UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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



For the quarterly period ended: October 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 number: 333-82084-01

                                          



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

 

Indicate by check mark whether each 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 each 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 whether either of the registrants is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See 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  ☒    (Do not check if a smaller reporting company)

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 November 1, 2016,  6,416,315 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 1 – FINANCIAL INFORMATION

Item 1 – Financial Statements (unaudited)





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



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







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Noncash activities: In September 2016, Appvion entered into a $4.5 million promissory note related to the Fox River Funding Agreement, and reclassified the amount due to short-term debt. The impact of this is included in the operating activities section of the Consolidated Statement of Cash Flows.



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

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





 

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1.       BASIS OF PRESENTATION

 

In the opinion of management, all adjustments made for the fair statement of comprehensive (loss) income for the three and nine months ended October 2, 2016 and October 4, 2015, the cash flows for the nine months ended October 2, 2016 and October 4, 2015 and financial position at October 2, 2016 and January 2, 2016 were normal recurring adjustments. As disclosed in Note 15 to the Condensed Consolidated Financial Statements, the Company adopted Accounting Standards Update (“ASU”) 2015-03, “Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs,” during the first quarter of 2016. In accordance with the guidance, $8.1 million of unamortized debt issuance costs, associated with the Company’s long-term debt, were reclassified from other assets, as previously reported on the Consolidated Balance Sheet as of January 2, 2016, to long-term debt. 



These condensed financial statements should be read in conjunction with the audited consolidated financial statements and notes of Paperweight Development Corp. (“PDC”) and its 100%-owned subsidiaries (collectively the “Company”), which includes Appvion, Inc. and its 100%-owned subsidiaries (collectively “Appvion”) for each of the three years in the period ended January 2, 2016, which are included in the annual report on Form 10-K for the year ended January 2, 2016. The condensed consolidated balance sheet data as of January 2, 2016, contained within these condensed financial statements, was derived from the audited financial statements of PDC but does not include all disclosures required by accounting principles generally accepted in the United States of America.



The results of operations for any interim period are not necessarily indicative of the results to be expected for the full year.



2.    DISCONTINUED OPERATIONS 



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 approximate $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. As of January 2, 2016, Appvion had used this entire amount of restricted cash to repay an additional $25 million in long-term debt and $10 million for capital investment. The estimated carrying value of the net assets sold was $11.8 million. The operating results for this business for the three and nine months ended October 4, 2015 have been reclassified and are now reported separately as discontinued operations.



In connection with the Sale, Appvion and Rise entered into certain other agreements, including a Supply Agreement, by 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.

 

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The following table presents the key line items constituting income from discontinued operations for the Encapsys Business for the three and nine months ended October 4, 2015 (dollars in thousands):

 



The following are the significant line items of the Encapsys Business impacting cash flow for the periods presented (dollars in thousands):







      













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3.       ACCOUNTS RECEIVABLE SECURITIZATION



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 Condensed Consolidated Balance Sheets as of October 2, 2016 and January 2, 2016. Proceeds received, including collections on the deferred purchase price notes receivable, are included in cash flows from operating activities in the Condensed Consolidated Statements of Cash Flows for the nine months ended October 2, 2016 and October 4, 2015.



Trade receivables sold to the third-party financial institution, and being serviced by Appvion, Inc., totaled $33.6 million as of October 2, 2016, for which $10.7 million in proceeds was received. Trade receivables sold to the third-party financial institution as of January 2, 2016 totaled $36.9 million, for which $18.1 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 October 2, 2016 was $21.1 million and $16.5 million as of year-end 2015 and is included in accounts receivable in the Condensed Consolidated Balance Sheets as of October 2, 2016 and January 2, 2016, 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 $0.1 million and $0.4 million for the three- and nine-month periods ended October 2, 2016, respectively, as well as for the three- and nine-month periods ended October 4, 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, ending June 2017. The remaining balance at October 2, 2016 was $0.2 million.



