ITEM 1. BUSINESS
GENERAL
PCA is the sixth largest producer of containerboard and corrugated products in the United States, based on production capacity as reported in the Pulp & Paper 2000 North American Fact Book. With 2000 net sales of $1.9 billion, PCA produced about 2.2 million tons of containerboard, about 80% of which was consumed in our corrugated products manufacturing plants, and shipped about 26.5 billion square feet of corrugated products.
In 2000, we produced over 1.3 million tons of kraft linerboard at our mills located in Counce, Tennessee and Valdosta, Georgia. We also produced more than 800,000 tons of semi-chemical corrugating medium at our mills located in Tomahawk, Wisconsin and Filer City, Michigan. We currently lease the cutting rights to approximately 140,000 acres of timberland located near our Counce and Valdosta mills. We also have supply agreements on about 600,000 of the 800,000 acres of timberland we sold during 1999 and 2000.
Our converting operations produce a wide variety of corrugated packaging products, including conventional shipping containers used to protect and transport manufactured goods. We also produce multi-color boxes and displays with strong visual appeal that help to merchandise the packaged product in retail locations. Finally, we are a large producer of meat boxes and wax-coated boxes for the agricultural industry.
CORPORATE DEVELOPMENTS
On April 12, 1999, Pactiv Corporation, formerly known as Tenneco Packaging Inc., a wholly owned subsidiary of Tenneco Inc., sold its containerboard and corrugated products business to PCA, an entity formed by Madison Dearborn Partners, LLC, a private equity investment firm, in January 1999, for $2.2 billion, consisting of $246.5 million in cash, the assumption of $1.76 billion of debt incurred by Pactiv immediately prior to the contribution, and a 45% common equity interest in PCA valued at $193.5 million. PCA Holdings LLC, an entity organized and controlled by Madison Dearborn, acquired the remaining 55% common equity interest in PCA for $236.5 million in cash, which was used to finance in part the transactions.
The financing of the transactions consisted of (1) borrowings under a new $1,469.0 million senior credit facility for which J.P. Morgan Securities Inc. and BT Alex. Brown Incorporated (the predecessor to Deutsche Banc Alex. Brown) were co-lead arrangers, (2) the offering of $550.0 million of 9 5/8% senior subordinated notes due 2009, and $100.0 million of 12 3/8% senior exchangeable preferred stock due 2010, (3) a cash equity investment of $236.5 million by PCA Holdings and (4) an equity investment by Pactiv valued at $193.5 million. As required by their terms, the $550.0 million of senior subordinated notes and $100.0 million of senior exchangeable preferred stock issued in the April 12, 1999 transactions were exchanged for publicly registered securities in the same amounts in a registered exchange offer completed in October 1999.
The senior credit facility was entered into to finance in part the transactions and to pay related fees and expenses and to provide future borrowings to PCA for general corporate purposes, including working capital. The senior credit facility initially consisted of three term loan facilities in an original aggregate principal amount of $1,219.0 million and a revolving credit facility with up to $250.0 million in availability. Effective December 14, 1999, PCA elected to reduce its availability under the revolving credit facility from $250.0 million to $150.0 million.
On January 28, 2000, PCA became a publicly-traded company with the initial public offering of its common stock. In the offering, Pactiv sold 35,000,000 shares and PCA sold 11,250,000 new shares of
common stock, both at an offering price of $12.00 per share. PCA used its net proceeds to redeem all of the outstanding senior exchangeable preferred stock on March 3, 2000.
PCA completed the refinancing of its $735.0 million senior secured debt and $150.0 million senior secured revolving credit facility on June 29, 2000. Completion of the refinancing eliminated Term Loan C, and reduced PCA's average effective interest rate on its senior secured term debt by approximately 100 basis points. PCA's total borrowings under the senior credit facility as of December 31, 2000 consisted of $177.0 million of term loans. No amounts were outstanding under the senior revolving credit facility as of that date.
On November 29, 2000, PCA entered into a three-year $150.0 million revolving credit facility, of which $142.0 million was initially drawn, in connection with the securitization of its trade receivables. The facility is secured by PCA's receivables and bears interest at a floating rate based on commercial paper plus an allowed margin under the agreement.
INDUSTRY OVERVIEW
According to the Fibre Box Association, the value of industry shipments of corrugated products was over $24 billion in 2000.
The primary end-use markets for corrugated products are shown below:
Corrugated products are generally delivered by truck. Compared to many other products, the amount of corrugated products that can fit into a truckload weighs much less. This, coupled with the relatively low price per ton of corrugated products, make shipping costs account for a relatively high portion of total costs. As a result, converting plants tend to be located in close proximity to customers to minimize freight costs. The corrugated products industry consists of an estimated 683 companies in the United States.
Containerboard, which includes both linerboard and corrugating medium, is the principal raw material used to manufacture corrugated products. Linerboard is used as the inner and outer facings, or liners, of corrugated products. Corrugating medium is fluted and laminated to linerboard in corrugator plants to produce corrugated sheets. The sheets are subsequently printed, cut, folded and glued in corrugator plants or sheet plants to produce corrugated products.
Containerboard may be manufactured from both softwood and hardwood fibers, as well as from recycled fibers from used corrugated and waste from converting operations. Kraft linerboard is made predominantly from softwoods like pine. Semi-chemical corrugating medium is made from hardwoods such as oak. Wood may be brought to the mill as logs to be chipped, or as already-chipped wood. The chips are chemically treated and cooked to form virgin fiber, also known as wood pulp. This pulp can be processed alone or blended with some percentage of recycled fiber on paper machines. The pulp is mixed with water and flows onto a moving wire screen, which allows the water to drain and concentrates the fibers. What remains is a paper mat that is compressed by a series of presses and then dried. The paper is wound into large rolls, which are slit to size as required by converters, and shipped to them.
Linerboard is made in a range of grades or basis weights. The most common basis weight for linerboard is 42 lb., although linerboard is produced in weights that vary from under 26 lb. to over 90 lb. Basis weight represents the weight in pounds per thousand square feet of linerboard. Producers
also market linerboard by performance characteristics, appearance and color. The following table describes different product weight, performance and color characteristics:
Historically, pricing for containerboard has reflected changes in containerboard supply that resulted from major capacity additions, as well as changes in demand.
PCA OPERATIONS AND PRODUCTS
Our two linerboard mills can manufacture a broad range of linerboard grades ranging from 26 lb. to 96 lb. Our two semi-chemical corrugating medium mills can manufacture grades ranging in weight from 21 lb. to 47 lb. All four of our mills have completed an extensive independent review process to become ISO 9002 certified. ISO 9002 is an international quality certification that verifies a facility maintains and follows stringent procedures for manufacturing, sales and customer service.
COUNCE. Our Counce, Tennessee mill is one of the largest linerboard mills in the United States. Its production capacity is approximately 1,003,000 tons per year. In 2000, we produced approximately 930,000 tons of kraft linerboard on two paper machines at Counce. We produced a broad range of basis weights from 31 lb. to 96 lb. The mill also produces a variety of performance and specialty grades of linerboard including high-ring crush and wet strength.
VALDOSTA. Our Valdosta, Georgia mill is a kraft linerboard mill that has a production capacity of approximately 457,000 tons per year. In 2000, our single paper machine at Valdosta produced approximately 414,800 tons of linerboard. Valdosta primarily produces light- to middleweight linerboard ranging from 35 lb. to 56 lb., and heavyweight/super heavyweight linerboard ranging from 61 lb. to 96 lb.
TOMAHAWK. Our Tomahawk, Wisconsin mill is the second largest corrugating medium mill in the United States with production capacity of 548,000 tons per year. In 2000, we produced approximately 535,100 tons of semi-chemical corrugating medium at Tomahawk using three paper machines, one of which is among the largest corrugating medium machines in the world. These machines produce a broad range of basis weights from 23 lb. to 47 lb. Our Tomahawk mill also produces a variety of performance and specialty grades of corrugating medium. This includes high ring crush, wet strength, tare weight and super heavyweight.
FILER CITY. Our Filer City, Michigan mill is a semi-chemical corrugating medium mill. In 2000, we produced approximately 285,100 tons of corrugating medium on two paper machines at Filer City. In July 1998, we shut down one machine at Filer City. Mill production capacity at Filer City is
367,000 tons a year if we run all three paper machines. Filer City produces a range of corrugating medium grades in basis weights from 21 lb. to 40 lb.
We operate 65 corrugated products plants, a supply services group, a technical and development center and five graphic design centers. Of the 65 corrugated products plants, 38 have a corrugator on site and manufacture both combined sheets and finished products. The remaining 27 corrugated products plants purchase combined sheets and create finished products. Two other small specialty facilities include a collating and distribution packaging center, as well as a machine rebuild facility. The five graphic design centers are located in Westmont, Illinois; Cincinnati, Ohio; Dallas, Texas; North Brunswick, New Jersey; and Southgate, California.
These graphic design centers were established in response to customers' increasing need for sophisticated, high impact graphics on their corrugated products. Customers are increasingly using special in-store corrugated displays to market their products and are requiring more intricate packaging designs. Our graphic design centers offer state-of-the-art computers and equipment that are capable of 24-hour design turnaround and reduced product delivery times.
Our converting operations are spread throughout the United States. Each corrugator plant serves a market radius that typically averages 150 miles. Our sheet plants are generally located in close proximity to our larger corrugator plants which enables us to offer additional services and converting capabilities such as small volume and quick turnaround items.
We produce a wide variety of 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 customers more attractive packaging.
TIMBERLAND
We currently lease the cutting rights to approximately 140,000 acres of timberland located near our Counce and Valdosta mills. All of the acres under cutting rights agreements are located within 100 miles of our mills, which results in lower wood transportation costs and provides a secure source of wood fiber. Virtually all of these leased cutting rights agreements have terms with over 20 years remaining.
During 1999 and 2000, PCA sold about 800,000 acres of timberland. As part of the timberland sale agreements, we entered into supply arrangements covering about 600,000 acres of the total acres sold. We also retained a one-third equity ownership interest in 385,000 acres sold to Southern Timber Venture, LLC. in November 2000.
In addition to the timberland we manage ourselves, our Forest Management Assistance Program provides professional forestry assistance to private timberland owners to improve harvest yields and to optimize their harvest schedule. We have managed the regeneration of approximately 100,000 acres by supplying pine seedlings. In exchange for our expertise, we are given the right of first refusal over timber sales from those lands. These private lands include over 200,000 acres of timberland. We expect to harvest over 150,000 cords of wood from these forests annually.
PCA also participates in the Sustainable Forestry Initiative, which is organized by the American Forest and Paper Association. This initiative is aimed at ensuring the long-term health and conservation of America's forestry resources. Activities include limiting tree harvest sizes, replanting harvest acreage, participating in flora and fauna research and protecting water streams.
SOLID WOOD AND RECYCLING FACILITIES
We own three sawmills located in Ackerman and Fulton, Mississippi and Selmer, Tennessee. During 2000, these three sawmills sold approximately 150.0 million board feet of lumber used to make furniture and building products. We also have an air-dry yard operation in Burnsville, Mississippi that holds newly cut lumber while it dries. Finally, we have a 50% interest in a wood chipping joint venture in Fulton, Mississippi.
We also operate three paper recycling centers, one in Jackson, Tennessee and two in Nashville, Tennessee. These recycling centers collect old corrugated containers, newspapers and other paper that provide a source of recycled fiber to our nearby Counce mill.
SALES AND MARKETING
Our corrugated products are sold through a direct sales and marketing organization. Sales representatives and a sales manager at each converting operations facility serve local and regional accounts. Corporate account managers serve large national accounts at multiple customer locations. Additionally, our graphic design centers maintain an on-site dedicated graphics sales force. General marketing support is located at our corporate headquarters.
Our containerboard sales group is responsible for the sale of linerboard and corrugating medium to our own corrugator plants, to other domestic customers and to the export market. This group handles order processing for all shipments of containerboard from our own mills to our own corrugator plants. These personnel also coordinate and execute all containerboard trade agreements with other containerboard manufacturers.
In addition to direct sales and marketing personnel, we utilize support personnel that are new product development engineers and product graphics and design specialists. These individuals are located at both the corrugator plants as well as the graphic design centers.
DISTRIBUTION
Our corrugated products are usually delivered by truck due to our large number of customers and their demand for timely service. Shipping costs represent a relatively high percentage of our total costs due to the high bulk of corrugated products. As a result, our converting operations typically service customers within a 150 miles radius.
Containerboard produced in our mills is shipped by rail or truck. Our individual mills do not own or maintain outside warehousing facilities. We do use some third-party warehouses for short-term storage.
CUSTOMERS
About 75% of our corrugated products customers are regional and local accounts, which are broadly diversified across industries and geographic locations. The remaining 25% of our customer base consists primarily of national accounts, or those customers with a national presence. These customers typically purchase corrugated products from several of our box plants throughout the United States.
Our 65 corrugated products plants consume approximately 80% of our mills' containerboard production. Of the remaining 20% of our containerboard production that we do not consume at our own converting operations, about 14% is sold to domestic customers, and about 6% is sold to export customers.
MAJOR RAW MATERIALS USED
FIBER SUPPLY. Fiber is the single largest cost in the manufacture of containerboard. To reduce our fiber costs we have invested in processes and equipment to ensure a high degree of fiber flexibility. Our mills have the capability to shift a portion of their fiber consumption between softwood, hardwood and recycled sources. With the exception of our Valdosta mill, our other mills can utilize some recycled fiber in their containerboard production. Our ability to use various types of virgin and recycled fiber helps mitigate the impact of changes in the prices of various fibers.
ENERGY SUPPLY. Energy at the mills is obtained through purchased electricity or through various fuels which are then converted to steam or electricity on-site. Fuel sources include coal, natural gas, oil, bark and by-products of the containerboard manufacturing and pulping process. These fuels are burned in boilers to produce steam. Steam turbine generators are used to produce electricity.
Our two kraft linerboard mills at Counce and Valdosta generate approximately 65% to 70% of their energy requirements from their own by-products. Presently, an average of 50% of our electricity consumption for the four mills is generated on-site.
COMPETITION
Corrugated products are produced by nearly 700 U.S. companies operating approximately 1,500 plants. Most corrugated products are custom manufactured to the customer's specifications. Corrugated producers generally sell within a 150-mile radius of their plants and compete with other corrugated producers in their local market. In fact, the Fibre Box Association tracks industry data by 47 distinct market regions.
The larger, multi-plant integrated companies may also solicit larger, multi-plant customers who purchase for all of their facilities on a consolidated basis. These customers are often referred to as national or corporate accounts.
Corrugated products businesses seek to differentiate themselves through pricing, quality, service, design and product innovation. We compete for both local and national account business and we compete against producers of other types of packaging products. On a national level, our competitors include Four M Corporation, Gaylord Container Corporation, Georgia-Pacific Corporation, International Paper Company, Smurfit-Stone Container Corporation, Temple-Inland Inc., Weyerhaeuser Company and Willamette Industries, Inc. However, with our strategic focus on local and regional accounts, we believe we compete as much with the smaller, independent converters as with the larger, integrated producers.
The competition relative to PCA's containerboard produced but not consumed at our own corrugated products plants are a number of large, diversified paper companies, including Georgia-Pacific Corporation, International Paper Company, Smurfit-Stone Container Corporation, Temple-Inland Inc., Weyerhaeuser Company and Willamette Industries, Inc., as well as other regional manufacturers. Containerboard is generally considered a commodity-type product and can be purchased from numerous suppliers.
EMPLOYEES
As of December 31, 2000, we had approximately 7,900 employees. Approximately 2,100 of these employees were salaried and approximately 5,800 were hourly. Approximately 75% of our hourly employees are represented by unions. Our unionized employees are represented primarily by the Paper, Allied Industrial, Chemical, Energy Workers International Union, the Graphic Communications International Union and the United Steel Workers of America.
Contracts for our unionized mill employees expire between May 2001 and October 2005. Contracts for unionized converting plant employees expire between June 2001 and November 2006. We are currently in negotiations to renew or extend any union contracts expiring in the near future.
There have been no instances of significant work stoppages in the past 15 years. We believe we have satisfactory relations with our employees.
ENVIRONMENTAL MATTERS
Compliance with environmental requirements is a significant factor in our business operations. We commit substantial resources to maintaining environmental compliance and managing environmental risk. We are subject to, and must comply with, a variety of federal, state and local environmental laws, particularly those relating to air and water quality, waste disposal and the cleanup of contaminated soil and groundwater. We believe that we are currently in material compliance with all applicable environmental rules and regulations. Because environmental regulations are constantly evolving, we have incurred, and will continue to incur, costs to maintain compliance with those laws. We work diligently to anticipate and budget for the impact of applicable environmental regulations and do not currently expect that future environmental compliance obligations will materially affect our business or financial condition.
