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PKG > SEC Filings for PKG > Form 10-Q on 8-Nov-2013All Recent SEC Filings

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Form 10-Q for PACKAGING CORP OF AMERICA


8-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

Packaging Corporation of America, or PCA, is the fourth largest producer of containerboard and corrugated products in the United States, based on production capacity. We produce a wide variety of corrugated products ranging from basic corrugated shipping containers to specialized packaging, such as wax-coated boxes for the agriculture industry. We also have multi-color printing capabilities to make high-impact graphics boxes and displays that offer our customers more attractive packaging. Our operating facilities and customers are located primarily in the United States.

On October 25, 2013 we completed the acquisition of Boise Inc. ("Boise"), a large manufacturer of packaging and paper products with $2.6 billion in net sales for the year ended December 31, 2012, for $12.55 per share. In connection with the acquisition, PCA refinanced approximately $775.0 million of Boise's indebtedness. The total transaction value, net of cash acquired, was approximately $1.94 billion, including the $775.0 million of Boise indebtedness. PCA incurred approximately $4.2 million in expenses relating to the transaction during the third quarter and will incur significant expenses relating to the transaction during the fourth quarter, including $55.7 million in redemption premiums paid to redeem Boise notes which will be recorded as interest expense. PCA used the proceeds of approximately $2.0 billion of new borrowings, including $1.3 billion in new term loan facilities and $700.0 million in new 4.50% ten year notes, together with cash on hand to finance the acquisition and related expenses and refinance Boise and certain PCA indebtedness.

The transaction is expected to increase PCA's containerboard capacity to approximately 3.7 million tons from its current level of 2.6 million tons, including the announced expansion of the DeRidder, Louisiana mill, PCA's corrugated products volume will increase by approximately 30%. As a result of the acquisition, PCA's corrugated products presence will expand in the Pacific Northwest. In addition to the Boise packaging business, PCA also acquired the Boise paper business, a major producer of uncoated freesheet and specialty papers. The results of operations of Boise will be included in PCA's results for periods on and after October 25, 2013.

In analyzing our operating performance, we focus on the following factors that affect our business and are important to consider when reviewing our financial and operating results:

containerboard and corrugated products demand;

corrugated products and containerboard pricing and mix;

cost trends and volatility for our major costs, including wood and recycled fiber, purchased fuels, electricity, labor and fringe benefits, and transportation costs; and

cash flow from operations and capital expenditures.

The cost to manufacture containerboard is dependent, in large part, on the costs of wood fiber, recycled fiber, purchased fuels, electricity and labor and fringe benefits. Excluding the cost of containerboard, labor and benefits costs make up the largest component of corrugated products' manufactured costs.

The market for containerboard is generally subject to changes in the U.S. economy. Historically, supply and demand, as well as industry-wide inventory levels, have influenced prices of containerboard and corrugated products. In addition to U.S. shipments, approximately 10% of domestically produced containerboard has been exported annually for use in other countries.

As reported by the Fibre Box Association, industry-wide shipments of corrugated products increased 0.6% for the three months ended September 30, 2013 compared to the same period in 2012. Reported industry containerboard production for the three months ended September 30, 2013 increased 3.3% compared to the same period in 2012. Trade publications reported that containerboard inventories at the end of the third quarter of 2013 were approximately 2.4 million tons compared to second quarter 2013 ending inventories of 2.2 million tons. Reported industry shipments to export markets decreased 8.7% for the third quarter of 2013 compared to last year's third quarter. Published containerboard prices did not change during the third quarter of 2013.


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During the third quarter of 2013, PCA produced approximately 671,000 tons of containerboard at our mills and sold 9.3 billion square feet ("bsf") of corrugated products. Our corrugated products shipments for the third quarter of 2013 were up 7.8% compared to the third quarter of 2012. Containerboard volume sold to domestic and export customers for the three months ended September 30, 2013 was 12,000 tons lower than the same period in 2012 due to increased internal demand for containerboard at our box plants.

Published prices for recycled fiber were 25% higher in the third quarter of 2013 compared to the third quarter 2012 average price and were up approximately 5% compared to the second quarter of 2013. Our wood costs increased compared to last year's third quarter due to an unusually wet third quarter in the U. S. Southeast which made it more difficult to access wood. Purchased fuel prices increased primarily due to higher prices for natural gas and coal. Our chemical costs in the third quarter of 2013 were slightly higher than the comparable period in 2012 due to higher purchase prices and usage. Transportation costs increased 3% compared to last year's third quarter.