4.       OTHER INTANGIBLE ASSETS

 

The Company’s intangible assets consist of the following (dollars in thousands):













Amortization expense of intangibles from continuing operations for the three and nine months ended October 2, 2016 was $0.6 million and $1.7 million, respectively. Amortization expense of intangibles from continuing operations for the three and nine months ended October 4, 2015 was $0.6 million and $1.7 million, respectively.

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5.       INVENTORIES    

 

Inventories consist of the following (dollars in thousands):







Stores and spare parts inventory represents manufacturing supplies and equipment parts of varying age that must be available, on demand, to ensure minimal interruption of manufacturing processes. The balance is valued at average cost. All other inventories are valued using the first-in, first-out (“FIFO”) method.



6.       PROPERTY, PLANT AND EQUIPMENT 



Property, plant and equipment balances consist of the following (dollars in thousands):











Depreciation expense from continuing operations for the three and nine months ended October 2, 2016 and October 4, 2015 consists of the following (dollars in thousands):

 













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7.       OTHER ACCRUED LIABILITIES



Other accrued liabilities, as presented in the current liabilities section of the Condensed Consolidated Balance Sheet, consist of the following (dollars in thousands):





As disclosed in Note 15, on September 1, 2016, Appvion paid $3.0 million of the Fox River Funding Agreement and reclassified the remaining $4.5 million to short-term debt.



8.       NEW ACCOUNTING PRONOUNCEMENTS



In August 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments.”  This guidance addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice.  This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years.  Early adoption is permitted.  This guidance should be applied using a retrospective transition method to each period presented.  The Company is assessing the impact the guidance will have, if any, on its consolidated financial statements.



In March 2016, FASB issued ASU No. 2016-09, “Improvements to Employee Share-Based Payment Accounting.” This guidance simplifies the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted. This guidance can be applied either prospectively, retrospectively or using a modified retrospective transition method. The Company is assessing the impact the guidance will have, if any, on its consolidated financial statements.



In March 2016, the FASB issued ASU No. 2016-05, “Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships.” This guidance clarifies that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument does not, in and of itself, require dedesignation of that hedging relationship provided all other hedge accounting criteria continue to be met. The guidance must be applied using a prospective or modified retrospective application method and will be effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. Early adoption is permitted. The Company is assessing the impact the guidance will have, if any, on its consolidated financial statements.



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In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” This guidance provides a single comprehensive revenue recognition model to apply in determining how and when to recognize revenue. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. When applying the new revenue model to contracts with customers, the guidance requires five steps to be applied which include: 1) identify the contract(s) with a customer, 2) identify the performance obligations in the contract, 3) determine the transaction price, 4) allocate the transaction price to the performance obligations in the contract and 5) recognize revenue when (or as) the entity satisfies a performance obligation. The guidance also requires both quantitative and qualitative disclosures which are more comprehensive than existing revenue standards. The disclosures are intended to enable financial statement users to understand the nature, timing and uncertainty of revenue and the related cash flow. Additionally, in March 2016, the FASB issued ASU No. 2016-08, “Principal versus Agent Considerations” to clarify the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, “Identifying Performance Obligations and Licensing” to clarify the guidance associated with identifying performance obligations and licensing. In May 2016, the FASB issued ASU No. 2016-11, “Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at March 3, 2016 EITF Meeting” to rescind specific guidance included in Topic 605, Revenue Recognition, and Topic 932, Extractive Activities-Oil and Gas, effective upon adoption of Topic 606. Also in May 2016, the FASB issued ASU No. 2016-12, “Narrow-Scope Improvements and Practical Expedients” to address certain issues in the guidance regarding assessing collectability, presentation of state taxes, noncash consideration, and completed contracts and contract modifications at transition. These ASU’s will be effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early adoption is permitted but no earlier than the original effective date of fiscal years, and interim periods within those years, beginning after December 15, 2016. The Company is assessing the impact the guidance will have, if any, on its consolidated financial statements.