In April 1998, the United States Environmental Protection Agency (EPA) finalized a new Clean Air and Water Act commonly referred to as the Cluster Rules, which govern all pulp and paper mill operations, including those at our mills. Over the next several years, the Cluster Rules will affect our allowable discharges of air and water pollutants. As a result, PCA and its competitors are required to incur costs to ensure compliance with these new rules. From 1997 through 2000, we spent approximately $28.2 million on Cluster Rule compliance to meet 2001 Clean Air Act requirements. Total capital costs for environmental matters, including Cluster Rule compliance, were $24.0 million for 2000 and we currently estimate that they will be $8.1 million for 2001 of which $2.1 million is for 2002 to 2005 Cluster Rule requirements. Our current spending projections to complete Cluster Rule compliance implementation at our four mills is about $25.7 million from 2001 to 2005.
As is the case with any industrial operation, we have in the past incurred costs associated with the remediation of soil or groundwater contamination. From January 1994 through December 2000, remediation costs at our mills and converting plants totaled about $2.6 million. We do not believe that any on-going remedial projects are material in nature. As of December 31, 2000, we maintained a reserve of $0.3 million for environmental remediation liability as well as a general overall environmental reserve of $2.6 million, which includes funds relating to onsite landfill and surface impoundments as well as on-going and anticipated remedial projects. We believe these reserves are adequate.
We could also incur environmental liabilities as a result of claims by third parties for civil damages, including liability for personal injury or property damage, arising from releases of hazardous substances or contamination. We are not aware of any material claims of this type currently pending against us.
In the transactions, Pactiv agreed to retain all liability for all former facilities and all sites associated with pre-closing offsite waste disposal. Pactiv also retained environmental liability for a closed landfill located near the Filer City mill.
ITEM 2.
ITEM 2. PROPERTIES
The table below provides a summary of our containerboard mills, the principal products produced and each mill's capacity.
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* We have operated only two of our three paper machines at Filer City since July 1998, reducing the total productive capacity by 70,000 tons to 297,000 tons.
Each of the mills is currently subject to a mortgage held by Morgan Guaranty Trust Company of New York on behalf of the lenders under the senior credit facility.
In addition to our mills, we own 43 corrugated products plants. We also own three sawmills, an air-drying yard, one recycling facility, one warehouse and miscellaneous other property, which includes sales offices and woodlands forest management offices. These sales offices and woodlands forest management offices generally have one to four employees and serve as administrative offices. We lease 22 corrugated products plants, five regional design centers, two recycling facilities and numerous other distribution centers, warehouses and facilities. PCA has no owned or leased properties outside of the continental United States. All of our owned real property is subject to a first priority mortgage held by Morgan Guaranty Trust Company of New York on behalf of the lenders under the senior credit facility.
We lease the cutting rights to approximately 140,000 acres of timberland located near our Counce and Valdosta mills. Virtually all of these cutting rights agreements have terms with over 20 years remaining.
We currently lease our executive and administrative offices in Lake Forest, Illinois from Pactiv under a lease expiring in January 2003. We currently believe that our facilities and properties are sufficient to meet our operating requirements for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On May 14, 1999, we were named as a defendant in a Consolidated Class Action Complaint which alleged a civil violation of Section 1 of the Sherman Act. The suit, captioned WINOFF INDUSTRIES, INC. V. STONE CONTAINER CORPORATION, MDL No. 1261 (E.D. Pa.), names us as a defendant based solely on the allegation that we are a successor to the interests of Tenneco Packaging Inc. and Tenneco Inc., both of which were also named as defendants in the suit, along with nine other linerboard manufacturers. The complaint alleges that the defendants, during the period October 1, 1993 through November 30, 1995, conspired to limit the supply of linerboard, and that the purpose and effect of the alleged conspiracy was artificially to increase prices of corrugated containers. The plaintiffs have moved to certify a class of all persons in the United States who purchased corrugated containers directly from any defendant during the above period, and seek treble damages and attorneys' fees on behalf of the purported class. The Court has yet to rule on the plaintiffs' motion for class certification, and the case is currently set for trial in June, 2002. We believe that the plaintiffs' allegations have no merit and intend to defend against the suit vigorously. We do not believe that the outcome of this litigation should have a material adverse effect on our financial position, results of operations, or cash flow.
We are also party to various legal actions arising in the ordinary course of our business. These legal actions cover a broad variety of claims spanning our entire business. We believe that the resolution of these legal actions will not, individually or in the aggregate, have a material adverse effect on our financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders in the fourth quarter of 2000.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
MARKET FOR COMMON STOCK; DIVIDENDS
As a result of PCA's initial public offering on January 28, 2000, PCA's common stock is listed on the New York Stock Exchange under the symbol "PKG". The following table sets forth the high and low sale prices as reported by the New York Stock Exchange during the last year.
As of March 16, 2001, there were 124 holders of record of PCA's common stock.
PCA has never paid dividends on the common stock. PCA currently has no plans to pay dividends on the common stock. The payment of any future dividends will be determined by PCA's Board of Directors in light of conditions then existing, including PCA's earnings, financial condition and capital requirements, restrictions in financing agreements, business conditions and other factors. Under the terms of the agreements governing our outstanding indebtedness, we are restricted in the amount of dividends we can pay on our common stock. In addition, under Delaware law, we are prohibited from paying any dividends unless we have "capital surplus" or "net profits" available for this purpose, as these terms are defined under Delaware law.
No equity securities of PCA were sold by PCA during fiscal year 2000 which were not registered under the Securities Act of 1933.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth the selected historical financial and other data of PCA and the containerboard and corrugated products business of Pactiv Corporation (the "Group"). The selected historical financial and other data as of and for the years ended December 31, 1996, 1997 and 1998, and for the period from January 1, 1999 to April 11, 1999, was derived from the audited combined financial statements of the Group and the related notes thereto included elsewhere in this report. The historical financial data as of December 31, 1999 and for the period from April 12, 1999 to December 31, 1999 and for the year ended December 31, 2000 has been derived from the audited consolidated financial statements of PCA included elsewhere in this report. The information contained in the following table also should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," the historical combined financial statements of the Group including the notes thereto and the historical consolidated financial statements of PCA including the notes thereto, contained elsewhere in this report.
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1) There was no activity for PCA from January 25, 1999, its date of inception, through April 11, 1999.
2) Net sales amounts have been restated in accordance with EITF 00-10. See Note 2 "Summary of Accounting Policies" in the 2000 Annual Report on Form 10-K for further information.
3) Earnings per share through April 11, 1999 has been calculated using the historical earnings of the Group and the number of common shares resulting from the closing of the acquisition on April 12, 1999 (94,600,000 common shares after giving effect to the 220-for-one stock split). For the PCA historical period from April 12, 1999 to December 31, 1999, earnings available to common stockholders includes a reduction for $9,296 of preferred stock dividends. For the year ended December 31, 2000, earnings available to common stockholders includes reductions of $2,371 of preferred stock dividends and $16,266 for the redemption of PCA's 12 3/8% preferred stock. PCA did not declare any dividends on its common shares in 1999 or 2000.
For all periods presented through April 11, 1999, basic and diluted earnings per share are the same because there are no potentially dilutive other securities. For the PCA historical period from April 12, 1999 to December 31, 1999, and for the year ended December 31, 2000, diluted earnings per share includes the dilutive effect of the portion of the 6,576,460 options granted in June 1999 that remained unexercised, and the dilutive effect of the 1,099,700 options granted in 2000. This dilutive effect is calculated using the treasury stock method.
4) Total long-term obligations include long-term debt, the current maturities of long-term debt and redeemable preferred stock. The amount excludes amounts due to Pactiv or other Tenneco affiliates as part of the Group's interdivision account or other financing arrangement.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements about us within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are subject to risks and uncertainties. Forward-looking statements include information concerning our future financial condition and business strategy. Statements that contain words such as "believes," "expects," "anticipates," "intends," "prospects," "estimates," "should," "may" or similar expressions are forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. While we believe these expectations and projections are reasonable, forward-looking statements are inherently subject to risks, uncertainties and assumptions about us.
The following discussion of historical results of operations and financial condition should be read in conjunction with the audited financial statements and the notes thereto which appear elsewhere in this report.
OVERVIEW
In connection with the transactions, PCA acquired The Containerboard Group of Pactiv Corporation, formerly known as Tenneco Packaging Inc., a wholly owned subsidiary of Tenneco Inc., which consisted of its containerboard and corrugated products business and which we refer to in this report as the Group. From its formation in January 1999 and through the closing of the acquisition on April 12, 1999, PCA did not have any significant operations. Accordingly, the historical financial results for periods prior to April 12, 1999 described below are those of the Group.
The Group operated prior to April 12, 1999 as a division of Pactiv, and not as a separate, stand-alone entity. As a result, the historical financial information included in this report does not necessarily reflect what the Group's financial position and results of operations would have been had the Group been operated as a separate, stand-alone entity during the periods prior to April 12, 1999.
The acquisition was accounted for using historical values for the contributed assets. Purchase accounting was not applied because, under the applicable accounting guidance, a change of control was deemed not to have occurred as a result of the participating veto rights held by Pactiv after the closing of the transactions under the terms of the stockholders agreement entered into in connection with the transactions.
GENERAL
Historically, prices for containerboard have reflected changes in containerboard supply that result from capacity additions and reductions, as well as changes in demand. Containerboard demand is dependent upon both domestic demand for corrugated products and linerboard export activity.
According to Pulp & Paper Week, after giving effect to price increases in 2000, average prices in December 2000 for linerboard and corrugating medium were 12% and 11% higher, respectively, than December 1999 prices.
Pulp & Paper Week, in its January 22, 2001 publication, reported that prices for linerboard and corrugating medium decreased $15 per ton, or 3%, and $20 per ton, or 4%, respectively, compared to December 2000 levels. The March 19, 2001 Pulp & Paper Week publication reported that prices remained unchanged from January 2001 levels.
RESULTS OF OPERATIONS
The historical results of operations of the Group and PCA are set forth below:
Note: Net sales amounts have been restated in accordance with EITF 00-10. See Note 2 "Summary of Accounting Policies" in the 2000 Annual Report on Form 10-K for further information.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO PRO FORMA YEAR ENDED DECEMBER 31, 1999
NET SALES
Net sales increased by $151.3 million, or 8.5%, for the year ended December 31, 2000 from the pro forma year ended December 31, 1999. The increase was primarily the result of increased sales prices of corrugated products and containerboard to third parties.
Corrugated products volume was essentially flat in 2000 compared to record volume in 1999 of 26.6 billion square feet. Containerboard volume to external domestic and export customers increased
2.6% to 586,000 tons for the year ended December 31, 2000 from 572,000 tons in the comparable period of 1999.
According to Pulp & Paper Week, average industry linerboard and semi-chemical medium prices for 42 lb. Liner-East and 26 lb. Medium-East, which are representative benchmark grades, were $468 and $446, respectively, per ton in 2000. This compares to $401 and $361, respectively, per ton in 1999. Acccording to the Fibre Box Association, average industry sale prices for corrugated products increased by 13.7% in 2000 from 1999.
INCOME BEFORE INTEREST EXPENSE AND INCOME TAXES (OPERATING INCOME)
Operating income increased by $138.4 million, or 67.2%, for the year ended December 31, 2000 compared to pro forma 1999. The increase was the result of increased sales prices of corrugated products and containerboard to third parties and reduced corporate overhead expenses. Operating income results for both years exclude fourth quarter gains on timberland sales of $60.4 million and $12.2 million for 2000 and 1999, respectively.
Gross profit increased $140.1 million, or 39.0%, for the year ended December 31, 2000 from the pro forma year ended December 31, 1999. Gross profit as a percentage of sales improved from 20.3% of sales in 1999 to 26.0% of sales in the current year primarily due to the sales price increases described above.
Corporate overhead for the year ended December 31, 2000, decreased by $2.5 million, or 5.8%, from the pro forma year ended December 31, 1999. The reduction primarily reflects the difference in cost between the overhead charged to the Group by Tenneco and Pactiv and overhead expenses incurred by PCA as a stand-alone entity. Corporate overhead for the pro forma year ended December 31, 1999 included three and one-half months of corporate overhead, through April 11, 1999, charged by Tenneco and Pactiv and eight and one-half months of corporate overhead expenses incurred by PCA as a stand-alone entity.
Selling and administrative expenses increased $4.6 million, or 4.2%, for the year ended December 31, 2000 from the comparable period in 1999. The increase was primarily the result of increased salary and other general selling related expenses.
INTEREST EXPENSE AND INCOME TAXES
Interest expense decreased by $34.0 million, or 22.4%, for the year ended December 31, 2000 from the comparable pro forma period in 1999, primarily due to voluntary prepayments PCA made on its term loans under the senior credit facility.
PCA's effective tax rate was 39.8% for the year ended December 31, 2000 and 45.5% for the pro forma year ended December 31, 1999. The tax rate is higher than the federal statutory rate of 35.0% due to state income taxes.
PRO FORMA YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998
NET SALES
Net sales increased by $126.7 million, or 7.7%, for the pro forma year ended December 31, 1999 from the comparable period in 1998. The increase was the result of increased sales volume of both corrugated products and containerboard and the increased sales prices of corrugated products and outside sales of containerboard.
Corrugated products volume increased by 6.4% to 26.6 billion square feet in 1999, from 25.0 billion square feet in 1998. Containerboard volume to external domestic and export customers increased 8.5% to 572,000 tons in 1999 from 527,000 tons in 1998.
According to Pulp & Paper Week, average linerboard and semi-chemical medium prices for 42 lb. Liner-East and 26 lb. Medium-East, which are representative benchmark grades, were $401 and $361, respectively, per ton in 1999. This compares to $373 and $315, respectively, per ton in 1998. Acccording
to the Fibre Box Association, average sale prices for corrugated products increased by 5.0% in 1999 from 1998.
INCOME BEFORE INTEREST EXPENSE AND INCOME TAXES (OPERATING INCOME)
Operating income increased by $87.1 million or 73.2% for the pro forma year ended December 31, 1999 compared to 1998. This increase excludes a $12.2 million gain on a 1999 fourth quarter timberlands sale and for the comparable period in 1998 a $16.9 million gain on the sale of non-strategic woodlands, a $15.1 million gain on the sale of a 20% interest in a recycled paperboard joint venture, a $14.4 million restructuring charge, and a $14.8 million charge for factored receivables financing. The increase was the result of increased sales volume of both corrugated products and containerboard, the increased sales prices of corrugated products and containerboard to third parties and reduced corporate overhead expenses.
Gross profit increased $78.0 million, or 27.7% for the pro forma year ended December 31, 1999 from the comparable period in 1998. Gross profit as a percentage of sales improved from 17.1% of sales in 1998 to 20.3% of sales in 1999 primarily due to the sales price and volume increases described above.
Corporate overhead for the pro forma year ended December 31, 1999, decreased by $20.5 million, or 32.4% from the comparable period in 1998. The reduction primarily reflects the difference in cost between the overhead charged to the Group by Tenneco and Pactiv and overhead expenses incurred by PCA as a stand-alone entity. Corporate overhead for the pro forma year ended December 31, 1999 included three and one-half months of corporate overhead, through April 11, 1999, charged by Tenneco and Pactiv and eight and one-half months of corporate overhead expenses incurred by PCA as a stand-alone entity. Corporate overhead for the comparable period in 1998 consisted exclusively of corporate overhead charged by Tenneco and Pactiv.
Selling and administrative expenses increased $0.9 million, or 0.8% for the pro forma year ended December 31, 1999 from the comparable period in 1998. The increase was primarily the result of Year 2000 remediation expenses (Y2K).
INTEREST EXPENSE AND INCOME TAXES
Interest expense increased by $148.9 million, or 5,353.3%, for the pro forma year ended December 31, 1999 from the comparable period in 1998, primarily due to borrowings under the senior credit facility and the issuance of $550.0 million of the senior subordinated notes. This indebtedness was incurred to finance the transactions.
PCA's effective tax rate was 45.5% for the pro forma year ended December 31, 1999 and 40.0% for the comparable period in 1998. The tax rate is higher than the federal statutory rate of 35.0% due to state income taxes.
LIQUIDITY AND CAPITAL RESOURCES
PRIOR TO THE TRANSACTIONS
As a division of Pactiv, the Group did not maintain separate cash accounts other than for petty cash. The Group's disbursements for payroll, capital projects, operating supplies and expenses were processed and funded by Pactiv through centrally managed accounts. In addition, cash receipts from the collection of accounts receivable and the sales of assets were remitted directly to bank accounts controlled by Pactiv.
