UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2014
or
For the transition period from to
96 South George Street, Suite 520
York, Pennsylvania 17401
(Address of principal executive offices)
(717) 225-4711
(Registrant’s telephone number, including area code)
Commission
file number
Exact name of registrant asspecified in its charter
IRS Employer
Identification No.
State or other jurisdiction ofincorporation or organization
N/A
(Former name or former address, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at the past 90 days. Yes x No ¨.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a small reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ¨ No x.
Common Stock outstanding on July 30, 2014 totaled 42,904,447 shares.
P. H. GLATFELTER COMPANY AND
SUBSIDIARIES
REPORT ON FORM 10-Q
For the QUARTERLY PERIOD ENDED
June 30, 2014
Table of Contents
PART I – FINANCIAL INFORMATION
Item 1
Financial Statements
Condensed Consolidated Statements of Income for the three months and six months ended June 30, 2014 and 2013 (unaudited)
Condensed Consolidated Statements of Comprehensive Income for the three months and six months ended June 30, 2014 and 2013 (unaudited)
Condensed Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013 (unaudited)
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013 (unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited)
Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3
Quantitative and Qualitative Disclosures About Market Risks
Item 4
Controls and Procedures
PART II – OTHER INFORMATION
Item 6
Exhibits
SIGNATURES
PART I
Item 1 – Financial Statements
P. H. GLATFELTER COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three months ended
June 30
Six months ended
In thousands, except per share
Net sales
Energy and related sales, net
Total revenues
Costs of products sold
Gross profit
Selling, general and administrative expenses
Gains on dispositions of plant, equipment and timberlands, net
Operating income
Non-operating income (expense)
Interest expense
Interest income
Other, net
Total non-operating expense
Income before income taxes
Income tax provision
Net income
Earnings per share
Basic
Diluted
Cash dividends declared per common share
Weighted average shares outstanding
The accompanying notes are an integral part of these condensed consolidated financial statements.
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GLATFELTER
6.30.14 Form 10-Q
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
In thousands
Foreign currency translation adjustments
Net change in:
Deferred gains (losses) on cash flow hedges, net of taxes of $(408), $136, $(381) and $(34), respectively
Unrecognized retirement obligations, net of taxes of $(1,513), $(2,263), $(2,928) and $(4,576), respectively
Other comprehensive income (loss)
Comprehensive income
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CONDENSED CONSOLIDATED BALANCE SHEETS
Cash and cash equivalents
Accounts receivable, net
Inventories
Prepaid expenses and other current assets
Total current assets
Plant, equipment and timberlands, net
Goodwill
Intangible assets
Other assets
Total assets
Current portion of long-term debt
Accounts payable
Dividends payable
Environmental liabilities
Other current liabilities
Total current liabilities
Long-term debt
Deferred income taxes
Other long-term liabilities
Total liabilities
Commitments and contingencies
Shareholders’ equity
Common stock
Capital in excess of par value
Retained earnings
Accumulated other comprehensive loss
Less cost of common stock in treasury
Total shareholders’ equity
Total liabilities and shareholders’ equity
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating activities
Adjustments to reconcile to net cash provided by operations:
Depreciation, depletion and amortization
Amortization of debt issue costs and original issue discount
Pension expense, net of unfunded benefits paid
Deferred income tax benefit
Share-based compensation
Change in operating assets and liabilities
Accounts receivable
Prepaid and other current assets
Accruals and other current liabilities
Other
Net cash (used) provided by operating activities
Investing activities
Expenditures for purchases of plant, equipment and timberlands
Proceeds from disposals of plant, equipment and timberlands, net
Acquisition, net of cash acquired
Net cash used by investing activities
Financing activities
Net borrowings under (repayments of) revolving credit facility
Payments of borrowing costs
Proceeds from term loan
Repurchases of common stock
Payments of dividends
Payments related to share-based compensation awards and other
Net cash (used) provided by financing activities
Effect of exchange rate changes on cash
Net decrease in cash and cash equivalents
Cash and cash equivalents at the beginning of period
Cash and cash equivalents at the end of period
Supplemental cash flow information
Cash paid for:
Interest, net of amounts capitalized
Income taxes, net
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
P. H. Glatfelter Company and subsidiaries (“Glatfelter”) is a manufacturer of specialty papers and fiber-based engineered materials. Headquartered in York, Pennsylvania, our manufacturing facilities are located in Spring Grove, Pennsylvania; Chillicothe and Freemont, Ohio; Gatineau, Quebec, Canada; Lydney, England; Caerphilly, Wales; Gernsbach, Falkenhagen and Heidenau, Germany; Scaër, France; and the Philippines. Our products are marketed worldwide, either through wholesale paper merchants, brokers and agents, or directly to customers.