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9.       EMPLOYEE BENEFITS



The components of net periodic benefit cost (gain) associated with the defined benefit pension plans include the following (dollars in thousands):





The Company does not expect to contribute any cash to its funded pension plan in 2016.



Certain of the Company’s hourly employees participated in a multi-employer defined benefit plan, the Pace Industry Union-Management Pension Plan (EIN #11-6166763). Participants in this plan included the West Carrollton, Ohio represented manufacturing employees, where the collective bargaining agreement expired on April 1, 2012. Participants also included the represented employees at the Kansas City, Kansas distribution center, where the collective bargaining agreement expired December 31, 2011. As a result of labor contracts ratified in June 2012 and September 2012, by the bargaining employees at the Kansas City, Kansas distribution center and West Carrollton, Ohio plant, respectively, both groups elected to end their participation in this multi-employer plan and instead participate in the defined benefit pension plan sponsored by the Company. In addition, during first quarter 2012 there was a workforce reduction at the West Carrollton, Ohio plant resulting from the cessation of papermaking activities. As a result, the Company recorded $25.0 million of expense in 2012 representing its estimated cost to satisfy a complete withdrawal liability under the terms of the plan’s trust agreement, with a payment period that began January 2014 and could extend for up to 20 years, discounted in accordance with ASC Section 450-20-S99-1. Payments of $0.5 million and $1.6 million were made during third quarter 2016 and the first nine months 2016, respectively, resulting in recorded interest expense of $0.3 million and $0.9 million for each of the two periods, respectively, and a $0.7 million reduction of the reserve since year-end 2015. Of the $22.7 million reserve, $0.9 million is classified as short-term and $21.8 million is classified as long-term within the Condensed Consolidated Balance Sheet at October 2, 2016.



10.      POSTRETIREMENT BENEFIT PLANS OTHER THAN PENSIONS

 

The components of other postretirement benefit gain include the following (dollars in thousands):







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11.      LONG-TERM INCENTIVE COMPENSATION     

 

In December 2001, the Company adopted the Long-Term Stock Appreciation Rights Plan (“SAR” Plan). As of January 3, 2010, the Company adopted the Long-Term Restricted Stock Unit Plan ("RSU" Plan). Both plans utilize phantom units. The value of a unit in the SAR Plan is based on the change in the fair market value of PDC’s common stock under the terms of the employee stock ownership plan (the “ESOP”) between the grant date and the exercise date. The value of a unit in the RSU Plan is based on the value of PDC common stock, as determined by the ESOP trustee. As of the end of third quarter 2016, the fair market value of one share of PDC common stock was $13.70.  



As of year-end 2015, 143,818 RSU units became vested and exercisable. In accordance with the RSU Plan, payment for these RSU’s was made in February 2016. During the first nine months of 2016, 130,850 additional units were granted under the RSU Plan. Due to terminations of employment, 84,140 unvested units were forfeited during the current year.  Additionally, 13,267 RSU units became vested and exercisable during third quarter 2016. Payment for 767 of these RSU units was made in third quarter 2016. A balance of 262,100 RSU units remains as of October 2, 2016. Payment for the remaining 12,500 RSU units vesting during third quarter 2016 was made in October 2016. Approximately $0.1 million and $0.8 million of expense, related to this RSU Plan, was recorded during each of the three- and nine-month periods ended October 2, 2016, respectively. Approximately $0.2 million and $1.2 million of expense, related to this plan, was recorded during the three- and nine-month periods ended October 4, 2015, respectively. As of October 2, 2016, total unrecognized stock-based compensation expense relating to unvested long-term restricted employee stock units was $1.5 million. This amount is expected to be recognized over the weighted-average period of 2.0 years. 



