP, and actions required to be taken under ancillary acquisition agreements.

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Recent Dispositions

 

In August 2015, as part of the Company’s strategic, long-term focus on its core paper businesses, Appvion completed the sale of the assets primarily used in the development, manufacture and sale of microencapsulation materials by the former Encapsys segment of the Company (the “Encapsys Business”) to Rise Acquisition LLC (“Rise”), a Delaware limited liability company and an affiliate of Sherman Capital Holdings LLC, a Delaware limited liability company. In connection with the sale, Appvion and Rise entered into a Supply Agreement, through which Rise will supply Appvion with all of its microencapsulation product requirements for use in its carbonless paper products for a ten-year term subject to renewal.

 

During second quarter 2009, the Company committed to a formal plan to sell C&H Packaging Company, Inc. (“C&H”) which was acquired in April 2003. On December 18, 2009, the Company completed the sale of C&H to The Interflex Group, Inc. During second quarter 2010, the Company committed to a formal plan to sell American Plastics Company, Inc. (“APC”) and New England Extrusion, Inc. (“NEX”). These companies were acquired in April 2003 and January 2005, respectively. On July 22, 2010, the Company completed the sale of APC and NEX to Mason Wells Buyout Fund II, Limited Partnership. Since C&H, APC and NEX engaged in the manufacture, printing, converting, marketing and sale of high-quality single and multilayer polyethylene films for packaging applications, their operations did not align with the Company’s strategic, long-term focus on its core competencies in specialty papers and microencapsulation.

 

The Company has determined that its former Encapsys segment met the criteria to be classified as discontinued operations which requires retrospective application to financial information for all periods presented. Refer to Note 3 of Notes to Consolidated Financial Statements for further information on the Company’s discontinued operations. 

 

For financial information regarding the Company’s business segments, refer to Note 23 of Notes to Consolidated Financial Statements contained below in “Item 8. Financial Statements and Supplementary Data.”

 

Thermal Papers

 

The thermal papers segment develops and produces substrates for the transaction and item identification markets and accounted for approximately 53% of total company net sales in 2015. The Company believes it is the largest manufacturer of direct thermal papers in North America. Thermal paper is used in four principal end markets:  (1) point-of-sale products for retail receipts and coupons; (2) label products for shipping, warehousing, medical and clean-room applications; (3) tags and tickets for airline and baggage applications, event and transportation tickets and lottery and gaming applications; and (4) printer, calculator and chart paper for engineering, industrial and medical diagnostic charts. The point-of-sale and label market segments, combined, accounted for the majority of thermal paper volume of the North American thermal market in 2015.

 

Point-of-sale products are sold to printers and converters who in turn sell to end-user customers or to resellers such as office supply stores, office superstores, warehouse clubs, mail order catalogs, equipment dealers, merchants and original equipment manufacturers. Label products are sold to companies who apply pressure sensitive adhesive coatings and release liners and then sell these products to label printers. Tag, ticket and chart grades are sold to specialty printing companies who convert them to finished products such as entertainment, lottery and gaming tickets, tags, coupons and medical charts.

 

The thermal papers market is growing with new applications being developed to use thermal technology. Based on its assessment of the period 2010 through 2015, the Company believes North American thermal markets expanded at a 2% compound average growth rate, with annual rates ranging from increases of 1% to 5%. The Company believes demand for thermal paper will continue to grow in North America and around the world. Sales of thermal papers have not been significantly impacted by seasonality. In addition to the Company, other significant thermal paper producers include Koehler AG, Kanzaki Specialty Papers, Ricoh Company, Ltd., Mitsubishi Paper Mills Company Ltd. and Hansol Paper Company, Ltd. In the thermal papers market, the Company competes primarily on the basis of product quality, service, breadth of product offering and price.

 

Carbonless Papers

 

The carbonless papers segment includes carbonless, security and other specialty paper products and accounted for approximately 47% of total company net sales in 2015. The Company produces and sells carbonless roll and sheet products under the NCR PAPER* brand. The Company believes its product line is among the broadest in the industry and offers customers a single source solution for their carbonless paper needs. The Company also produces coated paper products for design and print applications and offers custom paper coating solutions.

 

Carbonless products are sold to converters, printers and merchant distributors who stock and sell carbonless paper to printers. Carbonless paper is used to make multipart business forms such as invoices and purchase orders. Carbonless paper is used in a variety of end markets, including government, retail, financial, insurance and manufacturing, with no one predominant end market. Demand for carbonless products in many of these markets is tied to economic growth, which impacts the number of transactions completed in a given year. Historically, sales of carbonless products have not been significantly impacted by seasonality.

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The Company believes the North American market for carbonless paper products has been in decline since 1994 as a result of greater use of competing technologies such as digital laser, inkjet and thermal printers and electronic communications. The Company believes the North American carbonless paper market declined by approximately 7% to 10% annually from 2010 through 2015. The decline is expected to continue at historical rates over the next several years. The Company believes the worldwide carbonless market is also in decline, with demand declining at approximately 2% to 6% per year.

 

In addition to the Company, other significant carbonless paper producers include P.H. Glatfelter Company, Nekoosa Coated Products, Mitsubishi Paper Mills Company Ltd., Asia Pulp and Paper Co. Ltd., Koehler AG, Nippon Industries Co. Ltd. and Oji Paper Co. Ltd.

 

The Company produces security papers with features that resist forgery, tampering and counterfeiting. The Company’s portfolio of security papers products incorporates security technologies, including watermarks, taggants, reactive chemicals, embedded threads and fibers and machine-readable technologies, to serve global markets. Sales of the Company’s security papers products have not been significantly impacted by seasonality.

 

Security paper competitors include P.H. Glatfelter Company, Rolland Enterprises Inc., Domtar, Copamex, S.A. de C.V., Papierfabrik Louisenthal GmbH, Arjowiggins Security and De La Rue International.

 

In the carbonless market, the Company competes primarily on the basis of product quality, service, breadth of product offering and price.

 

* NCR PAPER is a registered trademark licensed to the Company.

 

Geographical Financial Information

 

Revenues from sales in the U.S. were $526.0 million in 2015, $568.6 million in 2014 and $577.9 million in 2013. Revenues from sales to customers in foreign countries were $174.0 million in 2015, $196.1 million in 2014 and $194.8 million in 2013. All long-lived assets were located in the U.S. as of January 2, 2016. Substantially all long-lived assets were located in the U.S. as of January 3, 2015 and December 28, 2013. See Note 23, Segment Information, of Notes to Consolidated Financial Statements.

 

Research and Development

 

Ongoing investment in research and development has enabled the Company to develop core competencies in specialty coating chemistry, coating application systems and security technologies. Research and development efforts are focused on cost reduction, product line extensions, new product development and technology transfer and development. Research and development costs related to the development of new products and significant improvements to existing products were $9.0 million in 2015, $9.5 million in 2014 and $9.2 million in 2013.

 

Sales, Marketing and Distribution

 

The Company promotes and sells products through its sales and marketing organization. Sales personnel operate from field locations. Marketing employees work to acquire market, end-user and competitor insight to uncover and deliver market-focused solutions. Technical service representatives assist customers with product applications and improvements and complaint resolution by telephone and in person at customer locations. Customer service representatives receive customer orders, establish delivery dates and answer inquiries about stock availability and order status.

 

The Company uses 10 distribution centers to store and distribute products to customers. Distribution centers are located in Appleton, Wisconsin; Monroe, Ohio; and Kansas City, Kansas. Third-party logistics services are contracted through distribution facilities at Middletown, Pennsylvania; McDonough, Georgia; Portland, Oregon; Ontario, California; Burlington, Ontario, Canada; Birmingham, England; and Utrecht, Netherlands.

 

Distributors and Customers

 

The Company currently sells through merchant distributors that stock and redistribute carbonless sheet products globally from approximately 265 locations. Carbonless rolls are sold through a variety of channels including merchants, agents and directly to printer and converter customers worldwide. In North America, some carbonless rolls are sold to forms printers through merchant distributors on a drop-shipment basis. In those cases, the Company ships products from distribution centers and provides customer support while the merchant bears the credit risk of nonpayment.

 

The Company sells thermal papers to converters who cut and rewind large rolls into smaller rolls, print and otherwise further process the paper based on end-user needs. The Company sells security products through merchants and to security printers who print checks, titles, certificates and other secure documents.

 

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Sales to the Company’s largest customer accounted for approximately 9% of 2015 and 2014 total company net sales and 8% of 2013 total company net sales. The five largest customers in the carbonless papers segment collectively accounted for approximately 44% of carbonless net sales in 2015, 41% of carbonless papers net sales in 2014 and 39% of carbonless papers net sales in 2013. The five largest customers in the thermal papers segment collectively accounted for approximately 44% of thermal papers net sales in 2015, 41% of thermal papers net sales in 2014 and 39% of thermal papers net sales in 2013.

 

Working Capital Practices

 

The Company maintains finished goods inventories sufficient to provide a high level of available stock items and next day delivery to most carbonless and thermal papers customers. Raw material inventories are maintained at levels consistent with demand for both stock and custom orders. Custom order lead times are typically less than 30 days. Accounts receivable management practices, including terms of sale, are designed to accommodate the competitive differences of each business segment and market channel.

 

Order Backlogs

 

In the carbonless papers business, customers typically order from stock grades and most orders are delivered the next day. Thermal papers customers also order primarily stock grades. Total carbonless papers and thermal papers products ordered but not shipped was approximately 4% of annual sales volume in 2015 and 2014, respectively, and 5% of annual sales volume in 2013.

 

Manufacturing

 

The Appleton plant, located in Appleton, Wisconsin, produces carbonless and specialty papers, as well as thermal papers. The Roaring Spring, Pennsylvania mill is a nearly fully-integrated pulp and paper mill with three paper machines and produces carbonless, security and specialty papers. The West Carrollton, Ohio plant produces thermal paper products.

 

Raw Materials

 

Raw materials purchases primarily consist of base stock and chemicals. In 2015, those materials made up approximately 59% of the cost of goods sold. The largest raw material component, base stock, which are rolls of uncoated paper used in the production of coated paper products, comprised 39% of cost of goods sold in 2015. Base stock is acquired from multiple sources pursuant to purchase agreements which establish pricing and volume targets. These agreements mitigate exposure to significant pricing cycles common for pulp and commodity paper products. The next largest raw material component is chemicals.

 

On February 22, 2012, the Company entered into a long-term supply agreement with a supplier for the purchase of carbonless and thermal base stock for coating at the Company’s converting facilities. Under the terms of this agreement, the supplier will be the exclusive supplier of certain thermal and carbonless base stock used by the Company. The term of the agreement is 15 years. The agreement includes successive five-year renewal terms unless either party gives notice of non-renewal at least two years prior to the expiration of the then current term. Prices to be paid by the Company are subject to certain rebates and certain adjustments during the term of the agreement based on volume, changes to raw material pricing, freight prices and productivity gains. The supplier has agreed to be competitive in terms of price, delivery, quality and services. Purchases made from this supplier were approximately 95% of total 2015 base stock purchases. For further information see the disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 20 of Notes to Consolidated Financial Statements.

The Company uses many specialty raw materials which are designed and manufactured to work best with its products and manufacturing processes. The Company makes purchasing decisions based upon quality, service, value and long-term strategic importance. There are long-term agreements with key suppliers designed to ensure stable and consistent supply, to promote joint development and engineering of new raw materials and products, to enhance total value to customers and to protect mutual strategic interests.

 

Employees

 

As of March 1, 2016, the Company employed 1,424 persons, of whom 947 were covered by union contracts. Manufacturing employees at the Company’s manufacturing facilities in Appleton, Wisconsin, Roaring Spring, Pennsylvania and West Carrollton, Ohio are represented by the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial and Service Workers International Union (“USW”). The Company has labor agreements in effect with represented employees at the Appleton plant through August 31, 2017; at the Roaring Spring mill through February 1, 2018; and at the West Carrollton plant until through March 31, 2018.

 

USW also represents employees at the Appleton, Wisconsin and Kansas City, Kansas distribution centers. Employees at the distribution center in Ohio are not represented.

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The Company has enjoyed good labor-management relations over an extended period of time. There have been no work stoppages for more than 30 years. This long-term relationship has been critical in developing efficient manufacturing sites and a workforce that is highly committed to the Company’s success.

 

Intellectual Property

 

As part of the acquisition of the business from NCR in 1978, the Company obtained a 100-year license to use forms of the NCR PAPER* trademark in branding for carbonless products. The Company also licenses technology from other companies covering non-critical articles of manufacture, manufacturing processes or materials used in such processes. The Company does not believe that any single patent or patent application is material to the Company’s business or operations. The Company believes that the duration of existing patents is consistent with its business needs.

 

Environmental

 

General

 

The Company’s operations are subject to comprehensive and frequently changing federal, state and local environmental laws and regulations. These include laws and regulations governing emissions of air pollutants, discharges of wastewater and storm water, storage, treatment and disposal of materials and waste, remediation of soil, surface water and groundwater contamination and liability for damages to natural resources. In addition, the Company is also governed by laws and regulations relating to workplace safety and worker health which, among other things, regulate employee exposure to hazardous chemicals in the workplace.