Excluding after-tax costs related to the Boise acquisition of $2.7 million, or $0.03 per diluted share, and a pension curtailment charge of $2.0 million, or $0.02 per diluted share, we earned net income of $89.0 million ($0.91 per diluted share) in the third quarter of 2013, compared with net income before special items of $53.3 million ($0.55 per diluted share) in the third quarter of 2012. Special items in the third quarter of 2012 included debt refinancing charges of $13.5 million, or $0.14 per diluted share. Information regarding our use of non-GAAP financial measures and reconciliations of non-GAAP measures used in this Item 2 to the most comparable measure reported in accordance with GAAP are included elsewhere in this section under "Reconciliations of Non-GAAP Financial Measures to Reported Amounts."

Looking ahead to the fourth quarter, we expect seasonally lower corrugated products volume than the third quarter resulting, in part, from two less corrugated products shipping days. We also expect lower mill production and higher operating costs related to the annual maintenance outage at our Filer City, Michigan mill. We also expect fuel costs to be seasonally higher with colder weather. Considering these items and excluding any impact from the Boise acquisition, we currently expect fourth quarter earnings to be lower than the third quarter.

Results of Operations

Three Months Ended September 30, 2013 Compared to Three Months Ended
September 30, 2012

The historical results of operations of PCA for the three months ended
September 30, 2013 and 2012 are set forth below:



                                          Three Months Ended
                                            September 30,
                                         2013           2012          Change
          (In thousands)
          Net sales                    $ 845,440      $ 723,473      $ 121,967

          Income from operations       $ 141,960      $  92,072      $  49,888
          Interest expense, net          (11,850 )      (30,590 )       18,740

          Income before taxes            130,110         61,482         68,628
          Provision for income taxes     (45,930 )      (21,691 )      (24,239 )

          Net income                   $  84,180      $  39,791      $  44,389

Net Sales

Net sales increased by $122.0 million, or 16.9%, for the three months ended September 30, 2013 from the comparable period in 2012, as a result of higher sales price and improved mix ($68.9 million) and higher sales volume ($53.1 million).


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Corrugated products shipments for the third quarter increased 7.8% compared to the third quarter of 2012 both on a total basis and a shipments-per-workday basis. Total corrugated products volume sold for the three months ended September 30, 2013 increased 0.7 bsf to 9.3 bsf compared to 8.6 bsf in last year's third quarter. Both the third quarter of 2013 and 2012 contained 63 workdays, those days not falling on a weekend or holiday.

Containerboard volume sold to outside domestic and export customers for the three months ended September 30, 2013 was 12,000 tons lower than the same period in 2012. Containerboard mill production for the third quarter was 671,000 tons compared to 670,000 tons in the third quarter of 2012.

Income from Operations

Income from operations increased $49.9 million, or 54.2%, for the three months ended September 30, 2013 compared to the three months ended September 30, 2012. Income from operations includes a pre-tax pension curtailment charge of $3.1 million and costs related to the Boise acquisition of $1.5 million. Excluding special items, income from operations increased $54.5 million, driven by higher pricing and improved mix ($68.9 million) and higher corrugated products volume ($8.1 million). These improvements were partially offset by higher expenses for incentive compensation ($4.7 million), labor ($4.3 million), fiber ($4.1 million), energy ($2.7 million), transportation ($1.8 million), chemicals ($1.7 million) and depreciation ($1.2 million).

Gross profit increased $63.3 million, or 38.9%, for the three months ended September 30, 2013 from the comparable period in 2012. Gross profit as a percentage of net sales increased to 26.7% for third quarter 2013 compared to 22.5% in third quarter 2012 primarily attributable to the price and volume increases previously described.

Selling and administrative expenses increased $4.9 million, or 9.6%, for the three months ended September 30, 2013 compared to the same period in 2012, primarily as a result of increased costs for incentive compensation ($2.4 million), salaries ($1.3 million), related fringe benefits ($0.5 million), and broker commissions ($0.4 million).

Corporate overhead increased $4.2 million, or 24.4%, for the third quarter 2013 compared to third quarter 2012. Excluding the costs related to the Boise acquisition of $1.5 million, corporate overhead increased $2.7 million, primarily due to increased costs related to incentive compensation ($1.2 million), salary and fringe benefits ($0.7 million), legal matters ($0.5 million) and travel ($0.3 million).