During the first nine months of 2016, 310,150 additional units were granted under the SAR Plan. Approximately $0.1 million of expense recovery and $0.5 million of expense, related to this plan, was recorded in both the three- and nine-month periods ended October 2, 2016, respectively. Approximately $0.1 million and $0.2 million of expense, related to this plan, was recorded in both the three- and nine-month periods ended October 4, 2015, respectively.



Beginning in 2006, the Company established a nonqualified deferred compensation agreement with each of its non-employee directors. In March 2013, the board adopted the Appvion, Inc. Non-Employee Director Deferred Compensation Plan to formalize the terms of the agreement. No expense was recorded during third quarter 2016 related to this plan. Approximately $0.3 million of expense, related to this plan, was recorded during the nine-month period ended October 2, 2016. Approximately $0.1 million and $0.5 million of expense, related to this plan, was recorded during the three- and nine-month periods ended October 4, 2015, respectively.



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12.      COMMITMENTS AND CONTINGENCIES

Lower Fox River

Appvion Caps Potential Liability.  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 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:



Effective August 31, 2016, the parties agreed that the amount due from Appvion on September 1, 2016, as set forth in (c) above would be separated into two payments: (i) $3.0 million, which was paid on September 1, 2016; and (ii) $4.5 million, which was subsequently paid on October 3, 2016.

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



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 Appvion Fox River Cap and the Appvion Future Sites Cap, respectively.



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.

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As a result of the Funding Agreement, $24.0 million of expense was recorded as selling, general and administrative expense in the Consolidated Statements of Comprehensive (Loss) Income for the year ended January 3, 2015. This expense represents the total 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 payments made on September 1, 2016 and October 3, 2016, discounted to reflect the long-term nature of the liability. A short-term liability of $4.5 million is recorded in the current portion of long-term debt on the Condensed Consolidated Balance Sheet as of October 2, 2016. The total of these liabilities were accreted to the full liability of $25.0 million during the course of the payment schedule.



Other



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 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. 



13.      EMPLOYEE STOCK OWNERSHIP PLAN 



The Company’s matching contributions charged to expense were $0.3 million and $0.4 million for the three-month periods ended October 2, 2016 and October 4, 2015, respectively. The Company’s matching contributions charged to expense were $1.2 million and $1.5 million for the nine-month periods ended October 2, 2016 and October 4, 2015, respectively. As a result of hardship withdrawals, required diversifications and employee terminations, 477,175 shares of PDC redeemable common stock were repurchased during the first nine months of 2016 at an aggregate price of approximately $6.1 million.  During the same period, the ESOP trustee purchased 69,090 shares of PDC redeemable common stock for an aggregate price of $0.9 million using pre-tax deferrals, rollovers and loan payments made by employees, while the Company’s matching contributions for the same period resulted in an additional 66,502 shares of redeemable common stock being issued.



As a result of hardship withdrawals, required diversifications and employee terminations, 438,484 shares of PDC redeemable common stock were repurchased during the first nine months of 2015 at an aggregate price of approximately $5.1 million. During the same period, the ESOP trustee purchased 96,574 shares of PDC redeemable common stock for an aggregate price of $1.1 million using pre-tax deferrals, rollovers and loan payments made by employees, while the Company’s matching contributions for the same period resulted in an additional 92,576 shares of redeemable common stock being issued.



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 should be 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.



As of October 2, 2016, the fair market value of one share of PDC common stock was $13.70.  Based on the estimated fair value of the redeemable common stock at October 2, 2016, an ultimate redemption liability of approximately $88 million was determined. The redeemable common stock recorded book value as of October 2, 2016,  was $113 million. The change in fair value and accretion of redeemable common stock was $5.1 million for the nine months ended October 2, 2016.



Based on the estimated fair value of the redeemable common stock at October 4, 2015, an ultimate redemption liability of approximately $90 million was determined. The redeemable common stock recorded book value as of October 4, 2015 was $121 million. The change in fair value and accretion of redeemable common stock was $5.9 million for the nine months ended October 4, 2015.