 

Compliance with environmental laws and regulations is an important facet of the business. The Company expects to incur capital expenditures of approximately $7.9 million in 2016, largely the result of the cost of required January 31, 2017 compliance with the Industrial Boiler MACT rules, and a total of approximately $0.7 million from 2017 through 2021 to maintain compliance with applicable federal, state, local and foreign environmental laws and regulations and to meet new regulatory requirements. The Company expects to continue to incur expenditures after 2021 to maintain compliance with applicable federal, state, local and foreign environmental laws and regulations and to meet new regulatory requirements.

 

The Company is subject to strict and, under some circumstances, joint and several liability for the investigation and remediation of environmental contamination, including contamination caused by other parties, at properties that it owns or operates and at properties where the Company or its predecessors have arranged for the disposal of regulated materials. As a result, the Company is involved from time to time in administrative and judicial proceedings and inquiries relating to environmental matters. The Company could be involved in additional proceedings in the future and the total amount of these future costs and other environmental liabilities may be material.

 

Other than what is discussed below, there are no known material liabilities with respect to environmental compliance issues.

 

Fox River Funding Agreement

 

On April 10, 2012, the United States District Court for the Eastern District of Wisconsin (“District Court”) granted Appvion’s motion for summary judgment and dismissed all claims against Appvion in the enforcement action for remediation of the Lower Fox River. The decision establishes that Appvion is no longer a potentially responsible party (“PRP”), no longer liable under the federal Comprehensive Environmental Response, Compensation, and Liability Act, (“CERCLA”), no longer considered a legal successor to NCR’s liabilities, and no longer required to comply with the 106 Order commanding remediation of the Lower Fox River.

 

On September 30, 2014, Appvion entered into a Funding Agreement with NCR Corporation (“NCR”), B.A.T. Industries, p.l.c. (“BAT”) and Windward Prospects Ltd. (“Windward”) relating to clean-up costs for the Lower Fox River and certain potential future sites. Under the Funding Agreement, the parties paid the following amounts on September 30, 2014 toward historical Fox River Costs (as defined in the Funding Agreement) incurred by NCR through September 1, 2014:  BAT ‑ $77.08 million; Windward ‑ $10 million; and Appvion ‑ $6 million.  In addition, BTI 2014 LLC, a wholly‑owned subsidiary of BAT (“BTI”), is responsible for funding 50% of the Fox River Costs incurred by NCR after September 1, 2014.  The parties also agreed:  (a) to vigorously pursue reasonable claims and viable claims against certain third parties and to deposit any recoveries therefrom into BTI; and (b) that any funds remaining in BTI after paying BAT and NCR for any unreimbursed funding of Fox River Costs would be used to fund 60% of any Future Sites Costs, as defined in the Funding Agreement.

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Subject to the limitations described below, Appvion agreed to assume the following additional funding obligations under the Funding Agreement:

 

 

Notwithstanding the foregoing, Appvion’s additional funding obligations are subject to the following limitations:

 

 

Appvion bears sole responsibility for its funding obligations under the Funding Agreement. The Funding Agreement does not, however, modify, alter or amend the two indemnification agreements entered into in 2001 wherein Windward agreed to indemnify PDC and PDC agreed to indemnify Appvion for certain costs, expenses and liabilities relating to Fox River and Future Sites, including Appvion’s costs and expenses in negotiating and entering into the Funding Agreement and any future costs and expenses incurred by Appvion in pursuing recoveries.

 

The parties to the Funding Agreement agree that they have no recourse against Appvion for any further liability relating to the Fox River or Future Sites beyond the funding obligations set forth above up to the Appvion Fox River Cap and the Appvion Future Sites Cap, respectively. For further discussion, see Note 18, Commitments and Contingencies.

 

As a result of the Funding Agreement, $24.0 million of expense was recorded as selling, general and administrative (“SG&A”) expense in the Consolidated Statement of Comprehensive (Loss) Income for the year ended January 3, 2015. This represents the total of the four payments expected to be made with respect to Fox River costs, as discussed above, with the first payment made on September 30, 2014, the second payment made on February 2, 2015, the third payment made on September 1, 2015 and the last payment due September 1, 2016, discounted to reflect the long-term nature of the liability.  A short-term liability of $7.3 million is recorded in other accrued liabilities on the Consolidated Balance Sheet as of January 2, 2016. The total of these liabilities will be accreted to the full liability of $25.0 million during the course of the payment schedule.

 

Item 1A.Risk Factors

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements. The words “will,” “may,” “should,” “believes,” “anticipates,” “intends,” “estimates,” “expects,” “projects,” “plans,” “seeks” or similar expressions are intended to identify forward-looking statements. All statements in this report other than statements of historical fact, including statements which address the Company’s strategy, future operations, future financial position, estimated revenues, projected costs, prospects, plans and objectives of management and events or developments that it expects or anticipates will occur, are forward-looking statements. All forward-looking statements speak only as of the date on which they are made. They rely on a number of assumptions concerning future events and are subject to a number of risks and uncertainties, many of which are outside the Company’s control, which could cause actual results to differ materially from such statements. These risks and uncertainties include, but are not limited to, the factors listed below. Many of these factors are beyond the Company’s ability to control or predict. Given these uncertainties, undue reliance should not be placed on the forward-looking statements. The Company disclaims any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

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The Company is subject to substantial costs and potential liabilities relating to environmental regulation and litigation.

 

The Company is subject to comprehensive and frequently changing laws and regulations enacted by various federal, state and local authorities concerning the impact of the environment on human health, the limitation and control of emissions and discharges into the air, ground and waters, the quality of ambient air and bodies of water and the handling, use and disposal of specified substances. Financial responsibility for the cleanup or other remediation of contaminated property or for natural resource damages can extend to previously-owned or used properties, waterways and properties owned by unrelated companies or individuals, as well as properties currently owned and used by the Company, regardless of whether the contamination is attributable entirely to prior owners. In addition, the Company makes capital expenditures and incurs operating expenses for environmental obligations and matters arising from its daily operations.

 

The Company may be named as a potentially responsible party, or PRP, in the future and the associated costs may be material. The Company expects environmental laws and regulations and the interpretation and enforcement of those laws and regulations to become increasingly stringent and to further limit emission and discharge levels and to increase the likelihood and cost of environmental cleanups and related activities. All of these factors are likely to increase the Company’s operating expenses, require continuing capital expenditures and adversely affect the operating flexibility of its manufacturing operations and may require indeterminable and significant additional expenditures in connection with such compliance.

 

Future greenhouse gas/carbon regulations or legislation and future Boiler Maximum Achievable Control Technology (“MACT”) regulations could adversely affect the Company’s costs of compliance with environmental laws.

 

In 2009, the EPA finalized its finding that greenhouse gas (“GHG”) emissions endanger the public health and welfare. Since then, the EPA has finalized rules to regulate GHG emissions under the federal Clean Air Act. Also in 2009, several bills were introduced in the U.S. Congress concerning climate change and the emission into the environment of carbon dioxide and other GHGs. If there is legislation, it may take the form of a cap and trade program and the Company may then be required, among other things, to purchase allowances or offsets to emit GHGs or other regulated pollutants or to pay taxes on such emissions. In April 2010, the EPA proposed three related air rules commonly known as the Industrial Boiler MACT under the Clean Air Act. These air rules were finalized by the EPA in December 2012. The Company’s current estimate of the cost of compliance with the regulations will result in capital spending of approximately $10 million; however, the amount of spending ultimately incurred may differ. The Company has received an extension until January 31, 2017 to achieve compliance with these rules. The majority of the expenditures are expected to occur during 2016. Enactment of new environmental laws or regulations or changes in existing laws or regulations could significantly change these estimates.

 

The Company has a substantial amount of indebtedness outstanding and, as a result, it is operating as a highly leveraged company.

 

The Company’s total debt at January 2, 2016, was approximately $423.4 million and, in accordance with its debt covenants, it had approximately $20.0 million of unused borrowing capacity under its revolving credit facility. For a description of the components of the Company’s debt, as well as discussion of the June 28, 2013 and November 19, 2013 voluntary refinancing of a portion of its debt, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and Note 10 of the Notes to Consolidated Financial Statements. This large amount of indebtedness could:

 

•         make it more difficult for the Company to satisfy its financial obligations with respect to the revolving credit facility, the first lien term loan, the second lien notes and other indebtedness;

 

•         require the Company to dedicate a substantial portion of cash flow from operations to payments on indebtedness, thereby reducing the availability of cash flow to fund working capital, capital expenditures, acquisitions, research and development or general corporate activities;

 

•         increase the Company’s vulnerability to general adverse economic, industry and competitive conditions;

 

•         place the Company at a competitive disadvantage compared to its competitors that have less leverage;

 

•         limit the Company’s ability to obtain additional financing for working capital, capital expenditures, acquisitions, research and development or general corporate purposes; and

 

•         limit the Company’s flexibility in planning for, or reacting to, changes in its businesses and the industries in which it operates.

 

Furthermore, although the Company’s ability to borrow money is restricted by the terms of its various debt agreements, it may be possible for the Company to incur even more debt and, if it does so, these risks could intensify.

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The Company’s ability to service its debt is dependent on its future operating results and the Company cannot be sure that it will be able to meet its debt obligations as they come due.

 

The Company’s ability to meet its payment obligations, relating to its indebtedness, is subject to a variety of factors, including, for example, changes in:

 

•         demand for and selling prices of the Company’s products;

 

•         competition;

 

•         costs of raw materials and operating costs;

 

•         the rate of decline in sales of carbonless paper products;

 

•         environmental regulations; and

 

•         general economic conditions.

 

The Company expects to use cash flow from operations to pay its expenses and scheduled interest and principal payments due under its outstanding indebtedness. Its ability to make these payments depends on its future performance, which will be affected by financial, business, economic and other factors, many of which the Company cannot control. Consequently, its business may not generate sufficient cash flow from operations in the future and its anticipated growth in revenue and cash flow may not be realized, either or both of which could result in the Company being unable to repay or pay interest on its indebtedness or to fund other liquidity needs. If the Company does not have enough money to meet its debt obligations when due, it may be required to refinance all or part of its then-existing debt, sell assets or borrow more money. The Company cannot make any assurances that it will be able to accomplish any of these alternatives on terms acceptable to it, or at all. In addition, the terms of existing or future debt agreements, including the first lien term loan, the revolving credit facility and the second lien notes indenture, may restrict the Company from adopting any of these alternatives. The failure to generate sufficient cash flow or to achieve any of these alternatives could significantly adversely affect the value of its indebtedness and its ability to pay the amounts due. In addition, if the Company defaults in the payment of amounts due, it would give rise to an event of default under the note indentures and possible acceleration of amounts due under its outstanding indebtedness. In the event of any acceleration, there can be no assurance the Company will have enough cash to repay its outstanding indebtedness. On June 28, 2013, the Company completed a voluntary refinancing of a portion of its debt. The indebtedness incurred under the first lien term loan and revolving line of credit bear interest at variable rates, and therefore if interest rates increase, debt service requirements would increase. On July 30, 2013, Appvion fixed the interest rate at 7.24%, on $100.0 million of this variable rate debt using an interest rate swap contract with a forward start date of September 15, 2014 and a maturity date of June 8, 2019.

 

Compliance with the covenants relating to the Company’s indebtedness may limit its operating flexibility.

 

Certain of the Company’s debt agreements contain provisions that require the Company to maintain specified financial ratios as such items are defined in the debt agreements. The Company’s ability to comply with the financial covenants in the future depends on achieving forecasted operating results. However, it can be difficult to predict the ultimate impact of current economic trends on the Company’s future operating results. Given the uncertain global economies and other market uncertainties, there are various scenarios, including a reduction from forecasted operating results, under which the Company could violate its financial covenants. The Company’s failure to comply with such covenants or an assessment that it is likely to fail to comply with such covenants, could also lead the Company to seek amendments to or waivers of the financial covenants. No assurances can be provided that the Company would be able to obtain any amendments to or waivers of the covenants. In the event of non-compliance with debt covenants, if the lenders will not amend or waive the covenants, the debt would be due and the Company would need to seek alternative financing. The Company cannot provide assurance that it would be able to obtain alternative financing. If the Company were not able to secure alternative financing, this would have a material adverse impact on the Company.

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The market for the primary product in the Company’s carbonless papers segment, carbonless paper, may decline more rapidly than anticipated.

 

The Company’s carbonless papers segment, of which the primary product is carbonless paper, accounted for 45% of net sales in 2013, 46% of net sales in 2014 and 47% of net sales in 2015. Total sales volume of carbonless paper products decreased approximately 6% from 2014 to 2015. Total sales volume of carbonless paper products increased approximately 2% from 2013 to 2014. Total sales volume of carbonless paper products decreased approximately 18% from 2012 to 2013 largely due to the Company’s decision to discontinue selling carbonless papers into certain non-strategic international markets. The Company believes the worldwide carbonless market is declining as users switch to alternative modes of technologies and communication. The Company expects that its total sales volume of carbonless paper products will continue to decline at rates that are consistent with the decline rate of the overall market. If the decline in the Company’s sales of carbonless paper products accelerates, or if it is unable to maintain the prices of its carbonless paper products or if it is unable to offset reductions in carbonless papers sales with increased sales of thermal papers or other products, then the Company’s business, financial condition and results of operations may be materially adversely affected.

 

The Company may be unable to develop and introduce new and enhanced products.

 

The Company’s success in developing new products will depend in large part on its ability to use its existing technical and manufacturing capabilities and knowledge in the development and introduction of new, value-added products targeted at new markets and customers. If the Company is unable to utilize its capabilities or, properly identify and address the evolving needs of targeted customers and markets, the Company’s ability to capture and develop new business opportunities will be limited. In addition, if the revenue and profits generated by new products are not sufficient to replace the anticipated decline in revenue and profits generated by carbonless products, then the Company’s business, financial condition and results of operations may be materially adversely affected.

