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KS > SEC Filings for KS > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for KAPSTONE PAPER & PACKAGING CORP

Form 10-K for KAPSTONE PAPER & PACKAGING CORP


28-Feb-2014

Annual Report


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

Executive Summary

Our mill operations had a strong year in 2013, producing a record 2.1 million tons of containerboard and specialty paper compared to 1.6 million tons in 2012. Net sales in 2013 of $1.7 billion reflect 2.2 million tons of product sold. In 2013, the average mill selling price per ton increased by $47 to $669 per ton. This increase was a result of full realization of our 2013 price increases for domestic containerboard and corrugated products.


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Some key highlights for 2013 include:

º •
º In February 2013, we announced a $50 per ton selling price increase for domestic containerboard and a 10 and 12 percent increase for corrugated packaging boxes and sheets, respectively. These price increases were fully realized by the third quarter of 2013.

º •
º In April 2013, production and sales began at our new Aurora, Illinois sheet plant.

º •
º In July 2013, the Company acquired 100 percent of the stock of Longview for $1.025 billion, plus $41.5 million of working capital adjustments. Longview is a leading manufacturer of high quality containerboard, kraft papers, and corrugated products. Longview's operations includes a paper mill located in Longview, Washington equipped with five paper machines which has the capacity to produce 1.3 million tons of containerboard and kraft paper annually. Longview also owns seven converting facilities located in the Pacific Northwest.

º •
º In December 2013, our board of directors approved a stock split. To implement the stock split, one share of common stock for each then outstanding share of common stock was distributed on January 7, 2014 to all shareholders of record as of the close of business on December 23, 2013.

º •
º During 2013, the Company made significant progress in its $29.0 million investment in the North Charleston, South Carolina paper mill to upgrade the No. 3 Paper Machine and select equipment in the fiber and utilities areas. This investment will increase capacity for ultra high performance linerboard grades. The project is expected to be completed during the first quarter of 2014. Total expenditures for this project through December 31, 2013 were $21.3 million.

º •
º As of December 31, 2013, we believe we are the 5th largest manufacturer of containerboard in the United States.

Results of Operations for the Years Ended December 31, 2013, 2012, and 2011

    The following table compares results of operations for the years ended
December 31, 2013 and 2012:

                                 Years Ended December 31,                    % of Net Sales
                                    2013           2012        % Change      2013      2012
Net sales                       $   1,748,162   $ 1,216,637         43.7 %    100.0 %   100.0 %
Cost of sales, excluding
depreciation and
amortization                        1,186,930       866,124         37.0 %     67.9 %    71.2 %
Depreciation and
amortization                           95,435        63,124         51.2 %      5.5 %     5.2 %
Freight and distribution
expenses                              135,972       108,438         25.4 %      7.8 %     8.9 %
Selling, general and
administrative expenses               110,612        70,055         57.9 %      6.3 %     5.8 %
Other operating income                    675           664          1.7 %        -       0.1 %


Operating income                      219,888       109,560        100.7 %     12.6 %     9.0 %
Foreign exchange gain/(loss)              232          (303 )      176.6 %        -         -
Interest expense, net                  25,130        11,774        113.4 %      1.4 %     1.0 %


Income before provision for
income taxes                          194,990        97,483        100.0 %     11.2 %     8.0 %
Provision for income taxes             67,652        34,978         93.4 %      3.9 %     2.9 %


Net income                      $     127,338   $    62,505        103.7 %      7.3 %     5.1 %

Net sales for the year ended December 31, 2013 were $1,748.2 million compared to $1,216.6 million for the year ended December 31, 2012, an increase of $531.6 million. The increase in net sales was driven primarily by the Longview acquisition which accounted for $439.6 million. Excluding the Longview acquisition, net sales increased by $92.0 million or 7.6 percent. Net sales


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(excluding Longview) increased by $77.3 million due to higher average selling prices, $9.2 million of other sales and $5.5 million due to volume and product mix changes. Average mill selling price per ton for 2013 was $669 compared to $622 for 2012. Average mill selling prices increased primarily due to the full realization of the 2012 and 2013 price increases for domestic containerboard and corrugated products.