Because of Pactiv's centrally managed cash system, in which the cash receipts and disbursements of Pactiv's various divisions were commingled, it was not feasible to segregate cash received from Pactiv, such as financing for the business, from cash transmitted to Pactiv, such as a distribution. Accordingly, the net effect of these cash transactions with Pactiv is represented as a single line item within the financing section of the statement of cash flows. Similarly, the activity of the interdivision account presents the net transfer of funds and charges between Pactiv and the Group as a single line item.
Since April 12, 1999, PCA has maintained its own cash accounts.
OPERATING ACTIVITIES
Cash flow provided by operating activities increased $127.8 million, or 60.5%, for the year ended December 31, 2000 from the comparable pro forma period in 1999. The increase was primarily due to an increase in net income.
Cash flow provided by operating activities increased by $15.8 million, or 8.1%, from 1998 to 1999. The increase was primarily due to the replacement of leased assets with owned, depreciable assets in connection with the April 12, 1999 transactions.
INVESTING ACTIVITIES
Cash used for investing activities increased by $31.5 million, or 20.9%, for the year ended December 31, 2000 compared to the pro forma year ended December 31, 1999. The increase was primarily attributable to increased capital expenditures and a reduction in proceeds from timberland sales.
Net cash used for investing activities decreased $328.1 million, or 184.6%, for the pro forma year ended December 31, 1999 from the comparable period in 1998, primarily attributable to a prepaid lease payment made in December 1998 to acquire timberland as part of a lease buy-out and timberlands sale proceeds received in the fourth quarter of 1999.
As of December 31, 2000, PCA had commitments for capital expenditures of $37.9 million. PCA believes operating cash flow from continuing operations will be sufficient to fund these commitments.
FINANCING ACTIVITIES
Cash used for financing activities increased by $29.4 million, or 6.8%, for the year ended December 31, 2000 compared to the pro forma year ended December 31, 1999, primarily reflecting increased voluntary prepayments made by PCA on its term loans under the senior credit facility.
Cash used for financing activities increased $413.3 million, or 2,339.0%, for the pro forma year ended December 31, 1999 from the comparable period in 1998. The increase was primarily attributable to the voluntary prepayments PCA has made on its term loans under the senior credit facility.
AFTER THE TRANSACTIONS
Following the transactions, PCA's primary sources of liquidity are cash flow from operations and borrowings under PCA's new revolving credit facility. PCA's primary uses of cash are for debt service and capital expenditures. PCA expects to be able to fund its debt service and capital expenditures from these sources.
PCA incurred substantial indebtedness in connection with the transactions. On April 12, 1999, PCA had approximately $1,769.0 million of indebtedness outstanding which included $1,219.0 million of senior secured bank debt, $550.0 million of 9 5/8% subordinated notes and $100.0 million of 12 3/8% preferred stock.
Concurrently with the transactions, PCA issued the notes and preferred stock and entered into the senior credit facility. The senior credit facility initially provided for three term loans in an aggregate amount of $1,219.0 million and a revolving credit facility with up to $250.0 million in availability. Upon the closing of the acquisition, PCA borrowed the full amount available under the term loans and $9.0 million under the senior revolving credit facility, the latter of which was repaid immediately thereafter.
In October and November 1999, PCA completed the sales of approximately 405,000 acres of timberland. Total proceeds received from the sales were $263.3 million, resulting in a pre-tax gain of $12.2 million.
Effective December 14, 1999, PCA elected to reduce its availability under the revolving credit facility from $250.0 million to $150.0 million. On June 29, 2000, PCA completed the refinancing of its $885.0 million senior credit facility.
On January 28, 2000, PCA became a publicly traded company with an initial public offering of its common stock. On March 3, 2000, PCA used the net proceeds from the offering to redeem all of its outstanding shares of 12 3/8% senior exchangeable preferred stock due 2010.
On November 16, 2000, PCA completed the sale of approximately 385,000 acres of timberland to Southern Timber Venture, LLC. The Company received $247.9 million in cash and a 33 1/3% equity ownership interest in Southern Timber Venture, LLC. PCA recorded a pre-tax gain of $60.4 million, and a portion of the gain was not recognized as a result of PCA's continuing ownership interest.
The following table provides the weighted average interest rate as of December 31, 2000 for each of the term loans and the revolving credit facility:
The borrowings under the senior revolving credit facility are available to fund PCA's working capital requirements, capital expenditures and other general corporate purposes. The Term Loan A must be repaid in quarterly installments from December 2002 through 2006. The Term Loan B must be repaid in quarterly installments from December 2002 through 2007. The senior revolving credit facility will terminate in 2006. The three-year revolving credit facility will terminate in 2003.
In 1999 and 2000, PCA made voluntary prepayments totaling approximately $440.0 million and $460.0 million, respectively, using free cash flow from operations of $389.0 million and proceeds from the sales of timberland of $511.0 million to permanently reduce its borrowings under the term loans.
The instruments governing PCA's indebtedness and the preferred stock contain financial and other covenants that restrict, among other things, the ability of PCA and its subsidiaries to:
- incur additional indebtedness,
- pay dividends or make certain other restricted payments,
- consummate certain asset sales,
- incur liens,
- 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.
PCA estimates that it will make approximately $135.0 million in capital expenditures in 2001. These expenditures will be used primarily for cost reduction, business growth, and environmental compliance.
PCA believes that cash generated from operations will be adequate to meet its anticipated debt service requirements, capital expenditures and working capital needs for the next 12 months, and that cash generated from operations and amounts available under the revolving credit facility will be adequate to meet its anticipated debt service requirements, capital expenditures and working capital needs for the foreseeable future. PCA's future operating performance and its ability to service or refinance the notes and to service, extend or refinance the senior credit facility will be subject to future economic conditions and to financial, business and other factors, many of which are beyond PCA's control.
ENVIRONMENTAL MATTERS
We are subject to, and must comply with, a variety of federal, state and local environmental laws, particularly those relating to air and water quality, waste disposal and the cleanup of contaminated soil and groundwater. Because environmental regulations are constantly evolving, we have incurred, and will continue to incur, costs to maintain compliance with those laws. In particular, the EPA recently finalized the Cluster Rules which govern pulp and paper mill operations, including those at the Counce, Filer City, Valdosta and Tomahawk mills. Over the next several years, the Cluster Rules will affect our allowable discharges of air and water pollutants, and require us to spend money to ensure compliance with those new rules.
As is the case with any industrial operation, we have, in the past, incurred costs associated with the remediation of soil or groundwater contamination, as required by the federal Comprehensive Environmental Response, Compensation and Liability Act, commonly known as the federal "Superfund" law, and analogous state laws. Cleanup requirements arise with respect to properties we currently own or operate, former facilities and off-site facilities where we have disposed of hazardous substances. Because liability under these laws is strict, meaning that liability is imposed without fault, joint and several, meaning that liability is imposed on each party without regard to contribution, and retroactive, we could receive notifications of cleanup liability in the future and this liability could be material. Under the terms of the contribution agreement, Pactiv has agreed to retain all liability for all former facilities and all sites associated with pre-closing off-site waste disposal. Pactiv has also retained environmentally impaired real property in Filer City, Michigan unrelated to current mill operations.
Because liability for remediation costs under environmental laws is strict, meaning that liability is imposed without fault, joint and several, meaning that liability is imposed on each party without regard to contribution, and retroactive, we could receive notifications of cleanup liability in the future and this liability could be material. From January 1994 through December 2000, remediation costs at our mills and converting plants totaled about $2.6 million. As of December 31, 2000, we maintained a reserve of $0.3 million for environmental remediation liability as well as a general overall environmental reserve of $2.6 million, which includes funds relating to onsite landfills and surface impoundments as well as on-going and anticipated remedial projects. Total capital costs for environmental matters, including Cluster Rule compliance, were $24.0 million for 2000 and we currently estimate that they will be $8.1 million for 2001, of which $2.1 million is for 2002 to 2005 Cluster Rule requirements.
IMPACT OF INFLATION
PCA does not believe that inflation has had a material impact on its financial position or results of operations during the past three years.
NEW ACCOUNTING STANDARDS
For a description of changes in accounting principles affecting PCA, see Note 2 to PCA's audited consolidated financial statements included elsewhere in this report.
ITEM 7A.
ITEM 7A. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Historically, PCA has not had any material market risk due to the fact that its debt financing and risk management activities were conducted by Pactiv or Tenneco. As a result of the transactions, PCA is exposed to the impact of interest rate changes and changes in the market value of its financial instruments. PCA periodically enters into derivatives in order to minimize these risks, but not for trading purposes.
Under the terms of the senior credit agreement dated as of April 12, 1999, PCA was required to maintain for at least two years after the closing of the transactions interest rate protection agreements establishing a fixed maximum interest rate with respect to at least 50% of the outstanding term loans under the senior credit agreement. Upon the refinancing of the senior credit agreement on June 29, 2000, this requirement was deleted.
PCA currently has interest rate collar agreements that protect against rising interest rates and simultaneously guarantee a minimum interest rate. The original notional amount of these collar agreements was $720.0 million. As PCA has made debt prepayments, the need for these collar agreements has diminished. Accordingly, PCA has reduced the notional amount of the collars to $250.0 million as of December 31, 2000. The weighted average floor of the interest rate collar agreements is 5.00% and the weighted average ceiling of the interest rate collar agreements is 6.83%. The interest rate on approximately 78% of PCA's variable-rate debt at December 31, 2000 is capped. PCA receives payments under the collar agreements if the applicable interest rate (LIBOR or commercial paper) exceeds the ceiling. Correspondingly, PCA makes payments under the collar agreements if the applicable interest rate drops below the floor. In both cases, the amounts received or paid are based upon the notional amount and the difference between the actual interest rate and the ceiling or floor rate. The weighted average duration of the interest rate collar agreements is approximately two and one quarter years.
PCA's earnings are affected by changes in short-term interest rates as a result of borrowings under its variable-rate debt instruments. If interest rates (LIBOR or commercial paper) for these borrowings increase one percent, PCA's interest expense would increase, and income before income taxes would decrease, by approximately $3.2 million and $7.8 million annually as of December 31, 2000 and 1999, respectively, until the applicable interest rate exceeds the ceiling rate. At that point, only 22% and 35% of the variable-rate debt as of December 31, 2000 and 1999, respectively, would result in additional interest expense. As of December 31, 2000, the weighted average LIBOR rate was 6.73% and the weighted average commercial paper rate was 6.60%. As of December 31, 1999, the interest rate on the term loans was based on a weighted average LIBOR rate of 5.95%. The effect of an interest rate change to the fair market value of the outstanding debt is insignificant. This analysis does not consider any other impact on fair value that could exist in such an interest rate environment. In the event of a change in interest rates, management could take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in PCA's financial structure.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is included in a separate section of this report on page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
There were no changes in or disagreements with PCA's accountants during 2000.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to PCA's directors is included under the caption "Board of Directors" in PCA's Proxy Statement, and is incorporated herein by reference. Information regarding certain Section 16(a) compliance is included under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in PCA's Proxy Statement, and is incorporated herein by reference.
EXECUTIVE OFFICERS
Brief statements setting forth the age at March 20, 2001, the principal occupation, employment during the past five years, the year in which such person first became an officer of PCA, and other information concerning each executive officer appears below.
PAUL T. STECKO is 56 years old and has served as Chief Executive Officer of PCA since January 1999 and as Chairman of PCA since March 1999. From November 1998 to April 1999, Mr. Stecko served as President and Chief Operating Officer of Tenneco Inc. From January 1997 to that time, Mr. Stecko served as Chief Operating Officer of Tenneco. From December 1993 through January 1997, Mr. Stecko served as President and Chief Executive Officer of Tenneco Packaging Inc. Prior to joining Tenneco Packaging, Mr. Stecko spent 16 years with International Paper Company. Mr. Stecko is a member of the board of directors of Pactiv Corporation, Tenneco Automotive Inc., State Farm Mutual Insurance Company, American Forest and Paper Association and Cives Corporation.
WILLIAM J. SWEENEY is 60 years old and has served as Executive Vice President--Corrugated Products of PCA since April 1999. From May 1997 to April 1999, Mr. Sweeney served as Executive Vice President--Paperboard Packaging of Tenneco Packaging Inc. From May 1990 to May 1997, Mr. Sweeney served as Senior Vice President and General Manager--Containerboard Products of Tenneco Packaging. From 1983 to that time, Mr. Sweeney served as General Manager and Vice President of Stone Container Corporation. From 1978 to 1983, Mr. Sweeney served as Sales Manager, Operations Manager and Division Vice President at Continental Group and from 1967 to that time, as Sales Manager and General Manager of Boise Cascade Corporation.
MARK W. KOWLZAN is 46 years old and has served as Vice President--Containerboard of PCA since April 1999. From 1998 to April 1999, Tenneco Packaging Inc. employed Mr. Kowlzan as Vice President and General Manager--Containerboard and from May 1996 to 1998, as Operations Manager and Mill Manager of the Counce mill. Prior to joining Tenneco Packaging, Mr. Kowlzan spent 15 years at International Paper Company, where he held a series of operational positions within its mill organization.
RICHARD B. WEST is 48 years old and has served as Chief Financial Officer of PCA since March 1999, as Corporate Secretary since April 1999 and also as Vice President since July 1999. From March 1999 to June 1999, Mr. West also served as Treasurer of PCA. Mr. West served as Vice President of Finance--Paperboard Packaging of Tenneco Packaging Inc. from 1995 to April 1999. Prior to joining Tenneco Packaging, Mr. West spent 20 years with International Paper Company where he served as an
Internal Auditor, Internal Audit Manager and Manufacturing Controller for the Printing Papers Group and Director/ Business Process Redesign.
ANDREA L. DAVEY is 44 years old and has served as Vice President--Human Resources of PCA since April 1999. From 1994 to April 1999, Ms. Davey was employed principally by Tenneco Packaging Inc. where she held the positions of Director of Field Employee Relations, Director of Training and Development, Director of Compensation and Benefits, and Project Manager of HRIS project and also served in the capacity of Vice President--Human Resources, Paperboard Packaging from May 1997 to April 1999. From 1992 until joining Tenneco Packaging in 1994, Ms. Davey served as Director of Human Resources for the Bakery division of Sara Lee Corporation. From 1989 to that time, she served as Human Resource Manager for the Converting Group of International Paper Company. Prior to that time, Ms. Davey spent five years with ITT Corporation, where she served in several human resources positions.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information with respect to executive compensation is included under the caption "Executive Compensation" in PCA's Proxy Statement and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to security ownership of certain beneficial owners and management is included under the caption "Information Regarding Beneficial Ownership of our Principal Shareholders, Directors and Management" in PCA's Proxy Statement and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to certain relationships and related transactions is included under the caption "Certain Relationships and Related Transactions" in PCA's Proxy Statement and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
(1) The financial statements listed in the "Index to Financial Statements."
(2) Financial Statement Schedules
The following consolidated financial statement schedules of the Group for the three years ended December 31, 1998 and for the period from January 1, 1999 through April 11, 1999 are included in this report.
Schedule II--Packaging Corporation of America--Valuation and Qualifying Accounts.
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* Consists primarily of write-offs and recoveries of bad debts.
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are inapplicable or not material, or the information called for thereby is otherwise included in the financial statements and therefore has been omitted.
We have audited in accordance with generally accepted auditing standards the financial statements of The Containerboard Group (a division of Tenneco Packaging Inc., which is a Delaware corporation and a wholly owned subsidiary of Tenneco Inc.), included in this report and have issued our report on the December 31, 1998, 1997 and 1996 financial statements dated February 26, 1999 and our report on the April 11, 1999 financial statements dated July 16, 1999. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed above is the responsibility of the company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois August 26, 1999
(2) FINANCIAL STATEMENT SCHEDULES (CONTINUED)
The following consolidated financial statement schedule of PCA for the year ended December 31, 2000 and for the period from April 12, 1999 through December 31, 1999 is included in this report.
Schedule II--Packaging Corporation of America--Valuation and Qualifying Accounts.
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* Consists primarily of write-offs and recoveries of bad debts.
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, are inapplicable or not material, or the information called for thereby is otherwise included in the financial statements and therefore has been omitted.
(b) REPORTS ON FORM 8-K
PCA did not file any Reports on Form 8-K during the period covered by this report.
(c) EXHIBITS
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* Management contract or compensatory plan or arrangement.
(1) Incorporated herein by reference to the same numbered exhibit to PCA's Registration Statement on Form S-1 (Registration No. 333-86963).
(2) Incorporated herein by reference to the same numbered exhibit to PCA's Registration Statement on Form S-4 (Registration No. 333-79511).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 27, 2001.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 27, 2001.