 

The Company’s ability to compete effectively in the marketplace depends, in part, on its ability to continually improve productivity and reduce operating costs.

 

The Company must continually strive to improve the productivity and cost structure of its manufacturing operations and the efficiency of its support services in order to offer products that are priced competitively and deliver an attractive value proposition to its customers. The Company sets specific productivity and cost reduction goals each year for each of its production facilities and key staff functions. Accomplishing these goals is essential to its near-term competitiveness and long-term financial viability. If the Company fails to reach these goals, it may experience an erosion of its profit margins, a decline in net sales or both, which could negatively affect its ability to service its debt and invest in the future growth of its business segments.

 

The Company currently relies on a relatively small number of customers to generate a significant amount of its net sales from each of its various businesses.

 

The five largest customers in the carbonless papers segment collectively accounted for approximately 44% of carbonless papers net sales in 2015, 41% of carbonless papers net sales in 2014 and 39% of carbonless papers net sales in 2013. The five largest customers in the thermal papers segment collectively accounted for approximately 44% of thermal papers net sales in 2015, 41% of thermal papers net sales in 2014 and 39% of thermal papers net sales in 2013.

 

Many of the Company’s customers are under no obligation to purchase its products in the future. Furthermore, some of the Company’s customers have become insolvent or financially distressed in recent years. If the Company loses one or more of its significant customers (e.g., to a competitor or as a result of their being acquired by a customer of a competitor) or any of the Company’s significant customers experience financial difficulty, then its business, financial condition and results of operations may be materially adversely affected.

 

The Company currently relies on a small number of third parties to supply several of the key raw materials used to produce its products.

 

The Company’s business depends upon the availability of key raw materials, including base stock and certain chemicals. On February 22, 2012, the Company entered into a long-term supply agreement for the purchase of carbonless and thermal base stock for coating at the Company’s converting facilities. Under the terms of this agreement, the supplier will be the exclusive supplier of certain thermal and carbonless base stock used by the Company. The term of the agreement is 15 years. This agreement has the effect of reducing the number of raw material suppliers to the Company and increasing the Company’s dependence on key suppliers. Should this supplier of base stock fail to supply quantities ordered by the Company, the Company may not be able to procure alternate sources of carbonless and thermal base stock in quantities sufficient to meet customer requirements or at prices comparable to the terms under this supply agreement. In 2015, the Company purchased approximately $215 million of base stock from various external suppliers. Nearly 100% of the base stock purchased to produce carbonless paper and approximately 94% of the base stock purchased to produce thermal papers came from the long-term supply vendor.

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For some of the key chemicals the Company uses in its products, it relies on one or two suppliers. If there is a disruption in the supply of raw materials, including chemicals, then the Company may be required to purchase these raw materials from alternative sources, which may result in a significant increase in its operating costs. Included in these increased costs would be development costs associated with qualifying new raw materials and suppliers. The Company may not be able to procure key chemicals or other raw materials from alternative suppliers in amounts sufficient to meet its needs or at prices consistent with historical prices.

 

The lack of available alternative suppliers could subject the Company to significant cost increases and manufacturing delays and its business, financial condition and results of operations may be materially adversely affected.

 

Global credit market uncertainty and economic weakness may adversely affect the Company’s customers and suppliers.

 

Global financial and credit markets continue to be extremely unstable and unpredictable. Worldwide economic conditions have been weak and may deteriorate further. The instability of the markets and weakness of the global economy could affect the demand for the Company’s customers’ products, the amount, timing and stability of their orders from the Company, the financial strength of its customers and suppliers, and/or the Company’s suppliers’ and customers’ ability to fulfill their obligations to the Company. These factors could materially adversely affect the Company’s business, financial condition and results of operations.

 

The Company has competitors in its various markets and it may not be able to maintain prices and margins for its products.

 

The Company faces strong competition in all of its business segments. Its competitors vary in size and the breadth of their product offerings and some of its competitors have significantly greater financial, technical and marketing resources than the Company. Regardless of the continuing quality of the Company’s primary products, the Company may be unable to maintain its prices or margins due to:

 

•         declining overall carbonless market size;

 

•         accelerating decline in carbonless sheet sales;

 

•         variations in demand for, or pricing of, carbonless products;

 

•         increasing manufacturing and raw material costs;

 

•         increasing competition in international markets or from domestic or foreign producers; or

 

•         declining general economic conditions.

 

In each of its business segments, the Company competes based on a number of factors, including price, product availability, quality and customer service. Additionally, the Company competes with domestic producers and imports from Europe and Asia. The Company’s inability to compete effectively or to maintain its prices and margins could have a material adverse effect on its earnings and cash flow.

 

Volatility of raw materials costs may adversely impact the Company’s margins for its products.

 

In the past, the Company has experienced volatility in raw materials costs, which comprise a significant portion of the Company’s operating costs. The Company endeavors to recover cost increases through continuous improvements in its business operations and product formulations and through selected price increases. However, the effects of rising raw materials costs on margins are difficult to match in precise amount or timing with offsetting price increases or cost reduction activities. To the extent the Company is unable to offset raw materials cost inflation, margins for products may be adversely impacted.

 

PDC and its eligible subsidiaries may fail to remain qualified to be taxed as subchapter S corporations and the ESOP may not continue to be exempt from U.S. federal or certain state and local income taxes.

 

PDC has made an election to be treated as a subchapter S corporation for U.S. federal and, where recognized, state and local income tax purposes and an election to treat its eligible subsidiaries as qualified subchapter S subsidiaries for U.S. federal and, where recognized, state and local income tax purposes. PDC believes that it qualifies as a subchapter S corporation and that Appvion and other eligible subsidiaries are qualified subchapter S subsidiaries. Appvion’s Canadian subsidiary is subject to Canadian tax law and is not eligible for this treatment.

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Section 1362 of the Internal Revenue Code of 1986, as amended, or the Code, provides that a corporation that meets certain requirements may elect to be taxed as a subchapter S corporation. Section 1361 of the Code provides that a corporation that, among other requirements, has all of its stock owned by a subchapter S corporation or a qualified subchapter S subsidiary may elect to be classified as a qualified subchapter S subsidiary. A qualified subchapter S subsidiary is disregarded as a separate entity for federal and most state and local income tax purposes. With limited exceptions, a subchapter S corporation does not pay any income tax. Rather, the income of an S corporation is allocated to its shareholders. An ESOP is exempt from income tax pursuant to Section 501 of the Code and is not taxed on its allocable share of a subchapter S corporation’s income. However, a plan is not treated as an ESOP unless it meets the requirements of Section 4975(e)(7) of the Code.

 

PDC’s continuing status as a subchapter S corporation and its eligible subsidiaries as qualified subchapter S subsidiaries for U.S. federal and state income tax purposes will depend upon its, and their ability to continue to meet the eligibility requirements.

 

It is possible that the Internal Revenue Service, or IRS, could take the position on audit that PDC is not eligible to be taxed as a subchapter S corporation and, as a consequence, terminate its subchapter S election. Additionally, the applicable law and regulations may change in a way that results in PDC being taxed as a corporation other than as a subchapter S corporation. Furthermore, the current law that exempts the ESOP trust from taxation on its allocable share of a subchapter S corporation’s income may change.

 

PDC could realize significant tax savings during profitable years due to the subchapter S corporation status. However, if, for any reason, it lost its subchapter S corporation status, or any of its qualified subchapter S subsidiaries loses its qualified subchapter S subsidiary status, it would be required to pay U.S. federal and certain state and local income taxes, thereby reducing the amount of cash available to repay debt or reinvest in the Company’s operations, which could have a material adverse effect on its earnings and cash flow. Similarly, if the plan does not qualify as an ESOP and becomes subject to tax on its share of the subchapter S corporation’s income, the Company would have to distribute cash to the ESOP trust to enable it to pay the resulting taxes, again reducing the amount of cash available to repay debt or to be reinvested in its operations.

 

The Company’s underfunded pension plans require future pension contributions which could limit flexibility in managing the Company.

 

The total projected benefit obligation of the Company’s defined benefit pension plans exceeded the fair value of the plan assets by $106.4 million at January 2, 2016. The Company was not required to make contributions to the pension plan in 2015. The Company contributed $16.1 million to the pension plan in 2014. The Company does not need to make contributions to the plan in 2016. Among the key assumptions inherent in the actuarially calculated pension plan obligation and pension plan expense are the discount rate and the expected rate of return on plan assets. If interest rates and actual rates of return on invested plan assets were to decrease significantly, the pension plan obligation could increase materially. The size of future required pension contributions could result in the Company dedicating a substantial portion of its cash flow from operations to making the contributions, which could materially adversely affect its business, financial condition and results of operations.

 

Future legislation or regulations intended to reform pension and other employee benefit plans could adversely affect the Company’s ability to repay its debt, reinvest in its operations or grow its business through new product development or through acquisitions.

 

From time to time in recent years, legislators and agencies of the executive branch have formulated or suggested various legislative proposals that would affect employee benefit plans. If legislation is adopted that requires the Company to lift restrictions on sales of PDC common stock held in participants’ KSOP accounts, or that limits the amount of PDC common stock that may be held by the KSOP, then the Company may be required to fund the repurchase of substantial amounts of PDC common stock or take some other action restrictive to its finances. These repurchases or other restrictive actions could reduce the amount of cash available to repay debt, reinvest in its operations or grow its business through new product development or through acquisitions. In addition, these repurchases could violate covenants under the Company’s outstanding debt agreements, which could lead to a default under those agreements.

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PDC’s legal obligations to repurchase common stock from employees and former employees may lead to a default under the agreements governing the Company’s indebtedness or may constrain the Company's ability to make necessary reinvestments in its operations or invest in new business opportunities.

 

It may be necessary for Appvion to make significant distributions to PDC in order for PDC to satisfy its share repurchase obligations under the terms of the KSOP to current and former employees who are participants in the ESOP. PDC incurs obligations to ESOP participants, when they retire or otherwise terminate employment, to repurchase shares of PDC. The ESOP allows PDC to satisfy its share repurchase obligations by installment payments and PDC currently satisfies its share repurchase obligations to former participants by making five equal annual installment payments. The ESOP also has obligations to permit certain participants to diversify the investment of a portion of their ESOP account, which would otherwise be invested in shares of PDC stock. However, the agreements governing the Company’s indebtedness contain limitations on its ability to satisfy the repurchase obligations. The amount of PDC’s repurchase obligations may at any time exceed these limitations and Appvion may elect, or be forced, to help PDC meet its obligations. Further, PDC, as a guarantor of the Company’s indebtedness, may also be limited to some extent from making payments to the ESOP or its beneficiaries by the terms of its and the Company’s indebtedness.

 

As a result of PDC’s legally imposed repurchase obligations, Appvion and/or PDC may be forced to violate the distribution and/or payment limitations contained in the agreements relating to its and the Company’s indebtedness, which may ultimately result in defaults under the agreements and the notes. Defaults on any of its indebtedness could result in acceleration of its indebtedness and cause the Company to dispose of its assets or declare bankruptcy and, as a result, it may not have sufficient funds to satisfy its obligations under the notes.

 

Moreover, PDC's legally imposed repurchase obligations are expected to consume a significant portion of the Company's cash flows from operations. After satisfying repurchase obligations and required debt repayments, the Company's remaining cash flow may be insufficient to make required reinvestments in its existing business or to invest in potentially desirable new business opportunities.

 

Item 1B.Unresolved Staff Comments

 

None.

 

Item 2.Properties 

 

The Company owns or leases the facilities reflected in the table below. The Company believes that its plants and facilities have been well maintained, are in good condition, are suitable for their respective operations and provide sufficient capacity to meet production requirements. 

 

 

 

 

The Company’s business is primarily operated in Appleton, Wisconsin; West Carrollton, Ohio; and Roaring Spring, Pennsylvania.

 

During the years 2011 through 2015, the Company invested approximately $86 million in capital improvements, of which, approximately $73 million was spent at its manufacturing facilities. The primary goal of this capital spending was to improve manufacturing efficiencies, product quality and cycle time. Of the $73 million spent on manufacturing facilities, approximately $2 million was spent to comply with applicable environmental regulations.

 

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Item 3.Legal Proceedings

 

From time to time the Company may be subject to various demands, claims, suits or other legal or regulatory proceedings arising in the ordinary course of business. The Company maintains a comprehensive insurance program to protect against such matters, though not all such exposures are, or can be, addressed by insurance. Estimated costs are recorded for such demands, claims, suits or proceedings of this nature when reasonably determinable. The Company has successfully defended such claims, settling some for amounts which are not material to the business and obtaining dismissals in others. While the Company will vigorously defend itself and expects to prevail in any similar cases that may be brought against it in the future, there can be no assurance that it will be successful.

 

The Company does not believe that any pending or threatened demands, claims, suits or other legal or regulatory proceedings will have, individually or in the aggregate, a materially adverse effect on its business, financial condition and results of operations or cash flows.

 

Item 4.Mine Safety Disclosures

 

Not applicable

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PART II

 

Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 

 

There is no established trading market for the common stock of PDC. All of the outstanding shares of PDC are owned of record by the KSOP, in which there are approximately 1,848 active participants who were invested in the Company’s Stock Fund as of January 2, 2016.