The following represents the Company's sales by product line:

                                                              Years Ended December 31,

                                Net Sales            Increase/                      Tons Sold            Increase/
Product Line Revenue:      2013          2012        (Decrease)      %         2013          2012        (Decrease)      %
Containerboard /
Corrugated products     $ 1,129,623   $   725,238    $   404,385     55.8 %   1,449,695     1,073,918        375,777     35.0 %
Specialty paper             530,853       417,510        113,343     27.1 %     753,363       606,547        146,816     24.2 %
Other                        87,686        73,889         13,797     18.7 %           -             -              -        -


Product sold            $ 1,748,162   $ 1,216,637    $   531,525     43.7 %   2,203,058     1,680,465        522,593     31.1 %

Tons of product sold in 2013 was 2,203,058 tons compared to 1,680,465 tons in 2012. Excluding the Longview acquisition, tons of products sold in 2013 decreased by 13,897 tons or 1 percent as follows:

º •
º Domestic containerboard sales increased 14.5 percent due to higher demand for ultra performance containerboard grades.

º •
º Corrugated product sales volume increased 3.9 percent reflecting a heavier basis weight of tons shipped and product mix, new customers, and the addition of the Aurora facility.

º •
º Export containerboard sales decreased by 30.3 percent as more containerboard volume was shipped to domestic customers and used for internal consumption.

º •
º Specialty paper sales decreased by 5.7 percent, primarily due to Kraft paper sales which decreased 20.5 percent, reflecting an overall decrease in demand in the industry and lower volume of sales to a customer as it internalized its needs, partially offset by higher Durasorb® and Kraftpak® volume.

Cost of sales, excluding depreciation and amortization expense, for the year ended December 31, 2013 was $1,186.9 million compared to $866.1 million for the year ended December 31, 2012, an increase of $320.8 million. The increase in cost of sales was mainly due to the $272.0 million impact of the Longview acquisition. Excluding the Longview acquisition, cost of sales increased by $48.8 million or 5.6 percent, mainly due to $32.5 million of inflation on labor, benefits and input costs, $6.5 million of higher planned maintenance outage costs, and other cost increases. Including Longview, annual planned maintenance outage costs during 2013 and 2012 totaled $24.9 million and $18.4 million, respectively, and were included in cost of sales for the year ended December 31, 2013 and 2012, respectively.

Depreciation and amortization expense for the year ended December 31, 2013 totaled $95.4 million compared to $63.1 million for 2012. The increase of $32.3 million was primarily due to $27.6 million from the Longview acquisition, $2.4 million of which is amortization of identified intangibles. Excluding the Longview acquisition, depreciation and amortization expense increased $5.3 million due to the recent investments in information technology, equipment upgrades, and replacements at the paper mills.

Selling, general and administrative expenses for the year ended December 31, 2013 totaled $110.6 million compared to $70.1 million in 2012. The increase of $40.5 million was primarily due to $26.1 million from the Longview acquisition. Excluding the Longview acquisition, selling, general, and


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administrative expenses increased by $14.4 million due to $8.5 million of Longview transaction fees and expenses, $5.9 million of higher compensation related expenses, $1.8 million of higher IT and consulting expenses, $1.4 million for the new manufacturing facility located in Aurora, IL, and $0.6 million of bad debt expense partially offset by $3.8 million of 2012 USC acquisition and integration related expenses. As a percentage of net sales, selling, general, and administrative expenses increased to 6.3 percent in 2013 from 5.8 percent in 2012.

Net interest expense for the years ended December 31, 2013 and 2012 was $25.1 million and $11.8 million, respectively. Interest expense reflects interest on the Company's borrowings under its Credit Facility and amortization of debt issuance costs. Interest expense was $13.3 million higher for the year ended 2013 due to higher term loan balances used to fund the Longview acquisition and an increase in interest rates.

Provision for income taxes for the years ended December 31, 2013 and 2012 was $67.7 million and $35.0 million, respectively, reflecting an effective income tax rate of 34.7 percent for 2013 compared to 35.9 percent for 2012. The higher provision for income taxes in 2013 primarily reflects higher pre-tax income and higher state income taxes partially offset by a $5.0 million favorable adjustment for reversal of a tax reserve for an uncertain tax position relating to alternative fuel mixture credits.

The following table compares results of operations for the years ended December 31, 2012 and 2011:

                                                 Years Ended December 31,                    % of Net Sales
                                                    2012            2011      % Change      2012       2011
Net sales                                       $    1,216,637    $ 906,119        34.3 %    100.0 %    100.0 %
Cost of sales, excluding depreciation and
amortization                                           866,124      628,613        37.8 %     71.2 %     69.4 %
Depreciation and amortization                           63,124       51,036        23.7 %      5.2 %      5.6 %
Freight and distribution expenses                      108,438       79,643        36.2 %      8.9 %      8.8 %
Selling, general and administrative expenses            70,055       41,265        69.8 %      5.8 %      4.6 %
Other operating income                                     664        1,179       (43.7 )%    (0.1 )%    (0.1 )%