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Board of Directors and Shareholders of Packaging Corporation of America:
We have audited the accompanying consolidated balance sheets of Packaging Corporation of America as of December 31, 2000 and 1999 and the related consolidated statements of income, changes in shareholders' equity and cash flows for the year ended December 31, 2000 and the period from January 25, 1999 (date of incorporation) to December 31, 1999. Our audit also included the financial statement schedule listed in the index at Item 14(a). These financial statements and schedule are the responsibility of Packaging Corporation of America management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Packaging Corporation of America at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for the year ended December 31, 2000 and the period from January 25, 1999 to December 31, 1999 in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
Ernst & Young LLP
Chicago, Illinois January 19, 2001
PACKAGING CORPORATION OF AMERICA CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2000 AND 1999
See notes to consolidated financial statements.
PACKAGING CORPORATION OF AMERICA CONSOLIDATED STATEMENTS OF INCOME
See notes to consolidated financial statements.
PACKAGING CORPORATION OF AMERICA CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE PERIOD JANUARY 25, 1999 (DATE OF INCORPORATION) THROUGH DECEMBER 31, 2000
See notes to consolidated financial statements.
PACKAGING CORPORATION OF AMERICA CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
1. BASIS OF PRESENTATION
Packaging Corporation of America ("PCA" or the "Company") was incorporated on January 25, 1999 pursuant to the General Corporation Law of the State of Delaware. PCA was formed to acquire the containerboard and corrugated packaging products business (the "Group") of Pactiv Corporation, formerly known as Tenneco Packaging Inc., a wholly owned subsidiary of Tenneco Inc. PCA had no operations from the date of incorporation on January 25, 1999 to April 11, 1999.
On April 12, 1999, Pactiv Corporation ("Pactiv") sold the Group to PCA for $2.2 billion. The Group is the predecessor to PCA. The $2.2 billion purchase price paid to Pactiv for the Group consisted of $246.5 million in cash, the assumption of $1.8 billion of debt incurred by Pactiv immediately prior to closing, and the issuance of a 45% common equity interest in PCA. PCA Holdings, an entity organized and controlled by Madison Dearborn Partners, LLC, acquired the remaining 55% common equity interest in PCA for $236.5 million in cash. These events are collectively referred to as the "Transactions." Because significant veto rights were retained by Pactiv, the carryover basis of accounting was used and no goodwill was recognized. Fees of $23.8 million were incurred as part of the Transactions and were recorded as a charge to shareholders' equity.
On August 25, 1999, PCA Holdings and Pactiv agreed that the acquisition consideration should be reduced as a result of a post-closing price adjustment by $20.0 million. On September 23, 1999, Pactiv paid PCA $20.7 million, representing the $20.0 million adjustment and $0.7 million of interest through the date of payment by Pactiv.
The Company is comprised of mills and corrugated products operations. The mill operations (the "Mills") consist of two Kraft linerboard mills located in Counce, Tennessee, and Valdosta, Georgia, and two medium mills located in Filer City, Michigan, and Tomahawk, Wisconsin. The Mills also include two recycling centers located in Nashville, Tennessee, and a recycling center located in Jackson, Tennessee. The Company leases the cutting rights to approximately 140,000 acres of timberland as of December 31, 2000. The Mills transfer the majority of their output to PCA's corrugated products operations ("Corrugated").
PCA's corrugated operations consist of 65 corrugated products plants, a supply services group, a technical and development center, and five graphic design centers. All plants are located in North America. Corrugated combines linerboard and medium (primarily from the Mills) into sheets that are converted into corrugated shipping containers, point-of-sale graphics packaging, point-of-purchase displays and other specialized packaging. Corrugated sells to diverse customers primarily in North America.
2. SUMMARY OF ACCOUNTING POLICIES
BASIS OF CONSOLIDATION
The accompanying consolidated financial statements of Packaging Corporation of America include all majority-owned subsidiaries. The Company has two joint ventures that are carried under the equity method. All significant intercompany transactions have been eliminated.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts in the financial statements and the accompanying notes. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include all cash balances and highly liquid investments with a maturity of three months or less. Cash equivalents are stated at cost, which approximates market.
INVENTORIES
Raw materials, work in process and finished goods are valued using the lower of last-in, first-out ("LIFO") cost or market method. Supplies and materials inventories are valued using a moving average cost. All inventories are stated at the lower of cost or market. Inventories valued using the LIFO method comprised 77% and 76% of inventories at current cost at December 31, 2000 and December 31, 1999, respectively.
The components of inventories are as follows:
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment and timber and timberlands are recorded at cost.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) Property, plant and equipment by major classification are as follows:
The amount of interest capitalized related to construction in progress was approximately $0.6 million for the year ended December 31, 2000 and $0.1 million for the period April 12, 1999 through December 31, 1999.
Depreciation is computed on the straight-line basis over the estimated useful lives of the related assets. The following lives are used for the various categories of assets:
Timber depletion is provided on the basis of timber cut during the period related to the estimated quantity of recoverable timber. Assets under capital leases are depreciated on the straight-line method over the term of the lease.
Expenditures for repairs and maintenance are expensed as incurred.
INTANGIBLE ASSETS
The Company has capitalized certain intangible assets based on their estimated fair value at the date of acquisition. Amortization is provided for these intangible assets on a straight-line basis over periods ranging from three to ten years. Covenants not to compete are amortized on a straight-line basis over the terms of the respective agreements.
OTHER LONG-TERM ASSETS
PCA has capitalized certain costs related to obtaining its financing. These costs are amortized to interest expense using the effective interest rate method over the terms of the senior credit facility and senior subordinated notes, which range from seven years to nine years. Deferred financing costs were $29.0 million and $50.6 million as of December 31, 2000 and December 31, 1999, respectively.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) PCA also capitalizes certain costs related to the purchase and development of software which is used in its business operations. The costs attributable to these software systems are amortized over their estimated useful lives based on various factors such as the effects of obsolescence, technology and other economic factors.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. In the event that facts and circumstances indicate that the carrying amount of any long-lived assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to discounted cash flows is required.
FINANCIAL INSTRUMENTS
The Company uses interest rate collar agreements to manage interest costs and the risk associated with changing interest rates. As interest rates change, the differential paid or received is recognized in interest expense of the period.
INCOME TAXES
PCA utilizes the liability method of accounting for income taxes whereby it recognizes deferred tax assets and liabilities for the future tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets are reduced by a valuation allowance when, based upon management's estimates, it is more likely than not that a portion of the deferred tax assets will not be realized in a future period. The estimates utilized in the recognition of deferred tax assets are subject to revision in future periods based on new facts or circumstances.
REVENUE RECOGNITION
The Company recognizes revenue as title to the products is transferred to customers. In 2000, the Company adopted EITF 00-10, "Accounting for Shipping and Handling Fees and Costs."
Shipping and handling costs are included in cost of sales. Shipping and handling billings to a customer in a sales transaction are included in revenue. Prior year amounts have been reclassed to conform to this treatment.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred. The amount charged was $3.4 million and $2.5 million for the year ended December 31, 2000 and for the period from April 12, 1999 through December 31, 1999, respectively.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) FREIGHT TRADES
PCA regularly trades containerboard with other manufacturers primarily to reduce shipping costs. The freight trade transactions are accounted for primarily as transactions in the inventory accounts; the impact on income is not material.
SEGMENT INFORMATION
The Company is primarily engaged in one line of business: the manufacture and sale of packaging materials, boxes and containers for industrial and consumer markets. No single customer accounts for more than 10% of total revenues. PCA has no foreign operations.
NEW ACCOUNTING PRONOUNCEMENTS
In June, 1998, Financial Accounting Standards No. 133 ("FAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities" was issued and is effective for the Company January 1, 2001. FAS No. 133, as amended by FAS No. 138, requires the Company to recognize all derivatives as either assets or liabilities and to measure those instruments at fair value. It further provides criteria for derivative instruments to be designated as fair value, cash flow or foreign currency hedges and establishes respective accounting standards for reporting changes in the fair value of the derivative instruments. Upon adoption, the Company will be required to adjust hedging instruments to fair value in the balance sheet and recognize the offsetting gains or losses as adjustments to be reported in net income or other comprehensive income, as appropriate. The adoption of FAS No. 133 on January 1, 2001, did not have a material impact on the Company's consolidated financial position or results of operations.
RECLASSIFICATIONS
Prior year's financial statements have been reclassified where appropriate to conform with current year presentation.
3. EARNINGS PER SHARE
All share and per share data included in the accompanying consolidated financial statements have been adjusted to reflect a 220-for-one-split of the Company's common stock which became effective on October 19, 1999.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
3. EARNINGS PER SHARE (CONTINUED) The following table sets forth the computation of basic and diluted income per common share for the periods presented.
4. ACCRUED LIABILITIES
The components of accrued liabilities are as follows:
5. EMPLOYEE BENEFIT PLANS AND OTHER POSTRETIREMENT BENEFITS
In connection with the Transactions, PCA and Pactiv entered into a human resources agreement which, among other items, granted PCA employees continued participation in the Pactiv pension and welfare plans for a period of up to five years following the closing of the Transactions for an agreed upon fee. For salaried employees, PCA will pay Pactiv $4.0 million in the first and second years, $6.0 million in the third year, $8.0 million in the fourth year, and $10.0 million in the fifth year following the closing date of the Transactions. For hourly employees, PCA will pay Pactiv $1.2 million per year through December 31, 2000 and then $4.5 million per year for two additional years. These amounts can be adjusted if there are material increases in the pension costs to Pactiv. The fees paid to Pactiv are expensed ratably throughout the year. PCA intends to adopt its own compensation and benefit plans with respect to its employees sometime in the future.
The Company adopted a supplemental executive retirement plan in 2000 that provides supplemental pension benefits for certain executive officers of the Company. Benefits are based upon
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
5. EMPLOYEE BENEFIT PLANS AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) years of service and the highest three year average of compensation. The benefit obligation and pension costs were not significant.
PCA also provides certain medical benefits for retired employees and certain medical and life insurance benefits for certain terminated employees. For salaried employees, the plan covers employees retiring from PCA on or after attaining age 55 who have had at least 10 years service with PCA after attaining age 45. For hourly employees, the postretirement medical coverage, where applicable, is available according to the eligibility provisions in effect at the employee's work location. Per the human resources agreement referred to above, Pactiv retained the liability relating to retiree medical and life benefits for PCA employees who had retired on or before the closing date of the Transactions or who will retire within two years of that date. Any postretirement liability recorded on PCA's balance sheet relates to active employees only.
Financial data pertaining to the Company's postretirement benefit plan follow:
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
5. EMPLOYEE BENEFIT PLANS AND OTHER POSTRETIREMENT BENEFITS (CONTINUED) The accrued postretirement benefit cost has been recorded based upon certain actuarial estimates as of September 30, 2000 and 1999, as shown below. These estimates are subject to revision in future periods given new facts or circumstances.
Increasing the assumed health care cost trend rate by one percentage point would increase the 2000 postretirement benefit obligation by approximately $0.4 million and would increase the net postretirement benefit cost by approximately $0.1 million.
On February 1, 2000, the Company adopted two defined contribution benefit plans that cover all full-time salaried employees and certain hourly employees at several of the Company's facilities. Employees can make voluntary contributions in accordance with the provisions of their respective plan. The Company expensed $6.1 million for matching contributions during 2000.
6. LONG-TERM DEBT
A summary of long-term debt is set forth in the following table:
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
6. LONG-TERM DEBT (CONTINUED) Additional information regarding PCA's variable rate debt is shown below:
Since April 12, 1999, PCA has made voluntary prepayments totaling approximately $900.0 million using excess cash and proceeds from the sale of certain timberlands to permanently reduce its borrowings under the term loans. As a result of these prepayments, PCA recorded a charge of $18.4 million ($11.1 million after tax) and $11.4 million ($6.9 million after tax), respectively, as an early extinguishment of debt in December, 2000 and 1999. No quarterly installments will be required under any of the term loans until December 31, 2002.
As of December 31, 2000, annual principal payments for debt during the next five years are: $0.2 million (2001), $7.6 million (2002), $175.4 million (2003), $36.4 million (2004), $37.5 million (2005), and $612.1 million (2006 and thereafter).
Interest payments in connection with the Company's debt obligations for the year ended December 31, 2000 and for the period from April 12, 1999 through December 31, 1999 amounted to $112.6 million and $89.5 million, respectively.
On June 29, 2000, the Company completed the refinancing of its senior credit facility. The new refinancing lowered the Company's margins over LIBOR on Term Loans A and B and eliminated Term Loan C, resulting in an average margin reduction of about 100 basis points. The Company incurred approximately $3.6 million in bank syndication and arrangement fees, which were rolled into the current debt structure.
On November 29, 2000, PCA entered into a three-year, $150.0 million revolving credit facility in connection with the securitization of trade receivables. The facility is secured by the Company's receivables and bears interest at a floating rate based upon commercial paper plus an allowed margin under the agreement. Proceeds received of $142.0 million were used to repay the Term Loans. In connection with the securitization transaction, PCA established Packaging Credit Company, LLC. This entity services PCA's receivables.
The senior credit facility is (1) jointly and severally guaranteed by each of PCA's existing subsidiaries and (2) secured by a first priority lien covering substantially all of the owned timberland, mills, plants and other facilities and substantially all tangible and intangible personal property of PCA and its domestic subsidiaries and by a pledge of all of the capital stock of PCA's domestic subsidiaries. In addition, the senior credit facility will also be secured by a pledge of 65% of the capital stock of any
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
6. LONG-TERM DEBT (CONTINUED) first tier foreign subsidiaries that PCA may acquire or form in the future. PCA's future domestic subsidiaries will guarantee the senior credit facility and secure that guarantee with certain of their real property and substantially all of their tangible and intangible personal property.
PCA's various debt agreements contain various covenants that restrict the ability of PCA and its subsidiaries to incur additional indebtedness, pay dividends or make certain other restricted payments, consummate certain asset sales, incur liens, enter into certain transactions with affiliates, or merge or consolidate with any other person or sell or dispose of all or substantially all of the assets of the Company. They also require PCA to comply with certain financial covenants, including the ratio of earnings before interest, taxes, depreciation, and amortization (EBITDA) to cash interest expense, the ratio of debt to EBITDA, and minimum net worth levels. At December 31, 2000, the Company was in compliance with all of its covenants.
The Company maintains interest rate collar agreements for its variable rate debt. The interest rate collar agreements protect against rising interest rates while simultaneously guaranteeing minimum interest rates. The notional amount of these collars is $250.0 million and $510.0 million at December 31, 2000 and December 31, 1999, respectively. Approximately 80% of PCA's term loan obligations are capped. The weighted average floor of the interest rate collar agreements is 5.00% and the weighted average ceiling is 6.83%. On November 29, 1999, PCA terminated $180.0 million of interest rate collar agreements and received $1.2 million. On January 14, 2000, PCA terminated $110.0 million of interest rate collar agreements and received $1.9 million. The senior credit facility provides PCA with the right to lock-in LIBOR interest rates for any amount of term loans for one, two, three, or six-month periods. With the approval of the lenders, PCA can lock-in LIBOR interest rates for either a two-week or twelve-month period. The three-year revolving credit facility also provides PCA with the right to lock-in commercial paper interest rates for a one, two, or three-month period.
A summary of the Company's drawings under credit facilities as of December 31, 2000 follows:
PCA is required to pay commitment fees on the unused portions of the revolving credit facilities. In December of 1999, PCA reduced the availability under the senior revolving credit facility from $250.0 million to $150.0 million.
At December 31, 2000 and December 31, 1999, letters of credit amounting to approximately $21.9 million and $19.7 million were outstanding which relate primarily to various environmental obligations, including landfills and solid waste programs, management equity loans, workers' compensation, and equipment leases.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
7. FINANCIAL INSTRUMENTS
The carrying and estimated fair values of PCA's financial instruments at December 31, 2000 and December 31, 1999 were as follows:
SHORT-TERM ASSETS AND LIABILITIES
The fair value of cash and cash equivalents, accounts receivable, notes receivable and accounts payable approximate their carrying amounts due to the short-term nature of these financial instruments.
LONG-TERM DEBT
The fair value of the senior credit facility and the three-year revolving credit faciltiy approximates their carrying amount due to the variable interest-rate feature of the instruments. The fair value of the senior subordinated notes is based on quoted market prices. The fair values of the remaining debt were considered to be the same as or were not determined to be materially different from the carrying amounts.
REDEEMABLE PREFERRED STOCK
The fair value of the redeemable preferred stock is based on amounts obtained from investment advisors.
INTEREST RATE COLLARS
The fair values of the interest rate collars are the amounts at which they could be settled and are estimated by obtaining quotes from banks.
8. MANDATORY REDEEMABLE PREFERRED STOCK
On April 12, 1999, PCA issued 1,000,000 shares of 12.375% senior exchangeable preferred stock, liquidation preference of $100 per share. Holders of the preferred shares are entitled to receive cumulative dividends paid in cash or in kind at a rate of 12.375% which are paid semi-annually. If PCA fails to pay dividends, holders of the preferred stock will be entitled to elect two additional members to PCA's Board of Directors. Holders of the preferred stock have no voting rights. The preferred stock
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
8. MANDATORY REDEEMABLE PREFERRED STOCK (CONTINUED) ranks senior to the common stock. 3,000,000 shares were authorized, and 1,058,094 shares were issued and outstanding as of December 31, 1999. PCA incurred $3.5 million of issuance costs, which are being amortized through 2010 at which time the preferred stock is required to be redeemed.