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14.      DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

The Company selectively uses financial instruments to manage some market risks from changes in foreign currency exchange rates, commodity prices and interest rates. The fair values of all derivatives are recorded in the Condensed Consolidated Balance Sheet. The change in a derivative’s fair value 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 and, if so, the type of hedge transaction.



The Company selectively hedges forecasted transactions that are subject to foreign currency exchange exposure by using forward exchange contracts. These instruments are designated as cash flow hedges and are recorded in the Condensed Consolidated Balance Sheet at fair value using Level 2 observable market inputs. The fair value of foreign currency forward contracts is based on a valuation model that discounts cash flows resulting from the differential between the contract price and the market-based forward note, also deemed to be categorized as Level 2. The effective portion of the contracts’ gains or losses due to changes in fair value is initially recorded as a component of accumulated other comprehensive income and is subsequently reclassified into earnings when the underlying transactions occur and affect earnings or if it becomes probable the forecasted transactions will not occur. These contracts are designed to hedge the variability in future cash flows attributable to changes in currency exchange rates. The notional amount of foreign exchange contracts used to hedge foreign currency transactions was $9.5 million as of October 2, 2016. These contracts have settlement dates extending through December 2016.



The Company selectively hedges forecasted commodity transactions that are subject to pricing fluctuations by using collar contracts to manage risks associated with market fluctuations in energy prices. These contracts are recorded in the Condensed Consolidated Balance Sheet at fair value using Level 2 observable market inputs based on the New York Mercantile Exchange as measured on the last trading day of the accounting period and compared to the collar 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. At October 4,  2015, the hedged volumes of these contracts totaled 280,909 MMBTU (Million British Thermal Units) of natural gas.



On July 30, 2013, Appvion entered into an interest rate swap contract on $100 million of its variable rate first lien term loan with a forward start date of September 15, 2014 and a maturity date of June 28, 2019. This interest rate swap pays the Company variable interest at the three-month Eurodollar rate or a fixed floor rate of 1.25%, whichever is greater, and the Company pays the counterparty a fixed interest rate. The fixed Eurodollar interest rate for the contract is 7.24%. Based on the terms of the interest rate swap contract and the underlying debt, the interest rate contract was determined to be effective, and thus qualifies as a cash flow hedge. Any changes in the fair value of the interest rate swap are recorded in accumulated other comprehensive income in the accompanying Condensed Consolidated Balance Sheet until earnings are affected by the variability of cash flows.



The following table presents the location and fair values of derivative instruments included in the Company’s Condensed Consolidated Balance Sheets (dollars in thousands):





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The following table presents the location and amount of (gains) losses on derivative instruments and related hedge items included in the Company’s Condensed Consolidated Statement of Comprehensive (Loss) Income for the three- and nine-months ended October 2, 2016 and October 4, 2015 and (gains) losses initially recognized in accumulated other comprehensive income in the Condensed Consolidated Balance Sheet at the period-ends presented (dollars in thousands):







For a discussion of the fair value of financial instruments, see Note 16, Fair Value Measurements.



15.      LONG-TERM OBLIGATIONS

 

Long-term obligations, excluding capital lease obligations, consist of the following (dollars in thousands):





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During the first nine months of 2016, the Company made mandatory debt repayments of $1.2 million on its State of Ohio loans. The Company also borrowed $271.4 million and repaid $258.0 million on its revolving credit facility, leaving an outstanding balance at quarter-end of $23.0 million. Approximately $15.0 million of the revolving credit facility commitment was used in the form of outstanding letters of credit issued thereunder, which, in accordance with its debt covenants, left approximately $6.6 million of unused borrowing capacity under its revolving credit facility. No amounts were drawn by beneficiaries under the outstanding letters of credit.



During the third quarter of 2016, the Company entered into a $4.5 million promissory note with NCR Corporation in relation to the Fox River Funding Agreement disclosed in Note 12. The unpaid principal balance of this Note bears interest at 6% per annum. Principal and interest were due and paid in full on October 3, 2016.