Operating income                                       109,560      106,741         2.6 %      9.0 %     11.8 %
Foreign exchange loss                                      303          319        (5.0 )%       -          -
Interest expense, net                                   11,774        6,081        93.6 %      1.0 %      0.7 %


Income before provision (benefit) for income
taxes                                                   97,483      100,341        (2.8 )%     8.0 %     11.1 %
Provision (benefit) for income taxes                    34,978      (23,640 )    (248.0 )%     2.9 %     (2.6 )%


Net income                                      $       62,505    $ 123,981       (49.6 )%     5.1 %     13.7 %

Net sales for the year ended December 31, 2012 were $1,216.6 million compared to $906.1 million for the year ended December 31, 2011, an increase of $310.5 million, or 34.3 percent. The increase in net sales was driven by the USC acquisition which accounted for $330.6 million of net sales. Excluding the USC acquisition, net sales decreased by $20.1 million due to $21.4 million of lower volume of paper sales as the Company used more tons for internal consumption rather than selling to third parties, $4.8 million in lower average selling prices, $4.0 million due to the unfavorable exchange rate effect of a stronger US dollar and $2.2 million due to a less favorable product mix, partially offset by $12.3 million of higher lumber and other sales. Average selling price per ton for 2012 was $622 compared to $627 for 2011. Average selling prices decreased primarily due to a $45 per ton reduction in export containerboard prices and product mix, partially offset by the partial realization of a $50 per ton containerboard price increase late in 2012.


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The following represents the Company's sales by product line:

                                                              Years Ended December 31,

                               Net Sales           Increase/                       Tons Sold            Increase/
Product Line Revenue:      2012         2011       (Decrease)      %          2012          2011        (Decrease)      %
Containerboard /
Corrugated products     $   725,238   $ 409,547    $   315,691     77.1 %    1,073,918       730,119        343,799     47.1 %
Specialty paper             417,510     435,019        (17,509 )   (4.0 )%     606,547       638,979        (32,432 )   (5.1 )%
Other                        73,889      61,553         12,336     20.0 %            -             -              -      0.0 %


Product sold            $ 1,216,637   $ 906,119    $   310,518     34.3 %    1,680,465     1,369,098        311,367     22.7 %

Tons of product sold in 2012 was 1,680,465 tons compared to 1,369,098 tons in 2011, an increase of 311,367 tons, or 22.7 percent. The increase in tons of paper sold was primarily driven by the USC acquisition. Excluding the USC acquisition, tons of paper sold decreased by 14,862 tons, or 1.1 percent.

º •
º Domestic containerboard sales increased 15.7 percent reflecting the impact of the USC acquisition and higher demand for lightweight containerboard grades.

º •
º Corrugated product sales volume increased 570.5 percent in 2012. Corrugated product sales, in billion square feet, was 6.2 billion in 2012 compared to 1.0 billion in 2011. Sales of corrugated products began with the USC acquisition which closed in the fourth quarter of 2011.

º •
º Export containerboard sales decreased 18.5 percent as more containerboard volume was shipped to domestic customers and used for internal consumption.

º •
º Specialty paper sales decreased by 4.0 percent, primarily due to Kraft paper sales which decreased 9.1 percent reflecting an overall decrease in demand in the industry and a transfer of volumes to lightweight containerboard grades. Durasorb® sales declined 5.0 percent due to lower demand in copper clad laminate markets in Japan, Korea and Southeast Asia and in Europe due to lower demand for high pressure laminates. These decreases were partially offset by Kraftpak® sales volume which increased by 6.3 percent due to higher volume with existing accounts.

Cost of sales, excluding depreciation and amortization expense, for the year ended December 31, 2012 was $866.1 million compared to $628.6 million for the year ended December 31, 2011, an increase of $237.5 million, or 37.8 percent. The increase in cost of sales was mainly due to the $246.4 million impact of the USC acquisition. Excluding the USC acquisition, cost of sales decreased by $8.9 million due to $19.7 million of lower sales volume and $5.4 million of productivity gains, partially offset by $12.0 million of inflation on labor, benefits and input costs. Other costs increased approximately $2.9 million due to higher lumber and other sales and by $1.3 million due to repairs and maintenance costs at the Roanoke Rapids paper mill due to a flood which occurred on August 25, 2012. The mill received 11 inches of rain in less than six hours which resulted in a loss of 707 tons of production. Annual planned maintenance outages during 2012 and 2011 totaled $18.4 million and $18.8 million, respectively.