PCA used substantially all of the net proceeds from its initial public offering to redeem all outstanding shares of its 12.375% senior exchangeable preferred stock due 2010 (1,058,094 shares as of March 3, 2000) at a redemption price of 112.375% of its liquidation preference, plus accrued and unpaid dividends through March 3, 2000, the date of redemption. The total paid to redeem the senior exchangeable preferred stock was $124.4 million, which included $5.5 million of accrued and unpaid dividends.
9. SHAREHOLDERS' EQUITY
On April 12, 1999, PCA issued 100 shares of Junior Preferred Stock, liquidation preference of $1.00 per share. Holders of the Junior Preferred Stock are not entitled to receive any dividends or distributions and had, prior to February 2, 2000, the right to elect one director to PCA's Board of Directors. Shares of Junior Preferred Stock may not be reissued after being reacquired in any manner by PCA. On December 20, 2000, PCA redeemed the Junior Preferred Stock.
In June 1999, PCA entered into management equity agreements with 125 of its management-level employees. Under these agreements, PCA Holdings and Pactiv Corporation sold 3,132,800 shares of common stock to 113 of these employees at $4.55 per share. The stock purchased under the management equity agreements is subject to vesting. The management equity agreements also provide for the grant of options (see Note 16).
On October 19, 1999, PCA effected a 220-for-one stock split of its common stock which resulted in an increase in the number of shares outstanding from 430,000 to 94,600,000. All historical share numbers for PCA contained in the financial statements and related notes reflect the 220-for-one split.
On January 28, 2000, PCA became a publicly traded company through the initial public offering of its common stock in which Pactiv Corporation sold 35,000,000 of its 41,160,240 shares of common stock in PCA, and PCA issued an additional 11,250,000 shares. The net proceeds to PCA were approximately $126.4 million, after deducting underwriting discounts and offering expenses at an initial public offering price of $12.00 per share. PCA utilized these proceeds to redeem its senior exchangeable preferred stock (see Note 8).
10. COMMITMENTS AND CONTINGENCIES
CAPITAL COMMITMENTS
The Company had authorized capital expenditures of approximately $37.9 million and $66.3 million as of December 31, 2000 and December 31, 1999, respectively, in connection with the expansion and replacement of existing facilities and equipment.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
10. COMMITMENTS AND CONTINGENCIES (CONTINUED) LEASE COMMITMENTS
The Company holds certain of its facilities, equipment, and other assets under long-term leases. The minimum lease payments under non-cancelable operating leases with lease terms in excess of one year are as follows:
Commitments under capital leases were not significant to the accompanying financial statements. Total rental expense for the year ended December 31, 2000 and for the period from April 12, 1999 through December 31, 1999 was $22.3 million and $15.0 million, respectively. These costs are included primarily in cost of goods sold.
PURCHASE COMMITMENTS
The Company has entered into various minimum purchase agreements to buy energy over periods ranging from one to five years. Total purchase commitments over the next five years are as follows:
The Company purchased approximately $9.3 million during the year ended December 31, 2000 and $7.8 million during the period from April 12, 1999 through December 31, 1999 under these purchase agreements.
LITIGATION
The Company is involved in various legal proceedings and litigation arising in the ordinary course of business. In the opinion of management and in-house legal counsel, the outcome of such proceedings and litigation will not materially affect the Company's financial position or results of operations.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
10. COMMITMENTS AND CONTINGENCIES (CONTINUED) ENVIRONMENTAL LIABILITIES
The estimated landfill closure and postclosure maintenance costs expected to be incurred upon and subsequent to the closing of existing operating landfill areas are accrued based on the landfill capacity used to date. Amounts are estimates using current technologies for closure and monitoring and are not discounted.
The potential costs for various environmental matters are uncertain due to such factors as the unknown magnitude of possible cleanup costs, the complexity and evolving nature of governmental laws and regulations and their interpretations, and the timing, varying costs and effectiveness of alternative cleanup technologies. Liabilities recorded by the Company for environmental contingencies are estimates of the probable costs based upon available information and assumptions. Because of these uncertainties, however, PCA's estimates may change. PCA believes that any additional costs identified as further information becomes available would not have a material effect on its financial statements.
In the transactions, Pactiv agreed to retain all liability for all former facilities and all sites associated with pre-closing offsite waste disposal. Pactiv also retained environmental liability for a closed landfill located near the Filer City mill.
11. INCOME TAXES
Following is an analysis of the components of consolidated income tax expense (benefit):
The effective tax rate varies from the U.S. Federal statutory tax rate principally due to the following:
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
11. INCOME TAXES (CONTINUED) The components of the deferred tax assets (liabilities) were as follows:
Cash payments for income taxes were $23.7 million for the year ended December 31, 2000 and $4.1 million for the period April 12, 1999 through December 31, 1999. As of December 31, 2000, the Company has available for income tax purposes approximately $15.5 million in alternative minimum tax credits which may be used to offset future taxable income. As of December 31, 1999, the Company had available approximately $39.0 million in net operating loss carry forwards and minimum tax credits.
12. RELATED PARTY TRANSACTIONS
PCA purchases pulpwood from Southern Timber Venture, LLC in accordance with the terms of a fiber supply agreement between the two companies which expires December 31, 2017. The price of pulpwood in this agreement is based upon the fair market value of pulpwood and is adjusted annually for any changes in the fair market value of pulpwood. PCA purchased $1.7 million of pulpwood for its Counce, Tennessee and Valdosta, Georgia mills from Southern Timber Venture, LLC during the period from November 16, 2000, through December 31, 2000.
PCA's sales to Pactiv Corporation are included in the accompanying consolidated financial statements. The net sales to Pactiv Corporation for the year ended December 31, 2000 were $100.5 million. The net sales to Pactiv Corporation for the period April 12, 1999 through December 31, 1999 were approximately $57.4 million. The accounts receivable relating to these sales as of December 31, 2000 and December 31, 1999 were $13.3 million and $12.3 million, respectively.
PCA entered into a transition services agreement with Pactiv which provided for the performance of transitional services by Pactiv and its affiliates to PCA that PCA required to operate its business. These services included: payroll, general accounting, tax support, treasury/cash management, insurance/
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
12. RELATED PARTY TRANSACTIONS (CONTINUED) risk management, procurement, human resources, telecommunications and information services. The initial term of the transition services agreement was for one year, but was extended by PCA for an additional six month term. During the period April 12, 1999 through December 31, 1999, PCA paid Pactiv $6.5 million for these services. For the year 2000, PCA paid Pactiv $2.6 million. As of October 2000, the transition services agreement was terminated.
Pactiv also agreed to reimburse PCA for up to $5.4 million in expenditures incurred by PCA relating to system enhancement and year 2000 compliance in the transition services agreement. The full $5.4 million was received by PCA during 1999.
PCA and Pactiv entered into a facility use agreement which provides for PCA's use of a portion of Pactiv's headquarters located in Lake Forest, Illinois and certain building and business services for up to four years following the closing of the transactions. PCA paid Pactiv $2.4 million for the year ended December 31, 2000 and $1.5 million for the period April 12, 1999 through December 31, 1999.
13. RESTRUCTURING AND OTHER CHARGES
As part of the April 12, 1999 Transactions, the Company assumed accruals related to a previously recorded restructuring charge set forth below. This charge was recorded prior to the Transactions following approval by Tenneco's Board of Directors of a comprehensive restructuring plan for all of Tenneco's operations, including those of the Company. In connection with this restructuring plan, four corrugated facilities were closed and 109 positions were eliminated.
The following table reflects the components of this assumed accrual:
The fixed assets at the closed facilities were written down to their estimated fair value. No significant cash proceeds are expected from the ultimate disposal of these assets. The remaining liability balance at December 31, 2000 will be used for rent payments related to the two closed facilities.
14. SALE OF TIMBERLANDS
In October and November, 1999, PCA completed the sales of approximately 405,000 acres of timberland. Total proceeds received from the sales were $263.3 million, resulting in a pre-tax gain of $12.2 million.
On November 16, 2000, PCA completed the sale of approximately 385,000 acres of timberland to Southern Timber Venture, LLC. The Company received $247.9 million in cash and a 33 1/3% equity ownership interest in Southern Timber Venture, LLC. PCA recorded a pre-tax gain of $60.4 million, and a portion of the gain was not recognized as a result of PCA's continuing ownership interest.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
15. SUMMARIZED COMBINED FINANCIAL INFORMATION ABOUT GUARANTOR SUBSIDIARIES
The following is summarized aggregated financial information for Packaging Credit Company, LLC, Dahlonega Packaging Corporation, Dixie Container Corporation, PCA Hydro, Inc., PCA Tomahawk Corporation and PCA Valdosta Corporation, each of which was a wholly-owned subsidiary of PCA and included in the Company's consolidated financial statements. Each of these subsidiaries fully, unconditionally, jointly and severally guaranteed $550.0 million in senior subordinated notes issued by PCA in connection with the Transactions. Effective January 1, 2000, Dahlonega Packaging Corporation, PCA Tomahawk Corporation and PCA Valdosta Corporation were merged into PCA. Separate financial statements of the guarantor subsidiaries are not presented because, in the opinion of management, such financial statements are not material to investors.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
15. SUMMARIZED COMBINED FINANCIAL INFORMATION ABOUT GUARANTOR SUBSIDIARIES (CONTINUED)
16. STOCK-BASED COMPENSATION
PCA entered into management equity agreements in June 1999 with 125 of its management-level employees. These agreements provide for the grant of options to purchase up to an aggregate of 6,576,460 shares of PCA's common stock at approximately $4.55 per share, the same price per share at which PCA Holdings purchased common stock in the Transactions. These options vest ratably over a five-year period. Upon completion of an initial public offering, the options become immediately exercisable. The option shares are subject to contractual restrictions on transfer for a period of up to 18 months following completion of the offering.
In October 1999, the Company adopted a long-term equity incentive plan, which provides for grants of stock options, stock appreciation rights (SARs), restricted stock and performance awards to directors, officers and employees of PCA, as well as others who engage in services for PCA. Under the plan, which will terminate on June 1, 2009, up to 4,400,000 shares of common stock is available for issuance under the long-term equity incentive plan.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
16. STOCK-BASED COMPENSATION (CONTINUED) A summary of the Company's stock option activity, and related information for the year ended December 31, 2000 and 1999 follows:
Summarized below is information about stock options outstanding at December 31, 2000:
Black-Scholes option-pricing model assumptions and fair value for these options are shown in the following table:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
PACKAGING CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
16. STOCK-BASED COMPENSATION (CONTINUED) As permitted by SFAS No. 123, "Accounting for Stock-Based Compensation," the Company has elected to account for its stock option plan under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and adopt the disclosure only provisions of SFAS No. 123. Under APB No. 25, no compensation costs are recognized because the number of options is fixed and the option exercise price is equal to the fair market price of the common stock on the date of the grant. Under SFAS No. 123, stock options are valued at the grant date using the Black-Scholes valuation model and compensation costs are recognized ratably over the vesting period. Had compensation costs been determined as prescribed by SFAS No. 123, the Company's net earnings and diluted earnings per common share for the year ended December 31, 2000, and the period January 25, 1999 through December 31, 1999, would have been lower by $5.1 million or $0.05 per diluted common share, and $0.6 million or $0.01 per diluted common share, respectively.
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
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Notes:
(1) PCA acquired the Group on April 12, 1999. As such, operating results for the period prior to April 12, 1999 have been excluded from PCA's 1999 results.
(2) PCA became a publicly traded company on January 28, 2000, as such, there are no stock prices for 1999.
(3) Net sales have been restated in accordance with EITF Issue No. 00-10, "Accounting for Shipping and Handling Fees and Costs".
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Tenneco Inc.:
We have audited the accompanying combined statements of assets, liabilities and interdivision account of THE CONTAINERBOARD GROUP (a division of Tenneco Packaging Inc., which is a Delaware corporation and a wholly owned subsidiary of Tenneco Inc.) as of April 11, 1999, and the related combined statements of revenues, expenses and interdivision account and cash flows for the period from January 1, 1999, through April 11, 1999. These financial statements are the responsibility of the Group's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the combined financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the combined financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall combined financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of The Containerboard Group as of April 11, 1999, and the results of its operations and its cash flows for the period from January 1, 1999, through April 11, 1999, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois July 16, 1999
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.) COMBINED STATEMENT OF ASSETS, LIABILITIES AND INTERDIVISION ACCOUNT AS OF APRIL 11, 1999 (IN THOUSANDS)
The accompanying notes to combined financial statements are an integral part of these statements.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.) COMBINED STATEMENT OF REVENUES, EXPENSES AND INTERDIVISION ACCOUNT FOR THE PERIOD FROM JANUARY 1, 1999, THROUGH APRIL 11, 1999 (IN THOUSANDS)
The accompanying notes to combined financial statements are an integral part of these statements.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.) COMBINED STATEMENT OF CASH FLOWS FOR THE PERIOD FROM JANUARY 1, 1999, THROUGH APRIL 11, 1999 (IN THOUSANDS)
The accompanying notes to combined financial statements are an integral part of these statements.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS
APRIL 11, 1999
1. BUSINESS DESCRIPTION
The Containerboard Group (the "Group") is a division of Tenneco Packaging Inc., ("Packaging") which is a wholly owned subsidiary of Tenneco Inc. ("Tenneco"). The Group is comprised of mills and corrugated products operations. Madison Dearborn Partners, LLC ("MDP"), is a private equity investment firm.
The Mill operations ("The Mills") consist of two Kraft linerboard mills located in Counce, Tennessee, and Valdosta, Georgia, and two medium mills located in Filer City, Michigan, and Tomahawk, Wisconsin. The Mills also include two recycling centers located in Nashville, Tennessee, and Jackson, Tennessee. The Mills also control and manage approximately 950,000 acres of timberlands. The Mills transfer the majority of their output to The Corrugated Products operations ("Corrugated").
Corrugated operations consist of 39 corrugated combining plants, 28 specialty/sheet plants and 5 design centers. All plants are located in North America. Corrugated combines linerboard and medium (primarily from The Mills) into sheets that are converted into corrugated shipping containers, point-of-sale graphics packaging, point-of-purchase displays and other specialized packaging. Corrugated sells to diverse customers primarily in North America.
On January 25, 1999, Packaging entered into a definitive agreement (the "Contribution Agreement") to sell its containerboard and corrugated packaging products business to Packaging Corporation of America ("PCA") for $2.2 billion. Under the terms of the Contribution Agreement, PCA Holdings, an entity organized and controlled by MDP and its coinvestors, acquired a 55% common equity interest in PCA, and Packaging contributed the Group to PCA in exchange for cash, the assumption of debt and a 45% common equity interest in PCA (in each case before giving effect to issuances of common equity to management).
The sale was completed on April 12, 1999. The financing of the transaction consisted of borrowings under a new $1.46 billion senior credit facility, the offering of notes and preferred stock, the cash equity investment of $236.5 million by PCA Holdings and a rollover equity investment by Packaging valued at $193.5 million.
The Group's sales to other Packaging entities and other Tenneco entities are included in the accompanying combined financial statements. The net sales to other Packaging entities for the period from January 1, 1999, through April 11, 1999, were approximately $21,350,000. The net sales to other Tenneco entities for the period from January 1, 1999, through April 11, 1999, were approximately $3,298,000. The profit relating to these sales is included in the accompanying combined financial statements.
As a result of the Group's relationship with Packaging, the combined statements of assets, liabilities and interdivision account and the related combined statements of revenues, expenses and interdivision account are not necessarily indicative of what actually would have occurred had the Group been a stand-alone entity. Additionally, these combined financial statements are not necessarily indicative of the future financial position or results of operations of the Group.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
2. SUMMARY OF ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying combined financial statements include the selected assets and liabilities of the Group as of April 11, 1999, and the revenues and expenses of the Group for the period January 1, 1999, through April 11, 1999. All significant intragroup accounts and transactions have been eliminated.
REVENUE RECOGNITION
The Group recognizes revenue as products are shipped to customers.
ACCOUNTS RECEIVABLE
Historically, a substantial portion of the Group's trade accounts receivable were sold by Packaging, generally without recourse, to a financing subsidiary of Tenneco Inc. Expenses relating to cash discounts, credit losses, pricing adjustments and other allowances on these factored receivables are accrued and charged to the Group. As part of the Containerboard transaction, these receivables were purchased by Packaging from the financing subsidiary and contributed to PCA. All purchase and sale transactions were consummated at fair value, which was the same as the net book value of the receivables as reflected on the Group's financial statements prior to the initial sale. Therefore, due to the pending sale transaction, the amount of trade accounts receivable sold was $0 at April 11, 1999.