 

No dividends have been declared on the common stock of PDC in the last two years, nor does PDC currently anticipate it will be paying dividends in the foreseeable future. PDC is and anticipates that it will continue to be restricted from declaring dividends and repurchasing common stock pursuant to provisions contained in the Company’s indebtedness agreements. For further information, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Description of Outstanding Indebtedness” and Note 10 of Notes to Consolidated Financial Statements.

 

During the year ended January 2, 2016, PDC sold approximately 167,177 shares of its common stock to the ESOP. The ESOP acquired the shares with pre-tax payroll deferrals, rollovers and employee loan payments made to the ESOP during the period from January 4, 2015 through January 2, 2016, by employees of the Company who are participants in the KSOP, as well as interest received by the trust. The aggregate sales price was $1.9 million. There were no underwriters used and no underwriting discounts or commissions paid. The offer and sale of the shares was made pursuant to Rule 701 under the Securities Act of 1933, as amended. The Company’s matching contributions over this same period resulted in an additional 160,097 shares of PDC redeemable common stock being issued. As a result of hardship withdrawals, diversification elections, employee terminations and employee loan requests, 775,075 shares of PDC redeemable common stock were repurchased during 2015 at an aggregate price of $9.4 million.

 

 

 

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Item 6.Selected Financial Data

 

The following tables set forth selected consolidated financial data for Paperweight Development Corp. and Subsidiaries (“PDC”) as of and for each of the five years in the five-year period ended January 2, 2016. The consolidated financial information shown below includes the Encapsys Business (through its sale in August 2015) as discontinued operations. Refer to Note 3 of Notes to Consolidated Financial Statements for further information on the Company’s discontinued operations. The selected consolidated statement of comprehensive income (loss) information for the years ended January 2, 2016, January 3, 2015 and December 28, 2013 and the selected consolidated balance sheet information as of January 2, 2016 and January 3, 2015, was derived from audited consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data." The remaining historical financial information presented below was derived from previously-reported consolidated financial statements, not included in this report.

 

The historical consolidated financial information presented below is not necessarily indicative of the financial position or results of operations for any future period. The financial and other operating data set forth below should be read in conjunction with "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and the historical consolidated financial statements and related notes included elsewhere in this report.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2)During 2012, the Company ceased papermaking operations at its West Carrollton, Ohio facility and moved its carbonless coating to the Company’s converting plant in Appleton, Wisconsin, resulting in the reduction of 314 jobs at the West Carrollton facility and the addition of 68 jobs at the Appleton facility. Related employee termination benefits and equipment decommissioning and other expenses are included in the 2012 restructuring charge.

 

(3)   See Note 18, Commitments and Contingencies, of Notes to Consolidated Financial Statements for further discussion.

 

(4)   Amounts exclude information related to discontinued operations.

 

 

 

 

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Item 7.            Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Unless stated to the contrary or the context requires otherwise, all references in this report to the Company refer to Paperweight Development Corp. (“PDC” or “Paperweight”) and its 100%-owned subsidiaries. It includes Appvion, Inc. and its 100%-owned subsidiaries (collectively “Appvion”).

 

Overview

 

This discussion summarizes significant factors affecting the consolidated operating results, financial position and liquidity of PDC as of and for the three-year period ended January 2, 2016. This discussion should be read in conjunction with the accompanying Consolidated Financial Statements and related Notes.

 

Sale of the Encapsys Business

 

On August 3, 2015, Appvion completed the sale of the assets primarily used in the development, manufacture and sale of microencapsulation materials by the Encapsys segment of the Company (the “Encapsys Business”) to Rise Acquisition LLC (“Rise”), a Delaware limited liability company and an affiliate of Sherman Capital Holdings LLC, a Delaware limited liability company, for an aggregate purchase price of $208 million in cash, subject to working capital adjustments, and the assumption of certain liabilities (the “Sale”). Total working capital adjustments and cash expenses of the Sale were approximately $7.5 million. Of the approximately $200.5 million of net proceeds, $165 million was used immediately to repay a portion of long-term debt. In addition, proceeds of $35 million were set aside as restricted cash to be used within one year of this transaction for the specific purpose of capital investment and/or further debt reduction. Appvion used this restricted cash to repay an additional $25 million in long-term debt and used $10 million for capital investment. As of year-end 2015, no restricted cash remains. The estimated carrying value of the net assets sold was $11.8 million.

 

In connection with the Sale, Appvion and Rise entered into certain other agreements, including a Supply Agreement, through which Rise will supply Appvion with all of its microencapsulation product requirements for use in its carbonless paper products for a ten-year term subject to renewal, and a Transition Services Agreement, by which Appvion will provide certain transition services to Rise for up to three years following the closing date. Additionally, Appvion and Rise entered into a lease agreement, by which Appvion will lease a portion of its facilities in Appleton, Wisconsin to Rise for a three-year term, as well as a Patent License Agreement with respect to certain shared patents related to the Encapsys Business and Appvion’s retained paper businesses.

 

Executed Third Amendment to the Credit Agreement

 

On August 3, 2015, Appvion, Paperweight and Jefferies Finance LLC, as administrative agent, and lenders under the Credit Agreement (the “Credit Agreement”) entered into a Third Amendment (the “Third Amendment”) to the Credit Agreement dated June 28, 2013. The Third Amendment became effective simultaneously with the closing of the Sale. Upon its effectiveness, the Third Amendment, among other things, (i) permitted the Company to consummate the Sale of the Encapsys Business and provided for the corresponding release of liens on the Encapsys Business, (ii) required that not less than $165 million of the net proceeds be applied to prepay the revolving credit loans and the term loans under the Credit Agreement and provided that the remainder of the net proceeds be reinvested or otherwise applied to further prepay indebtedness in accordance with the Credit Agreement, (iii) provided for a permanent reduction of the revolving credit facility commitments from $100 million to $75 million, (iv) required the payment of a consent fee equal to 0.175% of the aggregate principal amount of loans and commitments, (v) added a pricing grid providing that at any time after the fiscal year ended 2015 (x) if the reported consolidated first lien leverage ratio is greater than 3.00 to 1.00, the applicable margin on Eurodollar loans increases from 4.5% per annum to 5.0% per annum and the applicable margin on base rate loans increases from 3.5% per annum to 4.0% per annum and (y) if the reported consolidated first lien leverage ratio is less than or equal to 3.00 to 1.00, the applicable margin on Eurodollar loans returns to 4.5% per annum and the applicable margin on base rate loans returns to 3.5% per annum and (vi) further conformed certain terms and covenants under the Credit Agreement to account for the Sale of the Encapsys Business and the transactions contemplated thereby.

 

The Third Amendment also removed the maximum consolidated leverage covenant and added (i) a maximum consolidated first lien leverage covenant that requires maintenance of a consolidated first lien leverage ratio, initially, of not more than 3.50 to 1.00, and on and after the third fiscal quarter of 2016, of not more than 3.25 to 1.00 and on and after the third fiscal quarter of 2017, of not more than 3.00 to 1.00 and (ii) a minimum consolidated fixed charge coverage covenant that requires maintenance of a consolidated fixed charge coverage ratio, initially, of not less than 0.95 to 1.00 and on and after the first fiscal quarter of 2016, of not less than 1.00 to 1.00.

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Amendment to Employee Stock Ownership Trust Agreement

 

Effective August 3, 2015, the Company entered into an Amended and Restated Employee Stock Ownership Trust Agreement (“Trust Agreement”) with Argent Trust Company, in its capacity as trustee (the “ESOP Trustee”) of the Appvion, Inc. Employee Stock Ownership Trust (the “ESOP”). The Trust Agreement amendments were primarily to define the ESOP Trustee as the named fiduciary under the Trust, as well as provide the ESOP Trustee with full discretionary authority, unless expressly excepted and directed by the Company’s ESOP Administrative Committee.

 

Fox River Funding Agreement

 

On April 10, 2012, the United States District Court for the Eastern District of Wisconsin (“District Court”) granted Appvion’s motion for summary judgment and dismissed all claims against Appvion in the enforcement action for remediation of the Lower Fox River. The decision establishes that Appvion is no longer a potentially responsible party (“PRP”), no longer liable under the federal Comprehensive Environmental Response, Compensation, and Liability Act, (“CERCLA”), no longer considered a legal successor to NCR’s liabilities, and no longer required to comply with the 106 Order commanding remediation of the Lower Fox River.

 

On September 30, 2014, Appvion entered into a Funding Agreement with NCR Corporation (“NCR”), B.A.T. Industries, p.l.c. (“BAT”) and Windward Prospects Ltd. (“Windward”) relating to clean-up costs for the Lower Fox River and certain potential future sites. Under the Funding Agreement, the parties paid the following amounts on September 30, 2014 toward historical Fox River Costs (as defined in the Funding Agreement) incurred by NCR through September 1, 2014:  BAT ‑ $77.08 million; Windward ‑ $10 million; and Appvion ‑ $6 million.  In addition, BTI 2014 LLC, a wholly‑owned subsidiary of BAT (“BTI”), is responsible for funding 50% of the Fox River Costs incurred by NCR after September 1, 2014.  The parties also agreed:  (a) to vigorously pursue reasonable claims and viable claims against certain third parties and to deposit any recoveries therefrom into BTI; and (b) that any funds remaining in BTI after paying BAT and NCR for any unreimbursed funding of Fox River Costs would be used to fund 60% of any Future Sites Costs, as defined in the Funding Agreement.

 

Subject to the limitations described below, Appvion agreed to assume the following additional funding obligations under the Funding Agreement:

 

 

Notwithstanding the foregoing, Appvion’s additional funding obligations are subject to the following limitations:

 

 

Appvion bears sole responsibility for its funding obligations under the Funding Agreement. The Funding Agreement does not, however, modify, alter or amend the two indemnification agreements entered into in 2001 wherein Windward agreed to indemnify PDC and PDC agreed to indemnify Appvion for certain costs, expenses and liabilities relating to Fox River and Future Sites, including Appvion’s costs and expenses in negotiating and entering into the Funding Agreement and any future costs and expenses incurred by Appvion in pursuing recoveries.

 

The parties to the Funding Agreement agree that they have no recourse against Appvion for any further liability relating to the Fox River or Future Sites beyond the funding obligations set forth above up to the Appvion Fox River Cap and the Appvion Future Sites Cap, respectively. For further discussion, see Note 18, Commitments and Contingencies.

 

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As a result of the Funding Agreement, $24.0 million of expense was recorded as SG&A expense in the Consolidated Statements of Comprehensive (Loss) Income for the year ended January 3, 2015. This expense represents the total of the four payments expected to be made with respect to Fox River costs, as discussed above, with the first payment made on September 30, 2014, the second payment made on February 2, 2015, the third payment made on September 1, 2015 and the last payment due September 1, 2016, discounted to reflect the long-term nature of the liability.  A short-term liability of $7.3 million is recorded in other accrued liabilities on the Consolidated Balance Sheet as of January 2, 2016. The total of these liabilities will be accreted to the full liability of $25.0 million during the course of the payment schedule.

 

Accounts Receivable Securitization Program

 

During June 2014, the Company entered into an accounts receivable securitization program with a commitment size of $30.0 million, whereby transactions under the program are accounted for as sales of trade receivables in accordance with ASC Topic 860, “Transfers and Servicing.” Sales of trade receivables under the program are recorded as a reduction of accounts receivable in the Consolidated Balance Sheets as of January 2, 2016 and January 3, 2015. Proceeds received, including collections on the deferred purchase price notes receivable, are included in cash flows from operating activities in the Consolidated Statements of Cash Flows for the years ended January 2, 2016 and January 3, 2015.

 

Trade receivables sold to the third-party financial institution, and being serviced by Appvion, Inc., totaled $36.9 million as of January 2, 2016, for which $18.1 million in proceeds was received. Trade receivables sold to the third-party financial institution as of January 3, 2015 totaled $36.9 million, for which $16.8 million in proceeds was received. The fair value of the receivables sold equaled the carrying cost at the time of sale and no gain or loss was recorded as a result of the sale. The fair value of the deferred purchase price notes receivable recorded as of year-end 2015 was $16.5 million and $18.7 million as of year-end 2014 and is included in accounts receivable in the Consolidated Balance Sheet as of January 2, 2016 and January 3, 2015, respectively. The Company estimates the fair value of the deferred purchase price notes receivable using Level 3 inputs based on historical performance of similar receivables including an allowance for doubtful accounts, as well as estimated cash discounts to be taken by customers and potential credits issued to customers. The Company deems the interest rate risk related to the deferred purchase price notes to be de minimis primarily due to the short average collection cycle (30 days) of the related receivables.

 

Servicing fees paid for the program were $0.5 million and $0.4 million for the years ended January 2, 2016 and January 3, 2015, respectively. Transaction costs of $0.7 million, related to the June 2014 entry into this program, were deferred and recorded on the balance sheet as other long-term assets. They are being amortized over the three-year term of the securitization agreement. The remaining balance at January 2, 2016 was $0.3 million.