Depreciation and amortization expense for the year ended December 31, 2012 totaled $63.1 million compared to $51.0 million for the same period in 2011. The increase of $12.1 million was primarily due to $11.4 million from the USC acquisition, $4.7 million of which is amortization of identified intangibles. Excluding the USC acquisition, depreciation and amortization expense increased $0.7 million.

Freight and distribution expenses for the year ended December 31, 2012 totaled $108.4 million compared to $79.6 million for the year ended December 31, 2011. The increase of $28.8 million was primarily due to $26.5 million from the USC acquisition. Excluding the USC acquisition, freight and


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distribution expenses increased $2.3 million primarily due to product mix reflecting a higher percentage of domestic containerboard shipments where the Company pays for freight and inflation on fuel costs.

Selling, general and administrative expenses for the year ended December 31, 2012 totaled $70.1 million compared to $41.3 million in 2011. The increase of $28.8 million was primarily due to $24.9 million from the USC acquisition. Excluding the USC acquisition, selling, general and administrative expenses increased $3.9 million due to the higher compensation related expenses and $1.5 million of higher acquisition integration related expenses. As a percentage of net sales, selling, general and administrative expenses increased to 5.8 percent in 2012 from 4.6 percent in 2011.

Interest expense, net for the years ended December 31, 2012 and 2011 was $11.8 million and $6.1 million, respectively. Interest expense reflects interest on borrowings under the Company's then-existing credit facilities and amortization of debt issuance costs. Interest expense was $5.7 million higher in 2012 due to a higher term loan balance to fund the USC acquisition and $1.0 million of higher debt amortization costs.

Provision (benefit) for income taxes for the years ended December 31, 2012 and 2011 was $35.0 million expense and $23.6 million benefit, respectively, reflecting an effective income tax rate of 35.9 percent for 2012 compared to
(23.6) percent for the similar period in 2011. The higher benefit for income taxes in 2011 mainly reflects $63.0 million for the reversal of tax reserves relating to alternative fuel mixture tax credits upon completion of the 2009 IRS examination in the fourth quarter of 2011.

Liquidity and Capital Resources

Acquisition

On July 18, 2013, the Company acquired 100 percent of the stock of Longview Fibre Paper and Packaging, Inc., for $1.025 billion, plus $41.5 million of working capital adjustments. Longview is a leading manufacturer of high quality containerboard, specialty kraft papers, and corrugated containers. Longview's operations include a paper mill located in Longview, Washington equipped with five paper machines which have the capacity to produce approximately 1.3 million tons of containerboard and kraft paper annually. Longview also owns seven converting facilities located in the Pacific Northwest.

Credit Facilities

In conjunction with the Longview acquisition, the Company entered into the Amended and Restated Credit Agreement which provides for a senior secured credit facility in the amount of $1.675 billion, consisting of a Term Loan A-1 of $805.0 million, a Term Loan A-2 of $470.0 million, and the Revolver in an initial aggregate amount of $400.0 million (including a $50.0 million letter of credit sub-facility and a $30.0 million swing line loan sub-facility). The Credit Facility also includes an "accordion" feature that allows the Company, subject to certain terms and conditions, to increase the commitments under the Revolver by up to $300.0 million. The proceeds of Term Loan A-1, Term Loan A-2, and $154.3 million borrowings under the Revolver were used to finance the Company's acquisition of Longview, pay certain transaction fees and expenses, repay certain existing indebtedness, and provide for ongoing working capital requirements and general corporate purposes.

Depending on the type of borrowing, the applicable interest rate under the Credit Facility is calculated at a per annum rate equal to (a) LIBOR plus an applicable margin or (b) the base rate that is calculated as (i) the greatest of
(x) the prime rate, (y) the federal funds effective rate plus 0.50% or (z) a daily rate equal to one month LIBOR plus 1% plus (ii) an applicable margin. The unused portion of the Revolver will also be subject to an unused fee that will be calculated at a per annum rate (the "Unused Fee Rate"), which will initially be 0.50%.

Commencing with the delivery of the financial statements for the fiscal quarter ending December 31, 2013, the applicable margin for borrowings under the Credit Facility and the Unused Fee


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Rate will be determined by reference to the pricing grid based on the Company's total leverage ratio. Under such pricing grid, the applicable margins for Term Loan A-1 and Revolver will range from 1.25% to 2.25% for Eurodollar loans and from 0.25% to 1.25% for base rate loans and the Unused Fee Rate will range from 0.30% to 0.50%. The applicable margins for Term Loan A-2 will range from 1.50% to 2.50% for Eurodollar loans and from 0.50% to 1.50% for base rate loans.