INVENTORIES
Raw materials and finished goods are valued using the last-in, first-out ("LIFO") cost method and include material, labor and manufacturing-related overhead costs. Supplies and materials inventories are valued using a moving average cost. All inventories are stated at the lower of cost or market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Interest costs relating to construction in progress are capitalized based upon the total amount of interest cost (including interest costs on notes payable to Tenneco) incurred by Packaging.
The amount of interest capitalized related to construction in progress at the Group was approximately $19,000 for the period ended April 11, 1999.
Depreciation is computed on the straight-line basis over the estimated useful lives of the related assets. The following useful lives are used for the various categories of assets:
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) Timber depletion is provided on the basis of timber cut during the period related to the estimated quantity of recoverable timber. Assets under capital leases are depreciated on the straight-line method over the term of the lease.
Expenditures for repairs and maintenance are expensed as incurred.
Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. In the event that facts and circumstances indicate that the carrying amount of any long-lived assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to discounted cash flows is required.
CHANGES IN ACCOUNTING PRINCIPLES
In June, 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes new accounting and reporting standards requiring that all derivative instruments (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. This statement is effective for all fiscal years beginning after June 15, 2000. The adoption of this new standard is not expected to have a significant effect on the Group's financial position or results of operations.
In April, 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities," which requires costs of start-up activities to be expensed as incurred. This statement is effective for fiscal years beginning after December 15, 1998. The statement requires capitalized costs related to start-up activities to be expensed as a cumulative effect of a change in accounting principle when the statement is adopted. Tenneco adopted this new accounting principle in the first quarter of 1999. The adoption of this new standard did not have a significant effect on the Group's financial position or results of operations.
In March, 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which establishes new accounting and reporting standards for the costs of computer software developed or obtained for internal use. This statement will be applied prospectively and is effective for fiscal years beginning after December 15, 1998. The adoption of this new standard did not have a significant effect on the Group's financial position or results of operations.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) FREIGHT TRADES
The Group regularly trades containerboard with other manufacturers primarily to reduce shipping costs. The freight trade transactions are accounted for primarily as transactions in the inventory accounts; the impact on income is not material.
ENVIRONMENTAL LIABILITIES
The estimated landfill closure and postclosure maintenance costs expected to be incurred upon and subsequent to the closing of existing operating landfill areas are accrued based on the landfill capacity used to date. Amounts are estimates using current technologies for closure and monitoring and are not discounted.
The potential costs related to the Group for various environmental matters are uncertain due to such factors as the unknown magnitude of possible cleanup costs, the complexity and evolving nature of governmental laws and regulations and their interpretations, and the timing, varying costs and effectiveness of alternative cleanup technologies. Liabilities recorded by the Group for environmental contingencies are estimates of the probable costs based upon available information and assumptions relating to the Group. Because of these uncertainties, however, the Group's estimates may change. The Group believes that any additional costs identified as further information becomes available would not have a material effect on the combined statements of assets, liabilities and interdivision account or revenues, expenses and interdivision account of the Group.
COMBINED STATEMENTS OF CASH FLOWS
As a division of Packaging, the Group does not maintain separate cash accounts other than for petty cash. The Group's disbursements for payroll, capital projects, operating supplies and expenses are processed and funded by Packaging through centrally managed accounts. In addition, cash receipts from the collection of accounts receivable and the sales of assets are remitted directly to bank accounts controlled by Packaging. In this type of centrally managed cash system in which the cash receipts and disbursements of Packaging's various divisions are commingled, it is not feasible to segregate cash received from Packaging (e.g., as financing for the business) from cash transmitted to Packaging (e.g., as a distribution). Accordingly, the net effect of these cash transactions with Packaging are presented as a single line item within the financing section of the cash flow statements. Similarly, the activity of the interdivision account presents the net transfer of funds and charges between Packaging and the Group as a single line item.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred. The amounts charged were $1,015,000 from January 1, 1999, through April 11, 1999.
INTANGIBLE ASSETS
The Group has capitalized certain intangible assets, primarily trademarks and patents, based on their estimated fair value at the date of acquisition. Amortization is provided for these intangible assets
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) on a straight-line basis over periods ranging from 3 to 10 years. Covenants not to compete are amortized on a straight-line basis over the terms of the respective agreements. Such amortization amounted to $890,000 as of April 11, 1999.
Intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. In the event that facts and circumstances indicate that the carrying amount of any intangible assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows through the remaining amortization period associated with the asset would be compared to the asset's carrying amount to determine if a write-down to discounted cash flows is required.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
SEGMENT INFORMATION
The Group adopted SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information," in 1998 and determined that the Group is primarily engaged in one line of business: the manufacture and sale of packaging materials, boxes and containers for industrial and consumer markets. No single customer accounts for more than 10% of total revenues. The Group has no foreign operations.
EARNINGS PER SHARE (UNAUDITED)
Earnings per share has been calculated using the historical earnings of the Group and the number of shares resulting from the April 12, 1999 transaction (430,000 common shares), as adjusted to reflect the anticipated 220-for-one stock split. For the period presented, basic and diluted earnings per share are the same because there are not potentially dilutive securities.
3. INVESTMENT IN JOINT VENTURE
The Group has a 50% U.S. joint venture with American Cellulose Corporation to manufacture and market hardwood chips. The net investment, which was accounted for under the equity method, was $1,388,000 as of April 11, 1999.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
4. LONG-TERM DEBT
As of April 11, 1999, the annual payments for debt during the next five years and thereafter are (in thousands): $31,841 (1999), $35,699 (2000), $67,570 (2001), $97,570 (2002), $107,536 (2003) and $1,420,250 (2004 and thereafter).
In February, 1999, Tenneco Inc. paid off the remaining note payable as it relates to the Counce Limited Partnership. The payment was $27,220,000, including a $10,456,000 premium payment (net of tax $6,327,000) for the early extinguishment of debt.
Going-forward, PCA's various debt agreements require that it comply with certain covenants and restrictions, including specific financial ratios that must be maintained on the last day at the end of each fiscal quarter. Under the provisions of the credit agreement dated April 12, 1999 ("Credit Agreement"), PCA must maintain a consolidated interest coverage ratio of a minimum of 1.5 beginning on September 30, 1999, increasing per the guidelines set forth in the Credit Agreement to 2.5 as of March 31, 2005, and each fiscal quarter thereafter. Also, PCA must not exceed a leverage ratio of 6.75 at September 30, 1999, decreasing per the guidelines set forth in the Credit Agreement to 4.0 as of March 31, 2006, and each fiscal quarter thereafter. Lastly, PCA must maintain a minimum consolidated net worth beginning on June 30, 1999 of $315,000,000, increasing per the guidelines set forth in the Credit Agreement to $690,000,000 as of March 31, 2008.
In May through October of 1999, PCA made voluntary prepayments totaling approximately $322,100,000 using excess cash and proceeds from the sale of certain timberlands to permanently reduce its borrowings under the term loans. As a result of this prepayment, no payments will be required under any of the term loans until December, 2001.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
5. PENSION AND OTHER BENEFIT PLANS
Substantially all of the Group's salaried and hourly employees are covered by retirement plans sponsored by Packaging and Tenneco. Benefits generally are based on years of service and, for most salaried employees, on final average compensation. Packaging's funding policies are to contribute to the plans, at a minimum, amounts necessary to satisfy the funding requirements of federal laws and regulations. The assets of the plans consist principally of listed equity and fixed and variable income securities, including Tenneco Inc. common stock.
The Group's eligible salaried employees participate in the Tenneco Inc. Retirement Plan (the "Retirement Plan"), a defined benefit plan, along with other Tenneco divisions and subsidiaries. The pension expense allocated to the Group by Packaging for this plan was approximately $1,696,000 for the period ended April 11, 1999. Amounts allocated are principally determined based on payroll. This plan is overfunded and a portion of the prepaid pension costs has not been allocated to the Group.
The Group's eligible hourly employees participate in the Tenneco Packaging Pension Plan for Certain Hourly-Rated Employees, also a defined benefit plan, along with other Packaging divisions. As stated, due to the fact that other divisions within Packaging participate in the plan, certain of the disclosures required by SFAS No. 132, "Employers' Disclosures About Pension and Other Postretirement Benefits, such as a summary of the change in benefit obligation and the change in plan assets, are not available. Actuarial information as of April 11, 1999 is not available and in connection with the sale of the Group as described in Note 1 to these financial statements, the pension asset allocated to the Group will be excluded from the sale transaction and remain with Tenneco. As such, the actuarial information below is reported as of December 31, 1998.
The net pension income allocated to the Group for this plan was $213,000 for the period ended April 11, 1999. This plan is overfunded, and a portion of the related pension asset of $41,965,000 for April 11, 1999, has been allocated to the Group and is included in Other Long-Term Assets.
Actuarially allocated net pension cost for the Group's defined benefit plans, excluding the Retirement Plan, consists of the following components for the year ended December 31, 1998 (in thousands):
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
5. PENSION AND OTHER BENEFIT PLANS (CONTINUED) The funded status of the Group's allocation of defined benefit plans, excluding the Retirement Plan, reconciles with amounts recognized in the 1998 statements of assets and liabilities and interdivision account as follows (in thousands):
The weighted average discount rate used in determining the actuarial present value of the benefit obligations was 7.00% for the year ended December 31, 1998. The weighted average expected long-term rate of return on plan assets was 10% for 1998.
Middle management employees participate in a variety of incentive compensation plans. These plans provide for incentive payments based on the achievement of certain targeted operating results and other specific business goals. The targeted operating results are determined each year by senior management of Packaging. The amounts charged to expense for these plans were $1,599,000 for the period ended April 11, 1999.
In June, 1992, Tenneco initiated an Employee Stock Purchase Plan ("ESPP"). The plan allows U.S. and Canadian employees of the Group to purchase Tenneco Inc. common stock through payroll deductions at a 15% discount. Each year, an employee in the plan may purchase shares with a discounted value not to exceed $21,250. The weighted average fair value of the employee purchase right, which was estimated using the Black-Scholes option pricing model and the assumptions described below except that the average life of each purchase right was assumed to be 90 days, was $6.31 for the period ended December 31, 1998. The ESPP was terminated as of September 30, 1996. Tenneco adopted a new employee stock purchase plan effective April 1, 1997. Under the respective ESPPs, Tenneco sold 36,883 shares to Group employees for the period ended April 11, 1999.
In December, 1996, Tenneco adopted the 1996 Stock Ownership Plan, which permits the granting of a variety of awards, including common stock, restricted stock, performance units, stock appreciation rights, and stock options to officers and employees of Tenneco. Tenneco can issue up to 17,000,000 shares of common stock under this plan, which will terminate December 31, 2001.
The April 11, 1999, fair market value of the options granted was calculated using Tenneco's stock price at the grant date and multiplying the amount by the historical percentage of past Black-Scholes pricing values fair value (approximately 25%). The fair value of each stock option issued by Tenneco to the Group in prior periods was estimated on the date of grant using the Black-Sholes option pricing model using the following ranges of weighted average assumptions for grants during the past three
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
5. PENSION AND OTHER BENEFIT PLANS (CONTINUED) years: (a) risk-free interest rate ranging from 5.7% to 6.7%, (b) expected lives ranging from 5.0 years to 19.7 years, (c) expected volatility ranging from 24.6% to 27.8%, and (d) dividend yields ranging from $10.91 to $13.99.
The Group applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," to its stock-based compensation plans. The Group recognized after-tax stock-based compensation expense of approximately $146,000 for the period ended April 11, 1999. Had compensation costs for the Group's stock-based compensation plans been determined in accordance with SFAS 123, "Accounting for Stock-Based Compensation," based on the fair value at the grant dates for the awards under those plans, the Group's pro forma net income for the year ended April 11, 1999, would have been lower by $734,000.
6. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
In addition to providing pension benefits, the Group provides certain health care and life insurance benefits for certain retired and terminated employees. A substantial number of the Group's employees may become eligible for such benefits if they reach normal retirement age while working for the Group. The cost of these benefits for salaried employees is allocated to the Group by Packaging through a payroll charge and the interdivision account. Amounts allocated are principally determined based on payroll. The net obligation for these salaried benefits is maintained by Packaging and is not included in the liabilities section of the accompanying combined statements of assets, liabilities and interdivision account for the Group's share of the obligation.
Currently, the Group's postretirement benefit plans are not funded and a portion of the related postretirement obligation has been allocated to the Group. However, due to the fact that other divisions participate in the plan, certain of the disclosures required by SFAS No. 132, such as a summary of the change in benefit obligation, are not available. Actuarial information as of April 11, 1999, is not available and in connection with the sale of the Group as described in Note 1 to these financial statements, the long-term portion of the postretirement liability will not be assumed by PCA but will remain with Tenneco. As such, the actuarial information below is reported as of December 31, 1998, and the portion of the liability allocated as of April 11, 1999, is the same as the allocated amount as of December 31, 1998.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
6. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS (CONTINUED) The obligation of the plans, related to hourly employees, reconciles with amounts recognized in the combined statements of assets, liabilities and interdivision account at December 31, 1998, and April 11, 1999, as follows (in thousands):
The net periodic postretirement benefit costs as determined by actuaries for hourly employees for 1998 consist of the following components (in thousands):
The amounts expensed by the Group may be different because it was allocated by Packaging.
The weighted average assumed health care cost trend rate used in determining the 1998 accumulated postretirement benefit obligation was 5%.
Increasing the assumed health care cost trend rate by one percentage point would increase the accumulated postretirement benefit obligation as of September 30, 1998, by approximately $1,268,000, and would increase the net postretirement benefit cost for 1998 by approximately $130,000.
The discount rate (which is based on long-term market rates) used in determining the accumulated postretirement benefit obligation was 7% for 1998.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
7. INVENTORIES
The components of inventories as of April 11, 1999, are as follows (in thousands):
The amount by which current FIFO cost exceeded the stated LIFO inventory was $22,588,000 as of April 11, 1999.
8. RESTRUCTURING AND OTHER CHARGES
In the fourth quarter of 1998, the Group recorded a pretax restructuring charge of approximately $14 million. This charge was recorded following the approval by Tenneco's Board of Directors of a comprehensive restructuring plan for all of Tenneco's operations, including those of the Group. In connection with this restructuring plan, the Group will close four corrugated facilities and eliminate 109 positions.
The following table reflects components of this charge (in thousands):
Asset impairments are comprised mainly of goodwill totaling approximately $1,510,000 related to two of the facilities. The fixed assets at the closed facilities were written down to their estimated fair value. No significant cash proceeds are expected from the ultimate disposal of these assets. Of the $5,692,000 remaining cash charges at April 11, 1999, approximately $4,514,000 is expected to be spent in 1999. The actions contemplated by the restructuring plan should be substantially completed during 1999.
9. IMPAIRMENT LOSS
As a result of the sale transaction (Note 1), Tenneco recognized a pretax loss in the first quarter of 1999 of approximately $293 million. Part of that loss consisted of an impairment charge relating to the Group's property, plant and equipment and intangible assets, which was pushed down to the
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
9. IMPAIRMENT LOSS (CONTINUED) accompanying combined financial statements. The amount of the impairment charge was approximately $230.1 million.
The impairment charge of $230.1 million has been allocated to the following financial statement line items (in thousands):
The impairment charge will first be applied against the goodwill specifically attributable to the containerboard assets and the remaining amount will be applied against plant, property and equipment.
10 INCOME TAXES
The Group's method of accounting for income taxes requires that a deferred tax be recorded to reflect the tax expense (benefit) resulting from the recognition of temporary differences. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in differences between income for tax purposes and income for financial statement purposes in future years.
As a division, this Group is not a taxable entity. For purposes of these combined financial statements, income taxes have been allocated to the Group and represent liabilities to Packaging.
Following is an analysis of the components of combined income tax benefit through April 11, 1999 (in thousands):
The primary difference between income taxes computed at the statutory U.S. federal income tax rate and the income tax benefit in the combined statement of revenues, expenses and interdivision account is due to the effect of state income taxes.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
10 INCOME TAXES (CONTINUED) The components of the deferred tax assets (liabilities) at April 11, 1999, were as follows (in thousands):
11. ASSETS, LIABILITIES AND OTHER EXPENSE, NET DETAIL
PREPAID EXPENSES AND OTHER CURRENT ASSETS
The components of prepaid expenses and other current assets include (in thousands):
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
11. ASSETS, LIABILITIES AND OTHER EXPENSE, NET DETAIL (CONTINUED) OTHER LONG-TERM ASSETS
The components of the other long-term assets include (in thousands):
ACCRUED LIABILITIES
The components of accrued liabilities include (in thousands):
OTHER LONG-TERM LIABILITIES
The components of the other long-term liabilities include (in thousands):
OTHER EXPENSE, NET
The components of other expense, net include (in thousands):
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
12 RELATED-PARTY TRANSACTIONS
FUNDING OF CASH REQUIREMENTS
As discussed in Note 2, Packaging provides centralized treasury functions and financing for the Group including funding of its cash requirements for processing of accounts payable and payroll requirements.