Basis of Presentation The unaudited condensed consolidated financial statements (“financial statements”) include the accounts of Glatfelter and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.
We prepared these financial statements in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles” or “GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission pertaining to interim financial statements. In our opinion, the financial statements reflect all normal, recurring adjustments needed to present fairly our results for the interim periods. When preparing these financial statements, we have assumed that you have read the audited consolidated financial statements included in our 2013 Annual Report on Form 10-K.
Accounting Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingencies as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Management believes the estimates and assumptions used in the preparation of these financial statements are reasonable, based upon currently available facts and known circumstances, but recognizes that actual results may differ from those estimates and assumptions.
Recently Issued Accounting Pronouncements In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09 - Revenue from Contracts with Customers which clarifies the principles for recognizing revenue and develops a common revenue standard for GAAP and International Financial Reporting Standards. The new standard is required to be adopted for fiscal years beginning after December 15, 2016 and early adoption is not permitted. We are in the process of evaluating the impact this standard may have, if any, on our reported results of operations or financial position.
On April 30, 2013, we completed the acquisition of all outstanding shares of Dresden Papier GmbH (“Dresden”) from Fortress Paper Ltd. for $211 million, net of cash acquired. Dresden, based in Heidenau, Germany, is the leading global supplier of nonwoven wallpaper base materials, and is a major supplier to most of the world’s largest wallpaper manufacturers. Dresden’s revenue for the full year 2013 was $158.6 million and it employed approximately 146 people at its state-of-the-art, 72,800 short-ton-capacity manufacturing facility. We financed the acquisition through a combination of cash on hand and borrowings under our Revolving Credit Facility.
The acquisition of Dresden added another industry-leading nonwovens product line to our Composite Fibers business, and broadens our relationship with leading producers of consumer and industrial products. The Dresden acquisition also provided additional operational leverage and growth opportunities for Glatfelter globally, particularly in large markets such as Russia and China, and other developing markets in Eastern Europe and Asia.
Dresden now operates as part of our Composite Fibers business unit which manufactures fiber-based products for growing global niche markets including filtration papers for tea and single serve coffee applications, metallized papers, and technical specialties.
The share purchase agreement provides for, among other terms, indemnification provisions for claims that may arise, including among others, uncertain tax positions and other third party claims. The allocation of the purchase price to assets acquired and liabilities assumed is as follows:
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Assets
Inventory
Plant, equipment and timberlands
Liabilities
Deferred tax liabilities
Other long term liabilities
Total
less cash acquired
Total purchase price
The adjustments set forth above primarily relate to the recognition of additional indemnification receivable from the seller associated with certain tax matters. Such adjustments were recorded in the third quarter of 2013 and did not impact previously reported results of operations, earnings per share, or cash flows.
For purposes of allocating the total purchase price, assets acquired and liabilities assumed are recorded at their estimated fair market value. The allocation set forth above is based on management’s estimate of the fair value using valuation techniques such as discounted cash flow models, appraisals and similar methodologies. The amount allocated to intangible assets represents the estimated value of customer relationships, technological know-how and trade name.
Acquired property, plant and equipment are being depreciated on a straight-line basis with estimated remaining lives ranging from 5 years to 30 years. Intangible assets are being amortized on a straight-line basis over an average estimated remaining life of 17 years reflecting the expected future value.
In connection with the Dresden acquisition we recorded $74.9 million of goodwill and $87.6 million of intangible assets. The goodwill arising from the acquisition largely relates to strategic benefits, product and market diversification, assembled workforce, and similar factors. For tax purposes, none of the goodwill is deductible. Intangible assets consist of $9.8 million of non-amortizing tradename, and the remainder consists of technology and customer relationships.
Our results of operations include the results of Dresden prospectively since the acquisition was completed on April 30, 2013. All such results reported herein are included as part of the Composite Fibers business unit. Revenue of Dresden included in our consolidated results of operations for the second quarter and first six months of 2014 totaled $38.3 million and $79.6 million, respectively, and operating income for the same periods of 2014 totaled $8.2 million and $17.1 million, respectively.