Other expense for the three months ended September 30, 2013 increased $4.3 million or 218.3% compared to the comparable period in 2012, primarily due to the pension plan curtailment charge ($3.1 million) and increased expenses related to fixed asset disposals ($1.2 million).

Interest Expense, Net and Income Taxes

Net interest expense decreased $18.7 million, or 61.3%, for the three months ended September 30, 2013 compared to the same period in 2012. Net interest expense in the third quarter of 2013 included a $2.7 million charge for bridge financing fees related to the Boise acquisition, and net interest expense in the third quarter of 2012 included a $21.1 million charge primarily as a result of the premium associated with the early redemption of the Company's 5.75% notes due in 2013 in July 2012. Excluding these special items, net interest expense was $0.3 million lower for the three months ended September 30, 2013 compared to the same period in 2012.

PCA's effective tax rate was 35.3% for the three months ended September 30, 2013 and 2012. The effective tax rate varies from the U.S. federal statutory rate of 35.0% principally due to the impact of state and local income taxes and the domestic manufacturers' deduction. PCA had no material changes to its reserve for unrecognized tax benefits under ASC 740, "Income Taxes," during the third quarter of 2013 but does expect a significant change by the end of the year as described in Note 14 to the condensed consolidated financial statements.


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Nine Months Ended September 30, 2013 Compared to Nine Months Ended September 30, 2012

The historical results of operations of PCA for the nine months ended September 30, 2013 and 2012 are set forth below:

                                           Nine Months Ended
                                             September 30,
                                         2013             2012           Change
         (In thousands)
         Net sales                    $ 2,400,877      $ 2,107,298      $ 293,579

         Income from operations       $   352,476      $   345,040      $   7,436
         Interest expense, net            (30,333 )        (53,529 )       23,196

         Income before taxes              322,143          291,511         30,632
         Provision for income taxes      (112,885 )       (188,722 )       75,837

         Net income                   $   209,258      $   102,789      $ 106,469

Net Sales

Net sales increased by $293.6 million, or 13.9%, for the nine months ended September 30, 2013 from the comparable period in 2012, primarily as a result of higher sales price and mix ($144.8 million) and higher sales volume ($148.8 million).

Corrugated products shipments for the first three quarters of 2013 increased 6.7% compared to the same period in 2012 on a shipments-per-workday basis. Total corrugated products volume sold for the nine months ended September 30, 2013 increased 6.1% over the same period last year. The first nine months of 2013 contained 189 workdays, those days not falling on a weekend or holiday, compared to 190 workdays in the comparable period in 2012.

Containerboard volume sold to outside domestic and export customers decreased 22,000 tons for the nine months ended September 30, 2013 compared to the same period in 2012 primarily related to decreased export sales. Containerboard mill production during the first three quarters of 2013 was 1,945,000 tons compared to 1,948,000 tons in the comparable period of 2012.

Income from Operations

Income from operations in the first nine months of 2013 was $352.5 million including $10.9 million of pension curtailment charges and $1.5 million of costs related to the Boise acquisition. As described in Note 14 to the condensed consolidated financial statements, PCA amended its 2009 federal tax return in February 2012 to reallocate gallons between the alternative fuel mixture credits and the cellulosic biofuel producer credits. As a result, income from operations was increased for the nine months ended September 30, 2012 by $95.5 million to $345.0 million with an offsetting amount recorded in tax expense of $118.5 million.

Excluding special items, income from operations increased $115.4 million, primarily due to increased sales price and improved mix ($144.8 million) and higher sales volume ($18.7 million). Partially offsetting these items were increased expenses related to labor and benefits ($14.1 million), energy ($10.1 million), incentive compensation ($8.9 million), wood fiber ($4.8 million), transportation ($4.6 million) and chemicals ($2.7 million).

Gross profit increased $134.7 million, or 28.9%, for the nine months ended September 30, 2013 from the comparable period in 2012, primarily due to the sales price and volume increases described above. Gross profit as a percentage of net sales increased to 25.0% of net sales for the first three quarters of 2013 compared to 22.1% in the same period in 2012.


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Selling and administrative expenses increased $10.7 million, or 6.8%, for the nine months ended September 30, 2013 compared to the comparable period in 2012, primarily as a result of higher costs for incentive compensation ($4.6 million), salaries ($3.1 million), related fringe benefits ($1.4 million), travel ($0.7 million) and broker commissions $(0.8 million).