 

Voluntary Refinancings

 

On November 19, 2013, Appvion completed a voluntary refinancing of a portion of its debt to extend debt maturities and reduce interest expense. The refinancing included the issuance of $250 million of second lien senior secured notes payable carrying an interest rate of 9.0%. The notes will mature on June 1, 2020. Proceeds, less expenses and discounts, were $242.3 million. A portion of these proceeds was used to redeem the $32.2 million of remaining 9.75% senior subordinated notes payable due June 2014, plus interest of $1.6 million. Proceeds were also used to redeem in full the $161.8 million of 11.25% second lien notes payable due December 2015, plus $9.3 million of interest. In conjunction with the redemption of the second lien notes, a note premium of $33.2 million was paid to the noteholders and was recorded as a debt extinguishment expense on the current year Consolidated Statement of Comprehensive Income (Loss). The remaining proceeds were used to repay $4.2 million of the revolving credit facility. Transaction expenses totaling $6.5 million were recorded as deferred debt issuance costs in other long-term assets of the Consolidated Balance Sheet dated December 28, 2013. Also as a result of this refinancing, $1.4 million of unamortized deferred debt issuance costs were written off and included in debt extinguishment expense on the Consolidated Statement of Comprehensive Income (Loss) for the year ended December 28, 2013. For further information, see the Cash Flows from Financing Activities in the Liquidity and Capital Resources section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations as well as Note 10, Long-term Obligations, of Notes to Consolidated Financial Statements.

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On June 28, 2013, Appvion completed a voluntary refinancing of a portion of its debt to extend debt maturities, reduce interest costs and increase financial flexibility and liquidity options. The refinancing included the execution of a new credit agreement providing for a $100 million five-year revolving line of credit due June 2018 and a $335 million first lien term loan due June 2019. The new line of credit replaced the five-year, $100 million revolving credit facility due February 2015. Prior to execution of the Third Amendment discussed above, the new revolving credit facility provided for up to $100 million of revolving loans including a letter of credit sub-facility of up to $25 million and a swing line sub-facility of up to $5 million. Appvion’s borrowings under the revolving credit facility bear interest at Appvion’s option at either base rate plus 3.5% or LIBOR plus 4.5%, per annum and are subject to the first lien leverage ratio provisions of the Third Amendment. Proceeds from the $335 million first lien term loan, less expenses and discounts, were $326.3 million. These proceeds were used to redeem $300.7 million of the 10.5% senior secured first lien notes due June 2015, pay $1.1 million of interest due on the notes, pay $18.1 million of note premiums and costs associated with the note redemption, repay $6.0 million of the old revolver and pay $0.4 million of interest and fees due on the old revolver. The $18.1 million note premium is included in debt extinguishment expense on the Consolidated Statement of Comprehensive Income (Loss) for the year ended December 28, 2013. In addition, there was a cash outlay of $7.2 million for debt acquisition costs. As a result of the refinancing, $6.7 million of unamortized deferred debt issuance costs and original issue discount associated with the redeemed senior secured first lien notes and old revolver were written off and included in debt extinguishment expense.  The first lien term loan bears interest at Appvion’s option at either base rate plus 3.5% or LIBOR, but not less than 1.25%, plus 4.5%, per annum and are subject to the first lien leverage ratio provisions of the Third Amendment. On July 30, 2013, Appvion fixed the interest rate at 7.24% on $100.0 million of the variable rate debt using an interest rate swap contract with a forward start date of September 15, 2014 and a maturity date of June 28, 2019. On July 31, 2013, Appvion redeemed the remaining $4.3 million of 10.5% senior secured first lien notes. In conjunction with this $4.3 million repayment, a redemption premium of $0.2 million was paid and $0.1 million of unamortized deferred debt issuance costs and original issue discount were written off and included in debt extinguishment expense on the Consolidated Statement of Comprehensive Income (Loss) for the year ended December 28, 2013. For further information, see the Cash Flows from Financing Activities in the Liquidity and Capital Resources section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations as well as Note 10, Long-term Obligations, of Notes to Consolidated Financial Statements.

 

Financial Highlights

 

Results for 2015 include the following:

 

Net sales totaled $700.0 million, a $64.7 million, or 8.5%, decrease from 2014 net sales. Shipment volumes were approximately 4% lower than in 2014. In addition, revenue was negatively impacted by unfavorable pricing, largely due to foreign competition driving down the price of thermal receipt paper for much of the year. Thermal papers net sales were down 10.2% with shipment volumes approximately 2% lower than the prior year. Current year carbonless net sales were lower than 2014 net sales by 6.4% and shipment volumes were approximately 6% lower.

 

The Company’s 2015 fiscal year contained 52 weeks whereas its 2014 fiscal year included 53 weeks. As a result of the one-week difference, the decrease in 2015 sales, compared to 2014 sales, was nearly two percentage points higher because of the extra week. Similar consideration must be given to other comparisons made between 2015 and 2014 financial results.

 

Current year cost of sales of $576.4 million was $80.9 million, or 12.3%, lower than 2014 cost of sales. Cost of sales in 2015 included $4.5 million of additional manufacturing costs related primarily to the downtime associated with recovery boiler maintenance at the Roaring Spring, Pennsylvania mill. Current year cost of sales also includes a mark-to-market loss of $2.4 million related to the Company’s retiree benefit plans. This compares to a retiree plan mark-to-market loss of $44.6 million recorded in cost of sales at year-end 2014.

 

SG&A spending of $113.1 million was $27.2 million, or 19.4%, lower than 2014 spending. During 2015, the Company recorded a mark-to-market loss in SG&A, related to its retiree benefit plans, of $1.1 million. This compares to a mark-to-market loss of $18.6 million recorded in SG&A during 2014. Current year compensation and distribution expenses were lower than in 2014. In addition, prior year legal expenses were higher due to Fox River settlement matters and anti-dumping and countervailing duties claims related to imports of certain lightweight thermal paper.

 

Net debt as of January 2, 2016 was $421.6 million, compared to $589.5 million at the end of 2014. During third quarter 2015, the Company repaid $170.0 million on its first lien term loan using proceeds from the sale of its Encapsys Business.

 

Current year results include debt modification expense of $3.6 million related to the write-off of previously-deferred debt issuance costs in conjunction with the repayment of first lien term debt and the execution of the Third Amendment to the Credit Agreement.

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   The Company creates product solutions for customers and end users through its development and use of coating formulations and applications as well as security technologies. The Company has two reportable segments: thermal papers and carbonless papers.

 

Thermal Papers

 

The thermal papers market is growing with new applications being developed to use thermal technology. Based on its assessment of the period 2010 through 2015, the Company believes North American thermal markets expanded at a 2% compound average growth rate, with annual rates ranging from increases of 1% to 5%. The Company believes demand for thermal paper will continue to grow in North America and around the world. Sales of thermal papers accounted for approximately 53% of total company net sales in 2015.

 

The Company competes with domestic producers and imports from Europe and Asia based on a number of factors, including price, product availability, quality and customer service.  

 

Carbonless Papers

 

The carbonless papers segment includes carbonless, security and other specialty paper products. The Company believes the North American market for carbonless paper products has been in decline since 1994 as a result of greater use of competing technologies such as digital laser, inkjet and thermal printers and electronic communications. The Company believes the North American carbonless paper market declined by approximately 7% to 10% annually from 2010 through 2015. The decline is expected to continue at historical rates over the next several years. The Company believes the worldwide carbonless market is also in decline, with demand declining at approximately 2% to 6% per year. The carbonless papers segment accounted for approximately 47% of total company net sales in 2015.

 

The carbonless papers market is highly competitive. The Company competes based on a number of factors, including price, product availability, quality and customer service. In addition to declining North American and foreign carbonless markets, the carbonless business continues to experience competitive pricing from foreign and domestic producers. Other domestic carbonless producers have continued their competitive pricing strategies in efforts to maintain or gain share. In addition, foreign competitors continue to sell into the North American carbonless market with low-price strategies. As a result of this increased pricing competition, the Company has continued to experience pressure on selling prices for carbonless products. Nevertheless, market conditions permit the Company to implement price increases from time to time to offset the increasing costs of raw materials.

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Comparison 2015 and 2014

 

 

 

 

 

Net sales for 2015 were $700.0 million, a $64.7 million, or 8.5%, decrease from 2014 net sales. Shipment volumes were approximately 4% lower than in 2014.

 

Operating income of $10.5 million was recorded in 2015 compared to an operating loss of $56.9 million in 2014. Current year improvements in manufacturing operations, as well as cost savings initiatives, reduced manufacturing costs by $30.1 million compared to 2014. This reduction was partially offset by $4.5 million of additional manufacturing costs related primarily to the downtime associated with recovery boiler maintenance at the Roaring Spring mill. In addition, a mark-to-market loss of $3.5 million, related to the Company’s retiree benefit plans, was recorded in 2015 which compared to the retiree plan mark-to-market loss of $63.2 million recorded in the prior year. Of this $59.7 million mark-to-market difference, $42.2 million was in cost of sales and $17.5 million was in SG&A. Unfavorable price and product mix, all of  which was incurred within the thermal papers segment due to foreign competition driving down the price of receipt paper, reduced operating results by $35.7 million. Lower shipment volumes negatively impacted current year financial results by $14.3 million. SG&A spending was $27.2 million lower than 2014 due to reductions in compensation and distribution expenses. In addition, prior year legal expenses were higher due to Fox River settlement matters and anti-dumping and countervailing duties claims related to imports of certain lightweight thermal paper. In 2014, the Company also recorded a $24.0 million charge for the Fox River Funding Agreement.

 

Current year interest expense was $3.1 million lower than in 2014 as the Company used proceeds from the third quarter 2015 sale of the Encapsys Business to repay $170.0 million of first lien term debt. Current year results also include debt modification expense of $3.6 million related to the write-off of previously-deferred debt issuance costs in conjunction with this repayment of first

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lien term debt and the execution of the Third Amendment to the Credit.

In 2015, the Company recorded a loss from continuing of operations of $41.9 million compared to a loss from continuing operations of $109.0 million in the previous year.  Discontinued operations recorded income of $11.8 million through August 2, 2015, at which time the Encapsys Business was sold, resulting in a $188.7 million gain. In 2014, discontinued operations recorded income of $16.2 million. The Company recorded 2015 net income of $158.6 million compared to a net loss of $92.8 million in 2014. 

 

Business Segment Discussion – 2015

 

During 2015, net sales from continuing operations were $700.0 million, $64.7 million lower than 2014 net sales. Current year operating income of the papers business was $20.9 million compared to an operating loss of $24.0 million recorded in 2014. The year-on-year operating income variance was the result of the following (dollars in millions):

 

 

 

Thermal Papers

 

Thermal papers 2015 net sales of $372.8 million were $42.5 million, or 10.2%, lower than 2014 net sales of $415.3 million. During 2015, shipment volumes of thermal papers decreased approximately 2% compared to the prior year. Shipment volumes of tag, label and entertainment (“TLE”) products were flat year-on-year while shipments of receipt paper were approximately 4% lower than in 2014. This segment recorded a 2015 operating loss of $5.8 million compared to a 2014 operating loss of $11.4 million. The current year loss included a $0.9 million mark-to-market loss related to the Company’s retiree benefit plans whereas the 2014 operating loss included a mark-to-market loss of $24.1 million. Excluding the impact of mark-to-market losses, 2015 operating results decreased by $17.6 million from the prior year. Current year operating results were negatively impacted by unfavorable pricing and product mix of $36.8 million, largely due to foreign competition. Unfavorable pricing and product mix was partially offset by improved manufacturing operations and cost savings initiatives of $15.7 million. In addition, SG&A spending was $7.7 million lower than in 2014 because 2014 expenses included higher legal fees associated with anti-dumping and countervailing duties claims.

 

Carbonless Papers

 

Carbonless papers 2015 net sales totaled $327.2 million, a decrease of $22.2 million, or 6.4%, from the prior year. Current year shipment volumes were approximately 6% lower than 2014 shipments. This segment recorded current year operating income of $26.7 million compared to a 2014 operating loss of $12.6 million. Current year income included a $2.3 million mark-to-market loss related to the Company’s retiree benefit plans whereas the 2014 operating loss included a mark-to-market loss of $40.5 million. Excluding the impact of mark-to-market losses, 2015 operating results increased by $1.1 million from the prior year. Current year operating results were positively impacted by improved manufacturing operations of $14.4 million and $3.5 million of lower SG&A spending. These favorable items were offset by $11.8 million of reduced profits due to lower shipment volumes, as well as $4.5 million of additional manufacturing costs related primarily to recovery boiler maintenance at the Roaring Spring, Pennsylvania mill.

 

Unallocated Corporate Charges

 

As of year-end 2015, unallocated corporate charges totaled $10.4 million compared to $32.9 million last year. Prior year results included the $24.0 million charge related to the Fox River Funding Agreement as well as related legal fees.

 

Effects of Inflation. Prices for certain raw materials, including base stock and chemicals, as well as costs for natural gas, oil and electricity have been subject to price changes and can have material effects on the business, financial condition and results of operations. Prices for certain raw materials increased during 2015 and could continue to increase, or decrease, in response to changes in demand. The Company historically has been able to use price increases to recoup a portion of raw material price increases, but relies on cost-cutting measures and productivity and efficiency gains to offset the remaining portion of raw material price increases. While the Company expects that any significant increase in raw materials or energy costs will be offset by price increases and/or by cost containment and productivity and efficiency initiatives, profitability could be adversely affected if the Company is unable to pass on or mitigate any future cost increases.

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Comparison 2014 and 2013

 

 

Net sales for 2014 were $764.7 million, decreasing $8.0 million, or 1.0%, compared to $772.7 million of net sales in 2013. Revenue decreased despite 2014 shipment volumes that were approximately 2% higher than 2013 shipment volumes.