Annual principal repayments, paid quarterly, are as follows:

                 Fiscal year ending (in thousands):      Total
                 2014                                 $     4,950
                 2015                                      44,950
                 2016                                      55,013
                 2017                                      95,263
                 2018                                     578,262
                 2019                                       4,700
                 2020                                     440,625


                 Total                                $ 1,223,763

Voluntary and Mandatory Prepayments

For the year ended December 31, 2013, the Company made a $40.0 million voluntary prepayment on its term loans using cash generated from operations. No mandatory prepayments were required under the Amended and Restated Credit Agreement.

For the year ended December 31, 2012, the Company made a $50.0 million voluntary prepayment on its term loan under its then-existing credit agreement using cash generated from operations.

Other Borrowing

In 2013 and 2012, the Company entered into financing agreements of $5.1 million and $3.4 million, respectively, at an annual interest rate of 1.61 and 2.0 percent, respectively, for its annual property insurance premiums. These agreements required the Company to pay consecutive monthly payments through the term of each financing agreement ending on December 1st of each year. The Company entered into a similar agreement in 2014 with similar terms and conditions.

Debt Covenants

Under the financial covenants of the Amended and Restated Credit Agreement, the Company must comply on a quarterly basis with a maximum permitted leverage ratio. The leverage ratio is calculated by dividing the Company's debt by its rolling twelve month total earnings before interest expense, taxes, depreciation and amortization and allowable adjustments. The maximum permitted leverage ratio declines over the life of the Amended and Restated Credit Agreement. On December 31, 2013, the maximum permitted leverage ratio was 4.75 to 1.00. On December 31, 2013, the Company was in compliance with a leverage ratio of 2.73 to 1.00.

The Amended and Restated Credit Agreement also includes a financial covenant requiring a minimum fixed charge coverage ratio. This ratio is calculated by dividing the Company's twelve month total earnings before interest expense, taxes, depreciation and amortization and allowable adjustments less cash payments for income taxes and capital expenditures by the sum of our cash interest and required principal payments during the twelve month period. From the closing date of the Amended and Restated Credit Agreement through the quarter ending December 31, 2013, the fixed charge coverage ratio was required to be at least 1.25 to 1.00. On December 31, 2013, the Company was in compliance with the Amended and Restated Credit Agreement with a fixed charge coverage ratio of 5.02 to 1.00.


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As of December 31, 2013, Company was also in compliance with all other covenants in the Amended and Restated Credit Agreement.

Income Taxes

    Income taxes paid, net of refunds, were $4.0 million, $7.0 million, and
$0.3 million in 2013, 2012 and 2011, respectively. The Company expects to pay
significantly higher amounts of income taxes in 2014.

Sources and Uses of Cash

    Years ended December 31 ($ in thousands)       2013        2012         2011
    Operating activities                        $  298,694   $ 157,829   $  136,376
    Investing activities                          (634,945 )   (67,551 )   (423,863 )
    Financing activities                           332,730     (81,852 )    228,191


    Total change in cash and cash equivalents   $   (3,521 ) $   8,426   $  (59,296 )

2013

Cash and cash equivalents decreased by $3.5 million from December 31, 2012, reflecting $298.7 million of net cash provided by operating activities and $332.7 million of net cash provided by financing activities, offset by cash used in investing activities of $634.9 million.

Net cash provided by operating activities was $298.7 million due to non-cash charges of $158.6 million, net income of $127.3 million, and changes in operating assets and liabilities of $12.8 million. Net cash provided by operating activities increased by $140.9 million during the year ended December 31, 2013 compared to 2012 mainly due to higher non-cash charges of $69.0 million, higher net income of $64.8 million, and $7.1 million of cash provided by changes in operating assets and liabilities.

Net cash used in investing activities includes $538.2 million for the Longview acquisition and $96.7 million of capital expenditures. For the year ended December 31, 2013, capital expenditures included $10.2 million for the new manufacturing facility in Aurora, IL and $22.2 million for Longview. Net cash used in investing activities increased by $567.4 million in 2013 compared to 2012, primarily due to the Longview acquisition.

Net cash provided by financing activities totaled $332.7 million, reflecting $1,275.0 million of borrowings under the Credit Facility, partially offset by the $812.8 million payoff of the Company's prior credit facility and Longview's senior notes assumed in the acquisition, $63.5 million of short-term borrowing repayments, a $40.0 million voluntary prepayment, $19.7 million of debt issuance costs for the Amended and Restated Credit Agreement, and a $11.2 million scheduled principal payment. Net cash provided by financing activities increased by $414.6 million in 2013 compared to 2012, mainly due to higher net borrowings . . .

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