CORPORATE ALLOCATIONS
Packaging and Tenneco provide various services to the Group, including legal, human resources, data processing systems support, training, finance and treasury, public relations and insurance management. These expenses are allocated based on a combination of factors such as actual usage of the service provided, revenues, gross salaries and fixed assets and may not reflect actual costs the Group would incur if it were a stand-alone entity.
Certain receivables and transactions resulting from the financing relationship between Packaging and Tenneco are not reflected in the accompanying financial statements.
INSURANCE AND BENEFITS
The Group is self-insured for medical benefits and workers' compensation. Expenses related to workers' compensation, health care claims for hourly and salaried workers and postretirement health care benefits for hourly and salaried workers are determined by Packaging and are allocated to the Group. The Group incurred charges of $9,337,000 for health care and $1,801,000 for workers' compensation for the period ended April 11, 1999.
In general, all costs and expenses incurred and allocated are based on the relationship the Group has with Tenneco. If the Group had been a stand-alone entity, the costs and expenses would differ.
13. COMMITMENTS AND CONTINGENCIES
The Group had authorized capital expenditures of approximately $55,358,000 as of April 11, 1999, in connection with the expansion and replacement of existing facilities.
The Group is involved in various legal proceedings and litigation arising in the ordinary course of business. In the opinion of management and in-house legal counsel, the outcome of such proceedings and litigation will not materially affect the Group's financial position or results of operations.
14. LEASES
Rental expense included in the accompanying combined financial statements was $25,411,000 for the period ended April 11, 1999. These costs are primarily included in cost of goods sold.
As a result of the sale of the Group, Packaging received total consideration of $2.2 billion, which includes the $1.1 billion used to buy out certain timber and mill operating leases prior and concurrent
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
APRIL 11, 1999
14. LEASES (CONTINUED) to the sale transaction on April 12, 1999. Therefore, the remaining outstanding aggregate minimum rental commitments under noncancelable operating leases are as follows:
15. SALE OF ASSETS
In the second quarter of 1996, Packaging entered into an agreement to form a joint venture with Caraustar Industries whereby Packaging sold its two recycled paperboard mills and a fiber recycling operation and brokerage business to the joint venture in return for cash and a 20% equity interest in the joint venture. Proceeds from the sale were approximately $115 million and the Group recognized a $50 million pretax gain ($30 million after taxes) in the second quarter of 1996.
In June, 1998, Packaging sold its remaining 20% equity interest in the joint venture to Caraustar Industries for cash and a note of $26,000,000. The Group recognized a $15 million pretax gain on this transaction. At April 11, 1999, the balance of the note with accrued interest is $27,122,000. The note was paid in June, 1999.
16. SUBSEQUENT EVENTS
On August 25, 1999, PCA and Packaging agreed that the acquisition consideration should be reduced as a result of a postclosing price adjustment by an amount equal to $20 million plus interest through the date of payment by Packaging. The Group recorded $11.9 million of this amount as part of the impairment charge on the accompanying financial statements, representing the amount that was previously estimated by Packaging. PCA intends to record the remaining amount in September, 1999.
In August, 1999, PCA signed purchase and sales agreements with various buyers to sell approximately 405,000 acres of timberland. PCA has completed the sale of approximately 260,000 of these acres and expects to complete the sale of the remaining acres by mid-November, 1999.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Tenneco Inc.:
We have audited the accompanying combined statements of assets, liabilities and interdivision account of THE CONTAINERBOARD GROUP (a division of Tenneco Packaging Inc., which is a Delaware corporation and a wholly owned subsidiary of Tenneco Inc.) as of December 31, 1998, 1997 and 1996, and the related combined statements of revenues, expenses and interdivision account and cash flows for the years then ended. These financial statements are the responsibility of the Group's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the combined financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the combined financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall combined financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of The Containerboard Group as of December 31, 1998, 1997 and 1996, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois February 26, 1999
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.) COMBINED STATEMENTS OF ASSETS, LIABILITIES AND INTERDIVISION ACCOUNT
The accompanying notes to combined financial statements are an integral part of these statements.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.) COMBINED STATEMENTS OF REVENUES, EXPENSES AND INTERDIVISION ACCOUNT
The accompanying notes to combined financial statements are an integral part of these statements.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.) COMBINED STATEMENTS OF CASH FLOWS
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.) COMBINED STATEMENTS OF CASH FLOWS
The accompanying notes to combined financial statements are an integral part of these statements.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
1. BUSINESS DESCRIPTION
The Containerboard Group (the "Group") is a division of Tenneco Packaging Inc. ("Packaging") which is a wholly owned subsidiary of Tenneco Inc. ("Tenneco"). The Group is comprised of mills and corrugated products operations.
The Mill operations ("The Mills") consist of two Kraft linerboard mills located in Counce, Tennessee, and Valdosta, Georgia, and two medium mills located in Filer City, Michigan, and Tomahawk, Wisconsin. The Mills also include two recycling centers located in Nashville, Tennessee, and Jackson, Tennessee. The Mills also control and manage approximately 950,000 acres of timberlands. The Mills transfer the majority of their output to The Corrugated Products operations ("Corrugated").
Corrugated operations consist of 39 corrugated combining plants, 28 specialty/sheet and other plants and 5 design centers. All plants are located in North America. Corrugated combines linerboard and medium (primarily from The Mills) into sheets that are converted into corrugated shipping containers, point-of-sale graphics packaging, point-of-purchase displays and other specialized packaging. Corrugated sells to diverse customers primarily in North America.
The Group's sales to other Packaging entities and other Tenneco entities are included in the accompanying combined financial statements. The net sales to other Packaging entities for the years ended December 31, 1998, 1997 and 1996, were approximately $76,906,000, $69,981,000 and $76,745,000, respectively. The net sales to other Tenneco entities for the years ended December 31, 1998, 1997 and 1996, were approximately $14,251,000, $13,108,000 and $10,376,000, respectively. The profit relating to these sales are included in the accompanying combined financial statements.
As a result of the Group's relationship with Packaging, the combined statements of assets, liabilities and interdivision account and the related combined statements of revenues, expenses and interdivision account are not necessarily indicative of what actually would have occurred had the Group been a stand-alone entity. Additionally, these combined financial statements are not necessarily indicative of the future financial position or results of operations of the Group.
2. SUMMARY OF ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying combined financial statements include the selected assets, liabilities, revenues and expenses of the Group. All significant intragroup accounts and transactions have been eliminated.
REVENUE RECOGNITION
The Group recognizes revenue as products are shipped to customers.
ACCOUNTS RECEIVABLE
A substantial portion of the Group's trade accounts receivable are sold by Packaging, generally without recourse, to a financing subsidiary of Tenneco Inc. Expenses relating to cash discounts, credit losses, pricing adjustments and other allowances on these factored receivables are accrued and charged to the Group. The amount of trade accounts receivable sold was approximately $150,099,000, $149,907,000 and $133,703,000 at December 31, 1998, 1997 and 1996, respectively.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) INVENTORIES
Inventories for raw materials and finished goods are valued using the last-in, first-out ("LIFO") cost method and include material, labor and manufacturing-related overhead costs. Supplies and materials inventories are valued using a moving average cost. All inventories are stated at the lower of cost or market.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Interest costs relating to construction in progress are capitalized based upon the total amount of interest cost (including interest costs on notes payable to Tenneco) incurred by Packaging.
The amount of interest capitalized related to construction in progress at the Group was approximately $576,000, $975,000 and $5,207,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
Depreciation is computed on the straight-line basis over the estimated useful lives of the related assets. The following useful lives are used for the various categories of assets:
Timber depletion is provided on the basis of timber cut during the period related to the estimated quantity of recoverable timber. Assets under capital leases are depreciated on the straight-line method over the term of the lease.
Expenditures for repairs and maintenance are expensed as incurred.
Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. In the event that facts and circumstances indicate that the carrying amount of any long-lived assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows associated with the asset would be compared to the asset's carrying amount to determine if a write-down to discounted cash flows is required.
DEFERRED GAIN
In 1992, Packaging entered into a sale-leaseback transaction for financial reporting purposes involving certain of its timberlands. The deferred gain recognized upon sale is being amortized on a straight-line basis over the initial lease term.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) This deferred gain relates to a lease which was prepaid by the Group in December, 1998 (Note 12). The 1998 financial statements have reclassed the current and long-term portions of the deferred gain against the prepaid payment in Prepaid Expenses and Other Current Assets and Other Long-Term Assets.
CHANGES IN ACCOUNTING PRINCIPLES
In June, 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes new accounting and reporting standards requiring that all derivative instruments (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. This statement is effective for all fiscal years beginning after June 15, 1999. The adoption of this new standard is not expected to have a significant effect on the Group's financial position or results of operations.
In April, 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up Activities," which requires costs of start-up activities to be expensed as incurred. This statement is effective for fiscal years beginning after December 15, 1998. The statement requires capitalized costs related to start-up activities to be expensed as a cumulative effect of a change in accounting principle when the statement is adopted. Tenneco currently expects to adopt this new accounting principle in the first quarter of 1999. The adoption of this new standard is not expected to have a significant effect on the Group's financial position or results of operations.
In March, 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which establishes new accounting and reporting standards for the costs of computer software developed or obtained for internal use. This statement will be applied prospectively and is effective for fiscal years beginning after December 15, 1998. The adoption of this new standard is not expected to have a significant effect on the Group's financial position or results of operations.
FREIGHT TRADES
The Group regularly trades containerboard with other manufacturers primarily to reduce shipping costs. The freight trade transactions are accounted for primarily as transactions in the inventory accounts; the impact on income is not material.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) ENVIRONMENTAL LIABILITIES
The estimated landfill closure and postclosure maintenance costs expected to be incurred upon and subsequent to the closing of existing operating landfill areas are accrued based on the landfill capacity used to date. Amounts are estimates using current technologies for closure and monitoring and are not discounted.
The potential costs related to the Group for various environmental matters are uncertain due to such factors as the unknown magnitude of possible cleanup costs, the complexity and evolving nature of governmental laws and regulations and their interpretations, and the timing, varying costs and effectiveness of alternative cleanup technologies. Liabilities recorded by the Group for environmental contingencies are estimates of the probable costs based upon available information and assumptions relating to the Group. Because of these uncertainties, however, the Group's estimates may change. The Group believes that any additional costs identified as further information becomes available would not have a material effect on the combined statements of assets, liabilities and interdivision account or revenues, expenses and interdivision account of the Group.
COMBINED STATEMENTS OF CASH FLOWS
As a division of Packaging, the Group does not maintain separate cash accounts other than for petty cash. The Group's disbursements for payroll, capital projects, operating supplies and expenses are processed and funded by Packaging through centrally managed accounts. In addition, cash receipts from the collection of accounts receivable and the sales of assets are remitted directly to bank accounts controlled by Packaging. In this type of centrally managed cash system in which the cash receipts and disbursements of Packaging's various divisions are commingled, it is not feasible to segregate cash received from Packaging (e.g., as financing for the business) from cash transmitted to Packaging (e.g., as a distribution). Accordingly, the net effect of these cash transactions with Packaging are presented as a single line item within the financing section of the cash flow statements. Similarly, the activity of the interdivision account presents the net transfer of funds and charges between Packaging and the Group as a single line item.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred. The amounts charged were $3,728,000, $4,345,000 and $4,789,000 in 1998, 1997 and 1996, respectively.
INTANGIBLE ASSETS
Goodwill and intangibles, net of amortization, by major category are as follows:
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
2. SUMMARY OF ACCOUNTING POLICIES (CONTINUED) Goodwill is being amortized on a straight-line basis over 40 years. Such amortization amounted to $1,449,000, $1,452,000 and $1,440,000 for 1998, 1997 and 1996, respectively. Goodwill totaling approximately $3,463,000 was written off in 1998 related to a closed facility (Note 7).
The Group has capitalized certain intangible assets, primarily trademarks and patents, based on their estimated fair value at the date of acquisition. Amortization is provided for these intangible assets on a straight-line basis over periods ranging from 3 to 10 years. Covenants not to compete are amortized on a straight-line basis over the terms of the respective agreements. Such amortization amounted to $1,127,000, $1,234,000 and $1,416,000 in 1998, 1997 and 1996, respectively.
Intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. In the event that facts and circumstances indicate that the carrying amount of any intangible assets may be impaired, an evaluation of recoverability would be performed. If an evaluation is required, the estimated future undiscounted cash flows through the remaining amortization period associated with the asset would be compared to the asset's carrying amount to determine if a write-down to discounted cash flows is required.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
RECLASSIFICATIONS
The prior years' financial statements have been reclassified, where appropriate, to conform to the 1998 presentation.
SEGMENT INFORMATION
The Group adopted SFAS No. 131, "Disclosure About Segments of an Enterprise and Related Information," in 1998 and determined that the Group is primarily engaged in one line of business: the manufacture and sale of packaging materials, boxes and containers for industrial and consumer markets. No single customer accounts for more than 10% of total revenues. The Group has no foreign operations.
EARNINGS PER SHARE (UNAUDITED)
Earnings per share has been calculated using the historical earnings of the Group and the number of common shares resulting from the April 12, 1999 transaction (430,000 common shares), as adjusted to reflect the anticipated 220-for-one stock split. For all periods presented, basic and diluted earnings per share are the same because there are no potentially dilutive other securities.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
3. INVESTMENTS IN JOINT VENTURES
The Group has a 50% U.S. joint venture with American Cellulose Corporation to manufacture and market hardwood chips. The net investment, which was accounted for under the equity method, was $1,282,000, $1,310,000 and $1,519,000 as of December 31, 1998, 1997 and 1996, respectively. In the second quarter of 1996, Packaging entered into an agreement to form a joint venture with Caraustar Industries whereby Packaging sold its two recycled paperboard mills and a fiber recycling operation and brokerage business to the joint venture in return for approximately $115 million and a 20% equity interest in the joint venture. In June, 1998, Packaging sold its remaining 20% equity interest in the joint venture to Caraustar Industries. The net investment, which was accounted for under the equity method, was $0, $15,014,000 and $13,290,000 as of December 31, 1998, 1997 and 1996, respectively.
4. LONG-TERM DEBT AND CAPITALIZED LEASE OBLIGATIONS
In January, 1997, the General Electric Capital Corporation ("GECC") operating leases were refinanced. Through this refinancing, several capital lease obligations were extinguished as the assets were incorporated into the new operating lease (Note 12).
Annual payments for debt during the next five years and thereafter are: $617,000 (1999), $214,000 (2000), $3,569,000 (2001), $4,387,000 (2002), $4,240,000 (2003) and $4,525,000 (2004 and thereafter).
In 1997, Tenneco contributed the Counce Limited Partnership to Packaging which included notes payable totaling approximately $26,187,000.
In February, 1999, Tenneco Inc. paid off the remaining note payable as it relates to the Counce Limited Partnership. The payment was $27,220,000, including a $10,456,000 premium payment for the early extinguishment of debt.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
5. PENSION AND OTHER BENEFIT PLANS
Substantially all of the Group's salaried and hourly employees are covered by retirement plans sponsored by Packaging and Tenneco. Benefits generally are based on years of service and, for most salaried employees, on final average compensation. Packaging's funding policies are to contribute to the plans, at a minimum, amounts necessary to satisfy the funding requirements of federal laws and regulations. The assets of the plans consist principally of listed equity and fixed and variable income securities, including Tenneco Inc. common stock.
The Group's eligible salaried employees participate in the Tenneco Retirement Plan (the "Retirement Plan"), a defined benefit plan, along with other Tenneco divisions and subsidiaries. The pension expense allocated to the Group by Packaging for this plan was approximately $5,595,000, $3,197,000 and $3,111,000 for the years ended December 31, 1998, 1997 and 1996, respectively. Amounts allocated are principally determined based on payroll. This plan is overfunded and a portion of the prepaid pension costs has not been allocated to the Group.
The Group's eligible hourly employees participate in the Tenneco Packaging Pension Plan for Certain Hourly Rated Employees, also a defined benefit plan, along with other Packaging divisions. As stated, due to the fact that other divisions within Packaging participate in the plan, certain of the disclosures required by SFAS No. 132, "Employers' Disclosures About Pension and Other Postretirement Benefits", such as a summary of the change in benefit obligation and the change in plan assets, are not available. The net pension (income) cost actuarially allocated to the Group for this plan was $(466,000), $144,000 and $2,373,000 for the years ended December 31, 1998, 1997 and 1996, respectively. This plan is overfunded, and a portion of the related pension asset of $35,603,000, $35,137,000 and $34,429,000 for December 31, 1998, 1997 and 1996, respectively, has been actuarially allocated to the Group and is included in Other Long-Term Assets.