 

An operating loss of $56.9 million was recorded in 2014 compared to operating income of $119.2 million in 2013. A mark-to-market loss of $63.2 million, related to the Company’s retiree benefit plans, was recorded in 2014. This loss compared to the retiree plan mark-to-market gain of $62.7 million recorded in the prior year. Of this $125.9 million mark-to-market difference, $89.5 million was in cost of sales and $36.4 million was in SG&A. In addition, unfavorable price and product mix, largely due to foreign competition, reduced operating results by $23.8 million. Within SG&A, legal expenses were higher during 2014 due to Fox River matters and anti-dumping and countervailing duties claims related to imports of certain lightweight thermal paper. Compensation and consulting fees increased in support of future growth and rent expense was higher due to the 2014 migration from in-house to out-sourced computer system hosting. The Company also recorded a $24.0 million charge for the Fox River Funding Agreement discussed above.

 

Interest expense in 2014 was $6.4 million lower than in 2013 as the Company benefited from a full year of lower interest rates received as a result of the two voluntary refinancings completed during 2013. As a result of these refinancings, the Company also recorded $59.7 million of debt extinguishment expense during 2013 for premiums paid in conjunction with the note redemptions as well as the write-off of unamortized deferred debt issuance costs and original issue discount. During 2014, the Company incurred $2.0 million of additional foreign exchange loss, primarily due to the collection of certain accounts receivable denominated in Canadian dollars and Euros. An additional $0.7 million of expense was also recorded relating to its accounts receivable securitization program.

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In 2014, the Company recorded a loss from continuing of operations of $109.0 million compared to income from continuing operations of $3.8 million in the previous year.  Discontinued operations recorded income of $16.2 million and $13.5 million for the years 2014 and 2013, respectively. The Company recorded a 2014 net loss of $92.8 million compared to net income of $17.3 million in 2013. 

 

Business Segment Discussion – 2014

 

During 2014, net sales were $764.7 million, $8.0 million lower than 2013 net sales. During this same period, an operating loss of $24.0 million was recorded compared to operating income of $128.2 million in 2013. The year-on-year operating income variance was the result of the following (dollars in millions):

 

 

Thermal Papers

 

Thermal papers 2014 net sales of $415.3 million were $6.0 million, or 1.4%, lower than 2013 net sales of $421.3 million. During 2014, shipment volumes of thermal papers increased approximately 2% over the prior year. Continued strong demand for TLE products accounted for an increase in shipment volumes of approximately 9%. Shipments of receipt paper during 2014 were approximately 5% lower than in 2013. This segment recorded a 2014 operating loss of $11.4 million compared to 2013 operating income of $51.9 million. The 2014 loss included a $24.1  million mark-to-market loss related to the Company’s retiree benefit plans whereas 2013 operating income included a $22.0 million mark-to-market gain. Excluding the impact of mark-to-market gains and losses, 2014 operating results decreased by $17.2 million from the prior year. Operating results in 2014 were negatively impacted by unfavorable pricing and product mix of $17.9 million, largely due to increased foreign competition. The business also incurred increased legal fees associated with anti-dumping and countervailing duties claims in 2014.

 

Carbonless Papers

 

Carbonless papers 2014 net sales totaled $349.4 million, a decrease of $2.0 million, or 0.6%, from the prior year. Shipment volumes during 2014 were nearly 2% higher than 2013 shipments, benefiting from increased sales of specialty papers. This segment recorded a 2014 operating loss of $12.6 million compared to 2013 operating income of $76.3 million. The 2014 loss included a $40.5 million mark-to-market loss related to the Company’s retiree benefit plans whereas 2013 operating income included a $39.3 million mark-to-market gain. Excluding the impact of mark-to-market gains and losses, 2014 operating results decreased by $9.1 million from the prior year. Operating results in 2014 were negatively impacted by unfavorable pricing and product mix. Unfavorable product mix was the result of increased sales of specialty products, as well as increased sales into international markets, both of which have lower margins. In addition, the business incurred increased manufacturing spending as a result of lower manufacturing yields and increased material costs. 

 

Unallocated Corporate Charges

 

As of year-end 2014, unallocated corporate charges totaled $32.9 million compared to $9.0 million in 2013.  Results for 2014 include the $24.0 million charge related to the Fox River Funding Agreement as well as related legal fees.

 

Liquidity and Capital Resources

 

Overview. The Company’s primary sources of liquidity and capital resources are cash provided by operations and credit available under its revolving credit facility. The Company expects that cash on hand, internally-generated cash flow and available credit from its revolving credit facility, will provide the necessary funds for the reasonably foreseeable operating and recurring cash needs (e.g., working capital, debt service, other contractual obligations and capital expenditures). At January 2, 2016, the Company had $1.8 million of cash and, in accordance with its debt covenants, approximately $20.0 million of unused borrowing capacity under its revolving credit facility. At that date, the revolving credit facility had an outstanding balance of $9.6 million compared to $6.5 million at year-end 2014. Approximately $17.0 million of revolving credit facility commitment was used in the form of outstanding letters of credit issued thereunder. As of January 2, 2016, net debt (total debt less cash) was $421.6 million compared to $589.5 million at year-end 2014.

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Management reported that the Company was in compliance with all debt covenants at January 2, 2016, and is forecasted to remain compliant for the next 12 months. The Company’s ability to comply with the financial covenants in the future depends on achieving forecasted operating results and operating cash flows. The Company’s failure to comply with its covenants, or an assessment that it is likely to fail to comply with its covenants, could lead the Company to seek amendments to, or waivers of, the financial covenants. The Company cannot provide assurance that it would be able to obtain any amendments to or waivers of the covenants. In the event of noncompliance with debt covenants, if the lenders will not amend or waive the Company’s noncompliance with the covenants, the outstanding debt would become due and the Company would need to seek alternative financing. The Company cannot provide assurance that it would be able to obtain alternative financing in such circumstances. If the Company were not able to secure alternative financing, this would have a material adverse impact on the Company.

 

Cash Flows from Operating Activities. Net cash used by operating activities during 2015 was $9.5 million compared to $47.2 million of net cash provided by operating activities in 2014. In addition to a net income of $158.6 million, noncash charges totaling $38.9 million were recorded. Noncash charges included $27.8 million in depreciation and amortization, $3.6 million of debt modification expense, $1.9 million of noncash employer matching contributions to the KSOP and $5.6 million of other net noncash charges. In addition, a $188.7 million gain on the sale of the Encapsys Business was recorded during the current year period. During 2015, working capital increased by $14.4 million. This was largely the result of a $26.8 million decrease in accounts payable and other accrued liabilities due to the Company making $11.5 million of payments in accordance with the Fox River Funding Agreement, as well as paying its accounts payable sooner to take advantage of favorable vendor payment terms. This was partially offset by a $4.9 million decrease in accounts receivable, a $5.5 million decrease in inventories and a $2.0 million decrease in other current assets. During 2015, a mark-to-market pension loss of $10.3 million was recorded, accounting for the $7.9 million increase in accrued pension. Other, net cash used of $11.8 million included an $8.3 million postretirement health mark-to-market gain.

 

Net cash provided by operating activities during 2014 was $47.2 million compared to $22.7 million of net cash used by operating activities in 2013. In addition to a net loss of $92.8 million, noncash charges and gains totaling $37.8 million were recorded. Noncash charges included $30.0 million in depreciation and amortization, $2.3 million of noncash employer matching contributions to the KSOP, $2.1 million of foreign exchange loss and $3.4 million of other net noncash charges. During 2014, working capital decreased by $41.4 million. A significant component of this decrease was the $23.8 million decrease in accounts receivable.  During June 2014, the Company entered into an accounts receivable securitization program with a commitment size of $30.0 million, whereby transactions under the program are accounted for as sales of trade receivables in accordance with ASC Topic 860, “Transfers and Servicing.” Sales of trade receivables under the program are recorded as a reduction of accounts receivable in the Consolidated Balance Sheet as of January 3, 2015. Proceeds received, including collections on the deferred purchase price notes receivable, are included in cash flows from operating activities. As of year-end 2014, the accounts receivable securitization resulted in a net reduction of accounts receivable of $16.8 million. In addition, the $19.4 million increase in accounts payable and other accrued liabilities includes an $11.3 million short-term liability related to the Fox River Funding Agreement signed on September 30, 2014. During 2014, a $16.1 million contribution was made to the pension plan and a mark-to-market loss of $67.4 million was recorded, accounting for the majority of the $53.2 increase in accrued pension. Other, net cash provided of $7.6 million includes the $6.9 million long-term portion of the Fox River Funding Agreement.

 

Net cash used by operating activities during 2013 was $22.7 million compared to $23.3 million net cash provided by operating activities in 2012. Net income, adjusted for noncash charges and noncash gains, provided $61.9 million in operating cash for the period. Noncash charges included $30.1 million in depreciation and amortization, $2.6 million of noncash employer matching contributions to the KSOP and $3.8 million of other net noncash charges. Net income was also adjusted for $8.1 million of noncash debt refinancing costs related to the June 2013 and November 2013 voluntary refinancings. During 2013, working capital increased by $2.6 million, of which, the primary components were a $21.4 million decrease in accounts payable and other accrued liabilities and a $17.3 million decrease in accounts receivable. The change in accounts payable and other accrued liabilities included a $9.1 million lower reserve for compensation due to reduced incentive compensation, a $4.4 million reduction in customer rebates and a $2.9 million payment of vested deferred compensation. During 2013, a $12.5 million contribution was made to the pension plan and a mark-to-market gain of $55.9 million was recorded, accounting for the majority of the $70.5 decrease in accrued pension. Other, net used cash of $11.5 million included a mark-to-market gain of $6.0 recorded in postretirement benefits other than pensions.

 

Cash Flows from Investing Activities. Current year net cash provided by investing activities was $183.9 million. This included a $200.5 million increase to cash resulting from the sale of the Encapsys Business during the third quarter. In addition, $16.7 million was spent for the acquisition of property, plant and equipment. During 2014, net cash used by investing activities was $17.5 million. This amount included $19.7 million used for the acquisition of property, plant and equipment and $2.2 million of sale proceeds, primarily from the second quarter 2014 auction of papermaking equipment located at the West Carrollton, Ohio facility. Net cash used by investing activities in 2013 was $28.3 million, all of which was used for the acquisition of property, plant and equipment.

 

Cash Flows from Financing Activities.  During 2015, net cash used by financing activities was $175.2 million. During third quarter 2015, the Company repaid $170.0 million on its first lien term loan using proceeds from the sale of its Encapsys Business. In addition, it made mandatory debt repayments of $2.5 million on its first lien term loan. It also made mandatory debt repayments of $1.5 million on its State of Ohio loans. During the year, the Company borrowed a net $3.2 million on its revolving credit facility. The Company incurred $0.9 million of debt acquisition costs related to the execution of the Third Amendment to the Credit Agreement. These costs have been deferred and will be amortized over the remaining term of the Credit Agreement.

 

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Current year proceeds from the issuance of PDC redeemable common stock totaled $1.9 million. The ESOP trustee purchased this stock using pre-tax deferrals, rollovers and loan payments made by employees during 2015. Current year payments to redeem PDC common stock were $9.4 million.

 

Cash overdrafts increased $4.2 million during 2015. Cash overdrafts represent short-term obligations, in excess of deposits on hand, which have not yet cleared through the banking system. Fluctuations in the balance are a function of quarter-end payment patterns and the speed with which the payees deposit the checks.

 

During 2014, net cash used by financing activities was $28.8 million. The Company made mandatory debt repayments of $3.3 million on its first lien term loan and $1.4 million on its State of Ohio loans. The Company also repaid a net $1.2 million on its revolving credit facility.

 

Proceeds from the issuance of PDC redeemable common stock during 2014 totaled $2.4 million. The ESOP trustee purchased this stock using pre-tax deferrals, rollovers and loan payments made by employees during 2014. Payments to redeem PDC common stock in 2014 were $18.2 million. Cash overdrafts decreased $6.8 million during 2014.

 

During 2013, net cash provided by financing activities was $51.0 million. During the year, $2.7 million of secured variable rate industrial development bonds, due August 2013, were repaid. The Company made mandatory debt repayments of $1.3 million on its State of Ohio loans. The Company also borrowed a net $3.9 million on its revolving credit facility.

 

During 2013, proceeds from the issuance of PDC redeemable common stock totaled $2.9 million. The ESOP trustee purchased this stock using pre-tax deferrals, rollovers and loan payments made by employees during 2013. Current year payments to redeem PDC common stock were $16.4 million. Cash overdrafts increased $0.3 million during 2013.

 

On November 19, 2013, Appvion completed a voluntary refinancing of a portion of its debt to extend debt maturities and reduce interest expense. The refinancing included the issuance of $250 million of second lien senior secured notes carrying an interest rate of 9.0%. The notes will mature on June 1, 2020. Proceeds, less expenses and discounts, were $242.3 million. A portion of these proceeds was used to redeem the $32.2 million of remaining 9.75% senior subordinated notes payable due June 2014, plus interest of $1.6 million. Proceeds were also used to redeem in full the $161.8 million of 11.25% second lien notes payable due December 2015, plus $9.3 million of interest. In conjunction with the redemption of the second lien notes, a note premium of $33.2 million was paid to the noteholders and was recorded as debt extinguishment expense on the Consolidated Statement of Comprehensive Income (Loss) for the year ended December 28, 2013. The remaining proceeds were used to repay $4.2 million of the revolving credit facility. Transaction expenses totaling $6.4 million were recorded as deferred debt issuance costs in other long-term assets of the Consolidated Balance Sheet dated December 28, 2013. Also as a result of this refinancing, $1.4 million of unamortized deferred debt issuance costs were written off and included in debt extinguishment expense on the Consolidated Statement of Comprehensive Income (Loss) for the year ended December 28, 2013. For further information, see Note 10, Long-term Obligations, of Notes to Consolidated Financial Statements.