During the first quarter of 2016, the Company adopted ASU 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” In accordance with the guidance, $8.1 million of unamortized debt issuance costs, specifically attributable to each of the Company’s long-term debt issues, were reclassified from other assets, as previously reported on the Consolidated Balance Sheet as of January 2, 2016, to long-term debt. The unamortized debt issuance costs are now presented as a direct deduction from each debt liability, consistent with the presentation of the corresponding debt discount, where applicable.



On June 28, 2013, Appvion entered into a credit agreement (the “Credit Agreement”) providing for a $100 million revolving line of credit due June 28, 2018 and a $335 million first lien term loan due June 28, 2019.  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. As noted above, 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,  Appvion Canada, Ltd. and APVN Holdings LLC. 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.



After giving effect to the Third Amendment, (as defined below), the total amount committed under the revolving line of credit was reduced to $75 million and $170 million of the first lien term loan was repaid using proceeds from the Sale of the Encapsys Business. 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 the first lien term loan 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. 



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On August 3, 2015, Appvion, PDC, Jefferies Finance LLC, as administrative agent, Fifth Third Bank, as revolver agent, swing line lender and L/C issuer, and the lenders party to the Credit Agreement entered into a Third Amendment (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. 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.



On June 24, 2016, Appvion, PDC, Jefferies Finance LLC, as administrative agent, Fifth Third Bank, as revolver agent, swing line lender and L/C issuer, and the lenders party to the Credit Agreement entered into a Fourth Amendment (the “Fourth Amendment”) to its Credit Agreement dated June 28, 2013. The Fourth Amendment amends the definition of Consolidated EBITDA to provide for an additional add-back to Consolidated Net Income for cash, fees and/or expenses paid or incurred in connection with certain financial and advisory services provided to the Company and Appvion in an aggregate amount not to exceed $6.5 million.



On November 19, 2013, Appvion completed a voluntary refinancing of a portion of its debt to extend maturities and reduce interest expense. The refinancing included the issuance of $250 million in aggregate principal amount of second lien senior secured notes carrying an annual interest rate of 9.0%, payable semi-annually in arrears on June 1 and December 1 of each year. The notes will mature on June 1, 2020 and 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 Windward Prospects Ltd. and the ESOP and enter into transactions with certain affiliates.

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16.      FAIR VALUE MEASUREMENTS

 

The carrying amount (including current portions) and estimated fair value of certain of the Company’s recorded financial instruments are as follows (dollars in thousands):







The first lien term loan and the second lien notes are traded in public markets. Their fair value was determined using Level 2 inputs based on quoted market prices. The fair value of the State of Ohio loans was determined using Level 2 observable market inputs including current rates for financial instruments of the same remaining maturity and similar terms. The revolving credit facility and industrial development bonds have variable interest rates that reflect current market terms and conditions.



Due to their short-term nature, the carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities were reasonable estimates of fair value as of October 2, 2016 and January 2, 2016.

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17.      SEGMENT INFORMATION

 

The Company’s reportable segments are as follows: carbonless papers and thermal papers. Management evaluates the performance of the segments based primarily on operating income (loss). Items excluded from the determination of segment operating income (loss) are unallocated corporate charges, net interest expense, debt modification/extinguishment expense, foreign exchange loss (gain) and other expense. The Company does not allocate total assets internally in assessing operating performance and does not track capital expenditures by segment. Net sales, operating income (loss) and depreciation and amortization, as determined by the Company for its reportable segments, are as follows (dollars in thousands):







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18.      ACCUMULATED OTHER COMPREHENSIVE INCOME



The changes in accumulated other comprehensive income by component for the nine months ended October 2, 2016 are as follows (dollars in thousands):









The changes in accumulated other comprehensive income by component for the nine months ended October 4, 2015 are as follows (dollars in thousands):













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Details about these reclassifications are as follows (dollars in thousands):