Corporate overhead increased $8.2 million, or 16.0%, for the nine months ended September 30, 2013 compared to the same period in 2012, including the $1.5 million of costs related to the Boise acquisition. The remaining increase was primarily due to higher salary and fringe benefits expense ($2.2 million), incentive compensation ($1.9 million), legal costs ($1.7 million) and travel and meeting costs ($0.9 million).

Other expense for the nine months ended September 30, 2013 increased $12.8 million or 156.9% compared to the nine months ended September 30, 2012, primarily due to pension plan curtailment charges ($10.9 million), higher fixed asset disposal charges ($1.1 million) and increased expenses related to worker's compensation ($1.0 million).

Interest Expense, Net and Income Taxes

Net interest expense decreased $23.2 million, or 43.3%, for the nine months ended September 30, 2013 compared to the same period in 2012. The 2013 period included a $2.7 million charge for bridge financing fees related to the Boise acquisition. The 2012 period included charges of $24.8 million, primarily as a result of the $21.3 million premium associated with the early redemption of the Company's 5.75% notes due in 2013 in July 2012 and a $3.4 million loss from settling a treasury lock prior to its maturity. Excluding these special items, net interest expense was $1.1 million lower for the nine months ended September 30, 2013 compared to the same period in 2012. This decrease was driven by lower interest rates on PCA's variable rate debt ($0.5 million) and higher capitalized interest ($0.4 million) in 2013 compared to 2012.

PCA's effective tax rate was 35.0% for the nine months ended September 30, 2013. This compares to 64.7% for the nine months ended September 30, 2012, which included a 28.9% higher rate from amending our 2009 tax return in February 2012 related to the alternative energy tax credits described in Note 14 of the condensed consolidated financial statements. Excluding the amendment, the effective tax rate for the first nine months of 2012 would have been 35.8%. The effective tax rate varies from the U.S. federal statutory rate of 35.0% principally due to the impact of the alternative energy tax credits in 2012, state and local income taxes and the domestic manufacturers' deduction.

Liquidity and Capital Resources

The following table presents a summary of our cash flows for the periods
presented:



                                                    Nine Months Ended
                                                      September 30,
                                                  2013              2012            Change
(In thousands)
Net cash provided by (used for):
Operating activities                           $  420,168        $  251,811        $ 168,357
Investing activities                             (132,519 )         (73,546 )        (58,973 )
Financing activities                              (98,447 )        (193,672 )         95,225

Net increase (decrease) in cash and cash
equivalents                                    $  189,202        $  (15,407 )      $ 204,609

Operating Activities

Net cash provided by operating activities for the nine months ended September 30, 2013 was $420.2 million compared to $251.8 million for the nine months ended September 30, 2012, an increase of $168.4 million, or 66.9%. Cash provided by operating activities before changes in operating assets and liabilities was $451.8 million for the first nine months of 2013 compared to $357.8 million for the comparable period in 2012,


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an increase of $94.0 million that was driven by the stronger operations in 2013 as previously discussed and an additional $10.6 million of alternative energy tax credits used to reduce federal income tax payments during the first nine months of 2013, partially offset by higher pension contributions of $6.0 million made in 2013 compared to 2012. Cash used for operating assets and liabilities totaled $31.6 million for the nine month period ended September 30, 2013 compared to $106.0 million for the comparable period in 2012. The lower requirements for operating assets and liabilities in 2013 were driven by higher accounts payable and accrued liability levels in 2013 compared to 2012. Cash requirements for operating activities are subject to PCA's operating needs and the timing of collection of receivables and payments of payables and expenses.

Investing Activities

Net cash used for investing activities for the nine months ended September 30, 2013 increased $59.0 million, or 80.2%, to $132.5 million, compared to the nine months ended September 30, 2012. The increase was related to the receipt of $57.4 million in grant proceeds from the U.S. Treasury in 2012 and higher additions to property, plant and equipment of $36.0 million during the first nine months of 2013 compared to the same period in 2012. This was partially offset by a $35.4 million acquisition completed in the first quarter of 2012.