 

On June 28, 2013, Appvion completed a voluntary refinancing of a portion of its debt to extend debt maturities, reduce interest costs and increase financial flexibility and liquidity options. The refinancing included the execution of a new credit agreement providing for a $100 million five-year revolving line of credit due June 2018 and a $335 million first lien term loan due June 2019. The new line of credit replaced the five-year, $100 million revolving credit facility due February 2015. Prior to the Third Amendment to the Credit Agreement executed in August 2015, this revolving credit facility provided for up to $100 million of revolving loans including a letter of credit sub-facility of up to $25 million and a swing line sub-facility of up to $5 million. In addition, Appvion’s borrowings under the revolving credit facility accrued interest at Appvion’s option at either base rate plus 3.5% or Eurodollar plus 4.5%, per annum. After giving effect to the Third Amendment, the amount committed under the revolving line of credit was reduced to $75 million. Appvion’s borrowings under the revolving credit facility bear interest, (i) through Appvion’s 2015 fiscal year, at Appvion’s option, at either base rate plus 3.5% or Eurodollar plus 4.5%, per annum and (ii) thereafter, pursuant to the pricing grid discussed below.

 

Proceeds from the $335 million first lien term loan, less expenses and discounts, were $326.3 million. These proceeds were used to redeem $300.7 million of the 10.5% senior secured first lien notes due June 2015, pay $1.1 million of interest due on the notes, pay $18.1 million of note premiums and costs associated with the note redemption, repay $6.0 million of the old revolver and pay $0.4 million of interest and fees due on the old revolver. The $18.1 million note premium is included in debt extinguishment expense on the Consolidated Statement of Comprehensive Income (Loss) for the year ended December 28, 2013. As a result of the refinancing, $6.7 million of unamortized deferred debt issuance costs and original issue discount associated with the redeemed senior secured first lien notes and old revolver were written off and included in debt extinguishment expense. On July 31, 2013, Appvion redeemed the remaining $4.3 million of these first lien notes. In conjunction with this $4.3 million repayment, a redemption premium of $0.2 million was paid and $0.1 million of unamortized deferred debt issuance costs and original issue discount were written off and included in debt extinguishment expense on the Consolidated Statement of Comprehensive Income (Loss) for the year ended December 28, 2013.

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Prior to the Third Amendment to the Credit Agreement, the first lien term loan accrued interest at Appvion’s option at either base rate plus 3.5% or Eurodollar, but not less than 1.25%, plus 4.5%, per annum. The term loan amortized in equal quarterly installments in aggregate annual amounts equal to 1.0% of the original principal amount, with the balance payable on June 28, 2019.

 

After giving effect to the Third Amendment, the first lien term loan bears interest, (i) through Appvion’s 2015 fiscal year, at Appvion’s option at either base rate plus 3.5% per annum or Eurodollar plus 4.5% per annum and (ii) thereafter, at either base rate or Eurodollar with the applicable margin determined pursuant to a pricing grid which provides that (x) if the reported consolidated first lien leverage ratio is greater than 3.00 to 1.00, the applicable margin on Eurodollar loans increases from 4.5% per annum to 5.0% per annum and the applicable margin on base rate loans increases from 3.5% per annum to 4.0% per annum and (y) if the reported consolidated first lien leverage ratio is less than or equal to 3.00 to 1.00, the applicable margin on Eurodollar loans returns to 4.5% per annum and the applicable margin on base rate loans returns to 3.5% per annum. The Credit Agreement provides for a fixed floor rate of 1.25% for Eurodollar loans and 2.25% for base rate loans.

 

On July 30, 2013, Appvion fixed the interest rate at 7.24% on $100.0 million of this variable rate debt using an interest rate swap contract with a forward start date of September 15, 2014 and a maturity date of June 28, 2019.

 

Within five business days after the year-end financial statements have been filed, Appvion is required to prepay an aggregate principal amount of the term loan equal to the excess, if any, of (a) 50% of defined excess cash flow, provided that such percentage shall be reduced to (1) 25% based upon Appvion achieving a consolidated leverage ratio of less than 3.5 to 1.0 but greater than or equal to 2.5 to 1.0 and (2) 0% based upon Appvion achieving a consolidated leverage ratio of less than 2.5 to 1.0 minus (b) the aggregate amount of all prepayments of the revolving credit line which constitute permanent reductions of the revolving credit facility and all optional prepayments of the first lien term loan made during the year. Based on the required calculation, there is no prepayment due for the year ended January 2, 2016.

 

For further information, see Note 10, Long-term Obligations, of Notes to Consolidated Financial Statements.

 

Description of Outstanding Indebtedness. Long-term obligations, excluding capital lease obligations, consist of the following.

 

2015

 

On August 3, 2015, Appvion, PDC and Jefferies Finance LLC, as administrative agent, and lenders under the Credit Agreement entered into the Third Amendment to the Credit Agreement. The Third Amendment became effective simultaneously with the closing of the Sale of the Encapsys Business. Upon its effectiveness, the Third Amendment, among other things, (i) permitted the Company to consummate the Sale of the Encapsys Business and provided for the corresponding release of liens on the Encapsys Business, (ii) required that not less than $165 million of the net proceeds be applied to prepay the revolving credit loans and the term loans under the Credit Agreement and provided that the remainder of the net proceeds be reinvested or otherwise applied to further prepay indebtedness in accordance with the Credit Agreement, (iii) provided for a permanent reduction of the revolving credit facility commitments from $100 million to $75 million, (iv) required the payment of a consent fee equal to 0.175% of the aggregate principal amount of loans and commitments, (v) added the pricing grid discussed above and (vi) further conformed certain terms and covenants under the Credit Agreement to account for the Sale of the Encapsys Business and the transactions contemplated thereby.

 

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The Third Amendment also removed the maximum consolidated leverage covenant and added (i) a maximum consolidated first lien leverage covenant that requires maintenance of a consolidated first lien leverage ratio, initially, of not more than 3.50 to 1.00, and on and after the third fiscal quarter of 2016, of not more than 3.25 to 1.00 and on and after the third fiscal quarter of 2017, of not more than 3.00 to 1.00 and (ii) a minimum consolidated fixed charge coverage covenant that requires maintenance of a consolidated fixed charge coverage ratio, initially, of not less than 0.95 to 1.00 and on and after the first fiscal quarter of 2016, of not less than 1.00 to 1.00. The Company incurred $0.9 million of debt acquisition costs related to the execution of this amendment. These costs have been deferred and will be amortized over the remaining term of the Credit Agreement.

 

2013    

 

As discussed earlier, Appvion completed two voluntary refinancings during 2013, one in June and another in November. For further information, see the Cash Flows from Financing Activities in the Liquidity and Capital Resources section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations as well as Note 10, Long-term Obligations, of Notes to Consolidated Financial Statements.

 

These second lien senior secured notes at 9.0% are unconditionally, and jointly and severally, guaranteed by PDC and Appvion Canada, Ltd. The notes are secured by a second-priority security interest in substantially all of the property and assets of Appvion and the debt guarantors. These liens are junior in priority to the liens on this same collateral securing the outstanding debt incurred under the Credit Agreement. The notes contain covenants customary for similar debt which restrict Appvion’s ability, as well as the ability of the guarantors, to sell or lease certain assets or merge or consolidate with or into other companies, incur additional debt or issue preferred shares, incur liens, pay dividends or make other distributions, make other restricted payments and investments, place restrictions on the ability of certain of Appvion’s subsidiaries to pay dividends or other payments to Appvion, enter into sale and leaseback transactions, amend particular agreements relating to Appvion’s transaction with its former parent AWA and the ESOP and enter into transactions with certain affiliates.

 

The Credit Agreement ranks senior in right of payment to all existing and future subordinated indebtedness of Appvion and is secured by security interests in substantially all of the property and assets of Appvion and the debt guarantors. The maturity date of the revolving credit facility is June 28, 2018 and the maturity date of the first lien term loan is June 28, 2019. The Credit Agreement is unconditionally, and jointly and severally, guaranteed by PDC and Appvion Canada, Ltd. It contains covenants customary for similar credit facilities.  Affirmative and negative covenants under the Credit Agreement restrict Appvion’s ability and the ability of Appvion’s subsidiaries, subject to certain exceptions, to incur additional indebtedness and liens, engage in sale and leaseback transactions, make investments, make loans and advances, transact certain asset sales, engage in mergers, acquisitions, consolidations, liquidations and dissolutions, pay dividends or make other payments in respect of equity interests and other restricted payments, engage in certain transactions with affiliates, limit capital expenditures and make prepayments, redemptions and repurchases of other indebtedness.

 

On August 1, 2013, the Company made a mandatory debt repayment of $2.7 million, plus interest, on a portion of its Industrial Development Bonds.

 

Off-Balance Sheet Arrangements. The Company had no arrangements or other relationships with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of, or requirements for, capital resources at January 2, 2016.

 

Disclosures about Contractual Obligations, Commercial Commitments and Contingencies. A summary of significant contractual obligations, commercial commitments and contingencies as of January 2, 2016 is as follows:

 

 

(1)Represents obligations for interest, pension funding, postretirement health benefits, the Fox River Funding Agreement, deferred compensation payments and capital lease obligations. Interest is calculated using current rates.

 

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In addition to the contractual obligations listed above, it will also be necessary for the Company to use cash to satisfy its repurchase obligations related to the ESOP. The following table outlines the potential repurchase liability for the next five years based on management’s assumptions, developed in conjunction with the ESOP administrator, related to participant death, retirement, diversification requests, employment termination and changes in share valuation.

 

 

 

The Company expects that a portion of this share repurchase liability will be funded from new deferrals from employees into the Company Stock Fund. Employees may defer, on a pre-tax basis, a percentage of their pay in an amount, subject to certain IRS limitations, equal to between 2% and 50% of their annual compensation. Participants have the option of directing their deferrals to the 401(k) Fund, the Company Stock Fund or a combination of both. The Company believes that new deferrals from employees into the Company Stock Fund for the five-year period presented above will aggregate approximately $13 million and could be used to fund a portion of the repurchase liability set forth in the table above.

 

Deferrals directed to the Company Stock Fund accumulate in a short-term interest-bearing account within the ESOP trust until the next valuation date, June 30 or December 31. At that time, these deferrals and the interest earned on these amounts, are used to purchase shares based upon the price of a share of PDC common stock on the valuation date preceding or following the date on which the participant made the deferrals, whichever is lower.

 

Collective Bargaining Agreements

 

Manufacturing employees at the Company’s manufacturing facilities in Appleton, Wisconsin, Roaring Spring, Pennsylvania and West Carrollton, Ohio are represented by the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial and Service Workers International Union. The Company has labor agreements in effect with represented employees at the Appleton plant through August 31, 2017; at the Roaring Spring mill through February 1, 2018; and at the West Carrollton plant through    March 31, 2018.

 

USW also represents employees at the Appleton, Wisconsin and Kansas City, Kansas distribution centers. Employees at the distribution center in Ohio are not represented.

 

Disclosures About Certain Trading Activities that Include Non-Exchange Traded Contracts Accounted for at Fair Value.  The Company does not engage in any trading activities that include non-exchange traded contracts accounted for at fair value.

 

Disclosures About Effects of Transactions with Related and Certain Other Parties.  There were no significant transactions with related and certain other parties.

 

Disclosures About Critical Accounting Policies

 

PDC prepares its consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”).

 

This requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. Accounting policies are disclosed in the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data. The following policies are considered by management to be the most critical in understanding the judgments that are involved in the preparation of the consolidated financial statements and the uncertainties that could impact the results of operations, financial position and cash flows. Management has discussed the development, selection and disclosure of these estimates and assumptions with the Audit Committee of the Board of Directors.

 

Redeemable Common Stock. In accordance with ASC 480, “Distinguishing Liabilities from Equity,” the appropriate accounting for redeemable equity first depends upon a determination of whether the equity is currently redeemable or not currently redeemable.  Shares that are currently redeemable are recorded at redemption value.  For shares that are not currently redeemable, the accounting guidance allows for changes in redemption value to be accreted from the initial issuance date to the earliest redemption date. This guidance also specifies that if the redemption value is less than the original issuance cost, the carrying amount of the redeemable common stock should not be less than the original issuance cost. The fair value of redeemable common stock is determined by an independent, third-party appraiser selected by the ESOP Trustee, as required by law and the ESOP. Based upon the estimated fair value of redeemable common stock of 6,757,898 shares outstanding at $12.30 per share at January 2, 2016, an ultimate redemption liability of approximately $83 million was determined. The redeemable common stock recorded book value as of January 2, 2016, was $115 million.

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Income Taxes. In conjunction with the acquisition of Appvion, PDC elected to be treated as a subchapter S corporation and elected that its eligible subsidiaries be treated as qualified subchapter S subsidiaries for U.S. federal and, where recognized, state and local income tax purposes, and therefore, the Company anticipates that it will not incur any future U.S. federal income tax liability and minimal state and local income tax liabilities. Appvion’s Canadian subsidiary, Appvion Canada, Ltd., is not eligible for treatment as a qualified subchapter S subsidiary. As a result, the Company will incur a foreign tax liability. The Company’s income tax reserve at January 2, 2016, covers various audit issues and provisions for certain non-U.S. entities. All U.S. federal C corporation tax years are closed. Various Canadian and state tax years remain open.