However, in connection with the pending sale of the Group as described in Note 14 to these financial statements, the pension asset allocated to the Group will be excluded from the sale transaction and remain with Tenneco.
Actuarially allocated net pension cost for the Group's defined benefit plans, excluding the Retirement Plan, consists of the following components:
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
5. PENSION AND OTHER BENEFIT PLANS (CONTINUED) The funded status of the Group's allocation of defined benefit plans, excluding the Retirement Plan, reconciles with amounts recognized in the statements of assets and liabilities and interdivision account as follows:
The weighted average discount rate used in determining the actuarial present value of the benefit obligations was 7.00% for the year ended December 31, 1998, and 7.75% for the years ended December 31, 1997 and 1996. The weighted average expected long-term rate of return on plan assets was 10% for 1998, 1997 and 1996.
Middle management employees participate in a variety of incentive compensation plans. These plans provide for incentive payments based on the achievement of certain targeted operating results and other specific business goals. The targeted operating results are determined each year by senior management of Packaging. The amounts charged to expense for these plans were $5,920,000, $6,407,000 and $6,722,000 in 1998, 1997 and 1996, respectively.
In June, 1992, Tenneco initiated an Employee Stock Purchase Plan ("ESPP"). The plan allows U.S. and Canadian employees of the Group to purchase Tenneco Inc. common stock through payroll deductions at a 15% discount. Each year, an employee in the plan may purchase shares with a discounted value not to exceed $21,250. The weighted average fair value of the employee purchase right, which was estimated using the Black-Sholes option pricing model and the assumptions described below except that the average life of each purchase right was assumed to be 90 days, was $6.31, $11.09 and $10.77 in 1998, 1997 and 1996, respectively. The ESPP was terminated as of September 30, 1996. Tenneco adopted a new employee stock purchase plan effective April 1, 1997. Under the respective ESPPs, Tenneco sold 133,223 shares, 85,024 shares and 73,140 shares to Group employees in 1998, 1997 and 1996, respectively.
In December, 1996, Tenneco adopted the 1996 Stock Ownership Plan, which permits the granting of a variety of awards, including common stock, restricted stock, performance units, stock appreciation rights, and stock options to officers and employees of Tenneco. Tenneco can issue up to 17,000,000 shares of common stock under this plan, which will terminate December 31, 2001.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
5. PENSION AND OTHER BENEFIT PLANS (CONTINUED) The fair value of each stock option issued by Tenneco to the Group during 1998, 1997 and 1996 is estimated on the date of grant using the Black-Sholes option pricing model using the following weighted average assumptions for grants in 1998, 1997 and 1996, respectively: (a) risk-free interest rate of 5.7%, 6.7% and 6.0%, (b) expected lives of 10.0 years, 19.7 years and 5.0 years; (c) expected volatility of 25.6%, 27.8% and 24.6%; and (d) dividend yield of 3.2%, 2.9% and 3.2%. The weighted-average fair value of options granted during the year is $10.91, $13.99 and $11.51 for 1998, 1997 and 1996, respectively.
The Group applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," to its stock-based compensation plans. The Group recognized after-tax stock-based compensation expense of approximately $210,000 in 1998, 1997 and 1996. Had compensation costs for the Group's stock-based compensation plans been determined in accordance with SFAS 123, "Accounting for Stock-Based Compensation," based on the fair value at the grant dates for the awards under those plans, the Group's pro forma net income for the years ended December 31, 1998, 1997 and 1996, would have been lower by $7,828,000, $8,205,000 and $1,874,000, respectively.
6. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
In addition to providing pension benefits, the Group provides certain health care and life insurance benefits for certain retired and terminated employees. A substantial number of the Group's employees may become eligible for such benefits if they reach normal retirement age while working for the Group. The cost of these benefits for salaried employees is allocated to the Group by Packaging through a payroll charge and the interdivision account. Amounts allocated are principally determined based on payroll. The net obligation for these salaried benefits is maintained by Packaging and is not included in the liabilities section of the accompanying combined statements of assets, liabilities and interdivision account for the Group's share of the obligation.
Currently, the Group's postretirement benefit plans are not funded and a portion of the related postretirement obligation has been actuarially allocated to the Group. However, due to the fact that other divisions participate in the plan, certain of the disclosures required by SFAS No. 132, such as a summary of the change in benefit obligation, are not available. The obligation of the plans, related to
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
6. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS (CONTINUED) hourly employees, reconciles with amounts recognized on the accompanying combined statements of assets, liabilities and interdivision account at December 31, 1998, 1997 and 1996, as follows:
The net periodic postretirement benefit costs as determined by actuaries for hourly employees for the years 1998, 1997 and 1996 consist of the following components:
The amounts expensed by the Group may be different because it was allocated by Packaging.
The weighted average assumed health care cost trend rate used in determining the 1998 and 1997 accumulated postretirement benefit obligation was 5% in 1997, remaining at that level thereafter.
The weighted average assumed health care cost trend rate used in determining the 1996 accumulated postretirement benefit obligation was 6.0% in 1996 declining to 5.0% in 1997 and remaining at that level thereafter.
Increasing the assumed health care cost trend rate by one percentage point in each year would increase the accumulated postretirement benefit obligation as of September 30, 1998, 1997 and 1996, by approximately $1,268,000, $868,000 and $1,103,000, respectively, and would increase the net postretirement benefit cost for 1998, 1997 and 1996 by approximately $130,000, $75,000 and $102,000, respectively.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
6. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS (CONTINUED) The discount rate (which is based on long-term market rates) used in determining the accumulated postretirement benefit obligations was 7.00% for 1998 and 7.75% for 1997 and 1996.
7. RESTRUCTURING AND OTHER CHARGES
In the fourth quarter of 1998, the Group recorded a pretax restructuring charge of approximately $14 million. This charge was recorded following the approval by Tenneco's Board of Directors of a comprehensive restructuring plan for all of Tenneco's operations, including those of the Group. In connection with this restructuring plan, the Group will close four corrugated facilities and eliminate 109 positions. The following table reflects components of this charge:
Asset impairments include goodwill totaling approximately $5,043,000 related to two of the facilities. The fixed assets at the closed facilities were written down to their estimated fair value. No significant cash proceeds are expected from the ultimate disposal of these assets. Of the $7,730,000 remaining cash charges at December 31, 1998, approximately $7,300,000 is expected to be spent in 1999. The actions contemplated by the restructuring plan should be completed during the second quarter of 1999.
8. INCOME TAXES
The Group's method of accounting for income taxes requires that a deferred tax be recorded to reflect the tax expense (benefit) resulting from the recognition of temporary differences. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in differences between income for tax purposes and income for financial statement purposes in future years.
As a division, this Group is not a taxable entity. For purposes of these combined financial statements, income taxes have been allocated to the Group and computed on a separate return basis. These income taxes represent liabilities to Packaging and do not reflect any tax attributes of the Tenneco consolidated tax group.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
8. INCOME TAXES (CONTINUED) Following is an analysis of the components of combined income tax expense (benefit):
The primary difference between income taxes computed at the statutory U.S. federal income tax rate and the income tax expense in the combined statements of revenues, expenses and interdivision account is due to the effect of state income taxes.
The components of the deferred tax assets (liabilities) at December 31, 1998, 1997 and 1996, were as follows:
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
9. ASSETS, LIABILITIES AND OTHER INCOME, NET DETAIL
PREPAID EXPENSES AND OTHER CURRENT ASSETS
The components of prepaid expenses and other current assets include:
OTHER LONG-TERM ASSETS
The components of the other long-term assets include:
ACCRUED LIABILITIES
The components of accrued liabilities include:
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
9. ASSETS, LIABILITIES AND OTHER INCOME, NET DETAIL (CONTINUED) As part of the refinancing of the GECC leases in January, 1997 (Note 12), certain deferred lease credits were eliminated.
OTHER LONG-TERM LIABILITIES
The components of the other long-term liabilities include:
OTHER INCOME, NET
The components of other income (expense), net include:
10. RELATED-PARTY TRANSACTIONS
FUNDING OF CASH REQUIREMENTS
As discussed in Note 2, Packaging provides centralized treasury functions and financing for the Group including funding of its cash requirements for processing of accounts payable and payroll requirements.
CORPORATE ALLOCATIONS
Packaging and Tenneco affiliates provide services to the Group which are typical of a consolidated entity with operations in several businesses. These services included general management, investor and
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
10. RELATED-PARTY TRANSACTIONS (CONTINUED) media relations, legal, human resources, accounting, public company reporting, data processing systems, support, training, finance, treasury, and insurance management. These expenses were allocated to the Group in the aggregate, not individually, from Packaging and Tenneco affiliates, based upon the relative level of effort and time spent on Group activities. This was generally measured using a formula based upon the Group's percentage of Tenneco's fixed assets, revenues and payroll. The Group believes the method for the historical allocations was reasonable.
As a stand-alone entity, the Group does not expect that it will incur a similar level of costs due to a less complex corporate structure and a different level of need for such services. The Group estimates it will incur approximately $30 million in stand-alone overhead costs in the first year following the acquisition and believes this is representative of what the costs would have been as a stand-alone entity for historical periods.
Certain receivables and transactions resulting from the financing relationship between Packaging and Tenneco are not reflected in the accompanying financial statements.
INSURANCE AND BENEFITS
The Group is self-insured for medical benefits and workers' compensation. Expenses related to workers' compensation, health care claims for hourly and salaried workers and postretirement health care benefits for hourly and salaried workers are determined by Packaging and are allocated to the Group. The Group incurred charges of $32,151,000, $34,004,000 and $32,298,000 in 1998, 1997 and 1996, respectively, for health care and $5,109,000, $9,209,000 and $8,853,000 in 1998, 1997 and 1996, respectively, for workers' compensation.
In general, all costs and expenses incurred and allocated are based on the relationship the Group has with Tenneco. If the Group had been a stand-alone entity, the costs and expenses would differ.
11. COMMITMENTS AND CONTINGENCIES
The Group had authorized capital expenditures of approximately $49,392,000 as of December 31, 1998, in connection with the expansion and replacement of existing facilities.
The Group is involved in various legal proceedings and litigation arising in the ordinary course of business. In the opinion of management and in-house legal counsel, the outcome of such proceedings and litigation will not materially affect the Group's financial position or results of operations.
12. LEASES
Rental expense included in the combined financial statements was $96,193,340, $95,284,000 and $118,821,000 for 1998, 1997 and 1996, respectively. These costs are primarily included in cost of goods sold.
On January 31, 1997, Packaging executed an operating lease agreement with Credit Suisse Leasing 92A, L.P., and a group of financial institutions led by Citibank, N.A. The agreement refinanced the previous operating leases between GECC and Packaging which were entered into at the same time as GECC's purchase of certain assets from Georgia-Pacific in January, 1991. Through this refinancing,
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
12. LEASES (CONTINUED) several capital lease obligations were extinguished as the assets were incorporated into the new operating lease. Also with this refinancing, certain fixed assets and deferred credits were eliminated resulting in a net gain of approximately $38 million in the first quarter of 1997.
Aggregate minimum rental commitments under noncancelable operating leases are as follows (in thousands):
Minimum rental commitments under noncancelable operating leases include $68 million for 1999, $68 million for 2000, $68 million for 2001, $676 million for 2002, $18 million for 2003 and $34 million for years thereafter, payable to credit Suisse Leasing 92A, L.P. and Citibank, N.A., along with John Hancock, Metropolitan Life and others (the "Lessors") for certain mill and timberland assets. The remaining terms of such leases extend over a period of up to five years.
Following the initial lease period, Packaging may, under the provision of the lease agreements, extend the leases on terms mutually negotiated with the Lessors or purchase the leased assets under conditions specified in the lease agreements. If the purchase options are not exercised or the leases are not extended, Packaging will make a residual guarantee payment to the Lessors of approximately $653 million, included in the schedule above, which will be refunded up to the total amount of the residual guarantee payment based on the Lessors' subsequent sales price for the leased assets. Throughout the lease period, Packaging is required to maintain the leased properties which includes reforestation of the timberlands harvested.
Packaging's various lease agreements require that it comply with certain covenants and restrictions, including financial ratios that, among other things, place limitations on incurring additional "funded debt" as defined by the agreements. Under the provisions of the lease agreements, in order to incur funded debt, Packaging must maintain a pretax cash flow coverage ratio, as defined, on a cumulative four quarter basis of a minimum of 2.0, subsequently modified to 1.75 as of December 31, 1998. Packaging was in compliance with all of its covenants at December 31, 1998.
In December, 1998, the Group made a payment of $84 million to acquire the Meridian timberlands utilized by the Group. This transaction was undertaken in preparation for the separation of the Group's assets from Tenneco. Subsequent to year end, the Group paid a fee of $50,000 to effect the conveyance of the Meridian timberlands to the Group.
In connection with the pending sale of the Group described in Note 14 to these financial statements, Tenneco may purchase the Tomahawk and Valdosta mills and selected timberland assets currently under lease prior to the sale.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
13. SALE OF ASSETS
In the second quarter of 1996, Packaging entered into an agreement to form a joint venture with Caraustar Industries whereby Packaging sold its two recycled paperboard mills and a fiber recycling operation and brokerage business to the joint venture in return for cash and a 20% equity interest in the joint venture. Proceeds from the sale were approximately $115 million and the Group recognized a $50 million pretax gain ($30 million after taxes) in the second quarter of 1996.
In June, 1998, Packaging sold its remaining 20% equity interest in the joint venture to Caraustar Industries for cash and a note of $26,000,000. The Group recognized a $15 million pretax gain on this transaction.
At December 31, 1998, the balance of the note with accrued interest is $26,756,000.
14. SALE OF COMPANY AND RELATED IMPAIRMENT (UNAUDITED)
On January 26, 1999, Tenneco announced that it had entered into an agreement to contribute a majority interest in the Group to a new joint venture with Madison Dearborn Partners, in exchange for cash and debt assumption totaling approximately $2 billion, and a 45% common equity interest in the joint venture. The owned and leased assets to be contributed included the Group's four linerboard and medium mills, 67 plants, three sawmills, an air-drying yard, three recycling facilities, miscellaneous other property, which includes sales offices and woodlands forest management offices, numerous distribution centers, warehouses and five design centers and an ownership or controlling interest in approximately 950,000 acres of timberland. The transactions closed on April 12, 1999.
In connection with the transactions, Packaging borrowed approximately $1.8 billion, most of which was used to acquire assets used by the Group pursuant to operating leases and timber cutting rights, with the remainder remitted to Tenneco for corporate debt reduction.
Tenneco then contributed the Group's assets (subject to the new indebtedness and the Group's liabilities) to a joint venture, Packaging Corporation of America ("PCA") in exchange for (a) a 45% common equity interest in PCA valued at approximately $200 million and (b) approximately $240 million in cash. As a result of the sale transaction, Tenneco recognized a pretax loss in the first quarter of 1999 of approximately $293 million. Part of that loss consisted of an impairment charge relating to the Group's property, plant and equipment and intangible assets, which was pushed down to the Group's March 31, 1999 financial statements. The amount of the impairment charge is approximately $230.1 million.
The impairment charge of $230.1 million recorded in the Group's financial statements has been allocated to the following financial statement line items (in thousands):
The impairment charge will first be applied against the goodwill specifically attributable to the containerboard assets and the remaining amount will be applied against plant, property and equipment.
THE CONTAINERBOARD GROUP (A DIVISION OF TENNECO PACKAGING INC.)
NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998, 1997 AND 1996
14. SALE OF COMPANY AND RELATED IMPAIRMENT (UNAUDITED) (CONTINUED) The Group's financial statements reflect $230.1 million of the $293.0 million charge representing the impairment attributable to the assets reflected in the Group's financial statements.
15. SUMMARIZED COMBINED FINANCIAL INFORMATION ABOUT GUARANTOR SUBSIDIARIES
The following is summarized aggregated financial information for Dahlonega Packaging Corporation, Dixie Container Corporation, PCA Hydro, Inc., PCA Tomahawk Corporation and PCA Valdosta Corporation, each of which was a wholly-owned subsidiary of Packaging and included in the Group's combined financial statements. In conjunction with the sale of the Group as described in Note 14, each of these companies became subsidiaries of PCA and fully, unconditionally, jointly and severally guaranteed $550 million in subordinated debt issued by PCA in conjunction with the transaction. Separate financial statements of the guarantor subsidiaries are not presented because, in the opinion of management, such financial statements are not material to investors.