Financing Activities

Net cash used for financing activities totaled $98.4 million for the nine months ended September 30, 2013 compared to $193.7 million for the comparable period in 2012, a decrease of $95.2 million, or 49.2%. The decrease was primarily attributable to the July 2012 redemption of the Company's 5.75% senior notes due in 2013 for $421.3 million, a $65.5 million payment to settle a treasury lock in June 2012, and lower repurchases of PCA common stock of $33.7 million in 2013. This was partially offset by $397.0 million in net proceeds received from the Company's senior notes issuance that was completed in June 2012, lower proceeds and excess tax benefits from share-based awards of $8.8 million in 2013 and $8.2 million in bridge financing fees paid related to the Boise acquisition in 2013. Beginning in 2013, the Company began withholding shares from vesting equity awards to cover employee tax liabilities, which amounted to $10.9 million for the first nine months of 2013.

PCA's primary sources of liquidity are net cash provided by operating activities and borrowing availability under its revolving credit facility and receivables credit facility. Currently, PCA's primary uses of cash are for operations, capital expenditures, debt service and declared common stock dividends, which it expects to be able to fund from these sources.

The following table provides the outstanding balances, excluding unamortized debt discount, and the weighted average interest rates as of September 30, 2013 for PCA's senior credit facility, the receivables credit facility, and the senior notes:

                                                                                            Projected
                                        Balance at                Weighted                   Annual
                                       September 30,               Average                Cash Interest
Borrowing Arrangement                      2013                 Interest Rate               Payments
(Dollars in thousands)
Revolving Credit Facility             $            -                       N/A                       N/A
Term Loan                                     123,750                     1.68 %         $         2,078
Receivables Credit Facility                   109,000                     1.03                     1,121
3.90% Senior Notes (due
June 15, 2022)                                400,000                     3.90                    15,600
6.50% Senior Notes (due
March 15, 2018)                               150,000                     6.50                     9,750

Total                                 $       782,750                     3.65 %         $        28,549

The above table excludes the annual non-cash recorded interest expense of $5.7 million from the annual amortization of the treasury locks over the terms for both the 6.50% senior notes due 2018 and the 3.90% senior notes due 2022.


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The instruments governing PCA's indebtedness contain covenants that limit, among other things, the ability of PCA and its subsidiaries to:

enter into sale and leaseback transactions,

incur liens or secured indebtedness,

incur indebtedness at the subsidiary level,

enter into certain transactions with affiliates, or

merge or consolidate with any other person or sell or otherwise dispose of all or substantially all of the assets of PCA.

These limitations could limit corporate and operating activities.

A failure to comply with the covenants contained in the senior credit facility could lead to an event of default, which could result in an acceleration of any outstanding indebtedness and/or prohibit PCA from drawing on its revolving credit facility. Such acceleration may also constitute events of default under the senior notes indentures and the receivables credit facility. As of September 30, 2013, PCA was in compliance with these covenants.

To finance the Boise acquisition, refinance Boise's indebtedness and refinance the $123.8 million term loan under PCA's old credit agreement. PCA entered into a new senior unsecured credit agreement on October 18, 2013 and issued $700.0 million of new 4.50% ten year senior notes on October 22, 2013. The new credit agreement provides for a total of $1.65 billion in financing, consisting of a $350.0 million five year revolving credit facility, a $650.0 million five year term loan facility and a $650.0 million seven year term loan facility. PCA drew down the term loans on October 25, 2013. PCA may prepay loans under the new credit agreement at any time without premium or penalty. Except for $19.0 million in letters of credit, there are no outstanding borrowings under the revolving credit facility. The new credit agreement replaced PCA's old credit agreement dated October 11, 2011 and all amounts outstanding under the old credit agreement were repaid on October 25, 2013.

The term loans bear interest at the LIBOR rate plus a margin that is determined based on PCA's credit rating. The credit agreement contains customary covenants, including limitations on liens, mergers and consolidations, sales of assets and subsidiary indebtedness. PCA must maintain a minimum interest coverage ratio and may not exceed the leverage ratio specified by the credit agreement.

PCA currently expects to incur normal capital expenditures of about $130.0 million in 2013, primarily for maintenance capital, cost reduction, business growth and environmental compliance, plus $75.0 million for strategic investments in our existing box plants and $10.0 million required for compliance with the Boiler MACT rules. As of September 30, 2013, PCA incurred $130.4 million of capital expenditures and had committed to an additional $75.8 million of capital expenditures for the remainder of 2013 and beyond.

PCA believes that net cash generated from operating activities, cash on hand, available borrowings under its existing credit facilities and available capital through access to capital markets will be adequate to meet its liquidity and capital requirements, including payments of any declared common stock dividends, for the foreseeable future. As its debt or credit facilities become due, PCA will need to repay, extend or replace such facilities. Its ability to do so will . . .

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