 

Intangible and Long-Lived Assets.  The Company reviews the carrying value of intangible assets with indefinite lives for impairment annually or more frequently if events or changes in circumstances indicate that an asset might be impaired. A considerable amount of management judgment and assumptions are required in performing the impairment test, principally in determining the fair value of the respective indefinite-lived intangible assets. Indefinite-lived intangible assets are not amortized.

 

Other intangible assets with definite lives continue to be amortized over their estimated useful lives. These intangible assets, as well as long-lived assets are tested for impairment when events or changes in circumstances indicate that the asset might be impaired.

 

Revenue Recognition. Revenue is recognized by the Company when all of the following criteria are met: persuasive evidence of a selling arrangement exists; the Company’s price to the customer is fixed; collectability is reasonably assured; and title has transferred to the customer. These criteria are met at the time of shipment. Estimated costs for sales incentives, discounts and sales returns and allowances are recorded as sales reductions in the period in which the related revenue is recognized. The Company typically does not invoice its customers for shipping and handling fees, which are classified as selling, general and administrative expenses.

 

Sales Returns and Allowances. A reserve is established for expected sales returns and allowances. The amount of the reserve is based on historic sales and returns and allowances data, which is analyzed by product line and market channel to determine average returns and allowances as a percent of gross sales. This percentage is applied to recent sales activity and is adjusted, as necessary, for any significant known claims or trends.

 

Employee Benefit Plans.  The Company provides a range of benefits to its employees and retired employees, including pensions and postretirement healthcare. The Company recognizes all actuarial gains and losses immediately in net periodic cost annually in the fourth quarter of each year and whenever a plan is determined to qualify for a remeasurement during a fiscal year and, the market-related value of plan assets used in the cost calculations is equal to fair value.

 

The determination of the Company’s obligation and expense for pension and other postretirement benefits, such as retiree healthcare and life insurance, is dependent on the selection of certain assumptions in calculating such amounts. Those assumptions include, among others and where applicable, the discount rate and rates of increase in healthcare costs. The Company reviews its actuarial assumptions on an annual basis and makes modifications to the assumptions based on current rates and trends, when appropriate.

 

The discount rate is developed by selecting a portfolio of high-quality corporate bonds appropriate to provide for the projected benefit payments of the plan. This portfolio is selected from a universe of over 700 Aa-graded noncallable bonds available in the market as of January 2, 2016, further limited to those bonds with average yields between the 10th and 90th percentiles. After the bond portfolio is selected, a single rate is determined that equates the market value of the bonds selected to the discounted value of the plan’s benefit payments. Based on the methodology described above, and a selected portfolio of 24 bonds, the Company selected a discount rate of 4.58% for 2015 to value year-end liabilities for the pension plans. The discount rate used at year-end 2014 was 4.18%.

 

The expected long-term rate of return on assets assumption is developed considering the relative weighting of plan assets, the historical performance of total plan assets and individual asset classes and economic and other indicators of future performance. Expected returns for each asset class are developed using estimates of expected real returns plus expected inflation. Long-term expected real returns are derived from future expectations for the U.S. Treasury real yield curve. Based on the assumptions and methodology described above, the Company selected 7.00% as its long-term rate of return on assets assumption for both year-end 2015 and 2014.

 

Significant differences in actual experience or significant changes in assumptions may materially affect its pension and other postretirement obligations and future expense.

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Environmental and Legal Matters

 

The Company’s operations are subject to comprehensive and frequently changing federal, state and local environmental laws and regulations. These include laws and regulations governing emissions of air pollutants, discharges of wastewater and storm water, storage, treatment and disposal of materials and waste, remediation of soil, surface water and groundwater contamination and liability for damages to natural resources. In addition, the Company is also governed by laws and regulations relating to workplace safety and worker health which, among other things, regulate employee exposure to hazardous chemicals in the workplace.

 

Compliance with environmental laws and regulations is an important facet of the business. The Company expects to incur capital expenditures of approximately $7.9 million in 2016, largely the result of the cost of required January 31, 2017 compliance with the Industrial Boiler MACT rules, and a total of approximately $0.7 million from 2017 through 2021 to maintain compliance with applicable federal, state, local and foreign environmental laws and regulations and to meet new regulatory requirements. The Company expects to continue to incur expenditures after 2021 to maintain compliance with applicable federal, state, local and foreign environmental laws and regulations and to meet new regulatory requirements.

 

The Company is subject to strict and, under some circumstances, joint and several liability for the investigation and remediation of environmental contamination, including contamination caused by other parties, at properties that it owns or operates and at properties where the Company or its predecessors have arranged for the disposal of regulated materials. As a result, the Company is involved from time to time in administrative and judicial proceedings and inquiries relating to environmental matters. The Company could be involved in additional proceedings in the future and the total amount of these future costs and other environmental liabilities may be material.

 

The Company is involved from time to time in certain administrative and judicial proceedings and inquiries related to environmental matters. For a discussion of these environmental matters, see “Item 1. Business – Environmental” and Note 18 of the Notes to the Consolidated Financial Statements. Furthermore, from time to time the Company may be subject to various demands, claims, suits or other legal or regulatory proceedings arising in the ordinary course of business. A comprehensive insurance program is maintained to provide a measure of financial protection against such matters, though not all such exposures are, or can be, addressed by insurance. Estimated costs are recorded for such demands, claims, suits or proceedings of this nature when reasonably determinable. The Company has successfully defended such claims, settling some for amounts which are not material to its business and obtaining dismissals in others. While the Company will vigorously defend itself and expects to prevail in any similar cases that may be brought against it in the future, there can be no assurance that it will be successful.

 

The Company does not believe that any pending or threatened demands, claims, suits or other legal or regulatory proceedings will have, individually or in the aggregate, a materially adverse effect on its business, financial condition and results of operations or cash flows.

 

Item 7A.         Quantitative and Qualitative Disclosures About Market Risk

 

The Company selectively uses derivative instruments and other proactive risk management techniques to reduce market risk associated with changes in foreign currency exchange rates, commodity prices and interest rates.  All hedging transactions are authorized and executed pursuant to clearly defined policies and procedures which strictly prohibit the use of financial instruments for speculative purpose. At the inception of each hedge, the Company decides if it will be designated as a cash flow hedge and, if so, assesses the effectiveness of the hedge. The Company performs hedge effectiveness testing quarterly and any ineffectiveness is recorded in current earnings. The change in fair market value of each derivative is recorded each period in current earnings or accumulated other comprehensive income, depending on whether the derivative is designated and qualifies as part of a hedge transaction under ASC 815, “Derivatives and Hedging.” For additional information, see the following in the Consolidated Financial Statements: Note 2, Summary of Significant Accounting Policies, Derivative Financial Instruments and Hedging Activities, Note 10, Long-Term Obligations and Note 13, Derivative Instruments and Hedging Activities

 

Foreign Currency Risk. The Company has a sales organization in Canada. It also contracts with a third-party logistics service to provide product distribution services in Canada. A 10% appreciation or depreciation in the Canadian dollar at January 2, 2016 would not have a significant impact on the Company’s consolidated balance sheet, consolidated statement of comprehensive income (loss) or consolidated statement of cash flows.

 

The Company also sells its products worldwide and thus enters into transactions denominated in various foreign currencies. Company policy is to selectively hedge its foreign currency denominated transactions in a manner that partially offsets the effects of changes in foreign currency exchange rates. Foreign currency contracts are used to hedge only those currency exposures associated with sales to customers located outside the U.S. Corresponding gains and losses on the underlying transactions offset the gains and losses on these foreign currency hedges. Maturities of forward exchange contracts coincide with settlement dates of related transactions.

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Interest Rate Risk. The Company is exposed to interest rate risk on its revolving credit facility, first lien term loan and industrial development bonds. At January 2, 2016, the Company had a total of $173.9 million of variable rate borrowings outstanding, of which $158.3 million is the first lien term loan. After giving effect to the Third Amendment to the Credit Agreement executed on August 3, 2015 (See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Description of Outstanding Indebtedness and Note 10,  Long-Term Obligations, of Notes to Consolidated Financial Statements), the first lien term loan bears interest, (i) through Appvion’s 2015 fiscal year, at Appvion’s option at either base rate plus 3.5% per annum or Eurodollar plus 4.5% per annum and (ii) thereafter, at either base rate or Eurodollar with the applicable margin determined pursuant to a pricing grid which provides that (x) if the reported consolidated first lien leverage ratio is greater than 3.00 to 1.00, the applicable margin on Eurodollar loans increases from 4.5% per annum to 5.0% per annum and the applicable margin on base rate loans increases from 3.5% per annum to 4.0% per annum and (y) if the reported consolidated first lien leverage ratio is less than or equal to 3.00 to 1.00, the applicable margin on Eurodollar loans returns to 4.5% per annum and the applicable margin on base rate loans returns to 3.5% per annum. The Credit Agreement provides for a fixed floor rate of 1.25% for Eurodollar loans and 2.25% for base rate loans. A 100 basis point increase in the Eurodollar interest rate above the 1.25% floor would increase annual interest expense by approximately $1.6 million. On July 30, 2013, Appvion entered into an interest rate swap contract on $100 million of this variable rate first lien term loan with a forward start date of September 15, 2014 and a maturity date of June 28, 2019.

 

Commodity Prices. The Company is subject to the effects of changing raw material costs caused by movements in underlying commodity prices. The Company is exposed to fluctuating market prices for commodities, including pulp, chemicals and base stock, and has established programs to manage exposure to commodity prices through effective negotiations with suppliers. As listed within its contractual obligations, the Company enters into contracts with vendors to lock in commodity prices at various times and for various periods to limit near-term exposure to fluctuations in raw material prices.

 

The Company selectively hedges forecasted commodity transactions that are subject to pricing fluctuations by using swap and collar contracts to manage risks associated with market fluctuations in energy prices. These contracts are recorded in the Consolidated Balance Sheet at fair value using inputs based on the New York Mercantile Exchange as measured on the last trading day of the accounting period and compared to the strike price. The contracts’ gains or losses due to changes in fair value are recorded in current period earnings. As of January 2, 2016, all contracts have been settled.

 

The Company selectively hedged forecasted commodity transactions that were subject to pricing fluctuations by using swap contracts to manage risks associated with market fluctuations in pulp prices. These contracts were recorded in the Consolidated Balance Sheet at fair value using market inputs based on pricing published by RISI, Inc. (“RISI”) as measured on the last trading day of the accounting period and compared to the swap’s fixed price. Currently, there are no pulp swap contracts in place.

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Item 8.            Financial Statements and Supplementary Data 

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors

Paperweight Development Corp.

 

We have audited the accompanying consolidated balance sheet of Paperweight Development Corp. and its subsidiaries (the Company) as of January 2, 2016 and the related consolidated statements of comprehensive income (loss), cash flows, redeemable common stock, accumulated deficit and accumulated other comprehensive income for the year then ended.  Our audit also included the financial statement schedules of Paperweight Development Corp. and its subsidiaries listed in item 15(a). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Paperweight Development Corp. and its subsidiaries as of January 2, 2016, and the results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.

 

We also have audited the adjustments to the January 3, 2015 and December 28, 2013 financial statements to retrospectively apply the effects related to discontinued operations, as described in Note 3.   In our opinion, such adjustments are appropriate and have been properly applied. We were not engaged to audit, review, or apply any procedures to the January 3, 2015 and December 28, 2013 financial statements of the Company other than with respect to the adjustments and, accordingly, we do not express an opinion or any other form of assurance on the January 3, 2015 and December 28, 2013 financial statements taken as a whole.

 

 

 

 

/s/ RSM US LLP

Milwaukee, Wisconsin

March 25, 2016

 

 

 

 

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Report of Independent Registered Public Accounting Firm

 

To the Board of Directors

Paperweight Development Corp.

 

In our opinion, the consolidated balance sheet as of January 3, 2015 and the related consolidated statements of comprehensive income (loss), of redeemable common stock, accumulated deficit and accumulated other comprehensive income, and of cash flows for each of the two years in the period ended January 3, 2015, before the effects of the adjustments to retrospectively reflect the discontinued operations described in Note 3, present fairly, in all material respects, the financial position of Paperweight Development Corp. and its subsidiaries at January 3, 2015, and the results of their operations and their cash flows for each of the two years in the period ended January 3, 2015, in conformity with accounting principles generally accepted in the United States of America (the January 3, 2015 financial statements before the effects of the adjustments discussed in Note 3 are not presented herein).  In addition, in our opinion, the financial statement schedules for the each of the two years in the period ended January 3, 2015 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements before the effects of the adjustments described above.  These financial statements and financial statement schedules are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.  We conducted our audits, before the effects of the adjustments described above, of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

We were not engaged to audit, review, or apply any procedures to the adjustments to retrospectively reflect the discontinued operations described in Note 3 and accordingly, we do not express an opinion or any other form of assurance about whether such adjustments are appropriate and have been properly applied.  Those adjustments were audited by other auditors.

 

 

 

 

/s/ PricewaterhouseCoopers LLP

Milwaukee, Wisconsin

March 13, 2015

 

 

 

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

 

 

 

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

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

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