The table below summarizes pro forma financial information as if the acquisition and related financing transaction occurred as of January 1, 2013:
Pro forma
Diluted earnings per share
This unaudited pro forma financial information above is not necessarily indicative of what the operating results would have been had the acquisition been completed at the beginning of the respective period nor is it indicative of future results.
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During the first six months of 2014 and 2013, we completed sales of assets as summarized in the following table:
Dollars in thousands
2014
Timberlands
2013
The following table sets forth the details of basic and diluted earnings per share (“EPS”):
Weighted average common shares outstanding used in basic EPS
Common shares issuable upon exercise of dilutive stock options and PSAs / RSUs
Weighted average common shares outstanding and common share equivalents used in diluted EPS
The following table sets forth potential common shares outstanding for stock options and restricted stock units that were not included in the computation of diluted EPS for the period indicated, because their effect would be anti-dilutive:
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The following table sets forth details of the changes in accumulated other comprehensive income (losses) for the three months and six months ended June 30, 2014 and 2013.
in thousands
Balance at April 1, 2014
Other comprehensive income before reclassifications (net of tax)
Amounts reclassified from accumulated other comprehensive income (net of tax)
Net current period other comprehensive income (loss)
Balance at June 30, 2014
Balance at April 1, 2013
Balance at June 30, 2013
Balance at January 1, 2014
Balance at January 1, 2013
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Reclassifications out of accumulated other comprehensive income were as follows:
Cash flow hedges (Note 14)
(Gains) losses on cash flow hedges
Net of tax
Retirement plan obligations (Note 9)
Amortization of deferred benefit pension plan items
Prior service costs
Actuarial losses
Amortization of deferred benefit other plan items
Total reclassifications, net of tax
Income taxes are recognized for the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. The effects of income taxes are measured based on enacted tax laws and rates.
As of June 30, 2014 and December 31, 2013, we had $14.4 million and $14.9 million of gross unrecognized tax benefits. As of June 30, 2014, if such benefits were to be recognized, approximately $14.4 million would be recorded as a component of income tax expense, thereby affecting our effective tax rate.
We, or one of our subsidiaries, file income tax returns with the United States Internal Revenue Service, as well as various state and foreign authorities.
The following table summarizes, by major jurisdiction, tax years that remain subject to examination:
Jurisdiction
United States
Federal
State
Canada (1)
Germany (1)
France
United Kingdom
Philippines
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The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. Management performs a comprehensive review of its global tax positions on a quarterly basis and accrues amounts for uncertain tax positions. Based on these reviews and the result of discussions and resolutions of matters with certain tax authorities and the closure of tax years subject to tax audit, reserves are adjusted as necessary. However, future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are determined or resolved or as such statutes are closed. Due to potential for resolution of federal, state and foreign examinations, and the lapse of various statutes of limitation, it is reasonably possible our gross unrecognized tax benefits balance may decrease within the next twelve months by a range of zero to $5.2 million. Substantially all of this range relates to tax positions taken in the U.S. and Germany.
We recognize interest and penalties related to uncertain tax positions as income tax expense. The following table summarizes information related to interest and penalties on uncertain tax positions:
In millions
Penalties
Accrued interest payable
The P. H. Glatfelter Amended and Restated Long Term Incentive Plan (the “LTIP”) provides for the issuance of Glatfelter common stock to eligible participants in the form of restricted stock units, restricted stock awards, non-qualified stock options, performance shares, incentive stock options and performance units.
Pursuant to terms of the LTIP, we have issued to eligible participants restricted stock units, performance share awards and stock only stock appreciation rights.
Restricted Stock Units (“RSU”) and Performance Share Awards (“PSAs”) Awards of RSUs and PSAs are made under our LTIP. The RSUs vest on the passage of time, generally on a graded scale over a three, four, and five-year period, or in certain instances the RSUs were issued with five year cliff vesting. PSAs are issued annually to members of management and each respective grant cliff vests each December 31 of the third year following the grant, assuming the achievement of predetermined, three-year cumulative performance targets. The performance measures include a minimum, target and maximum performance level providing the grantees an opportunity to receive more or less shares than targeted depending on actual financial performance. For both RSUs and PSAs, the grant date fair value of the awards, which is equal to the closing price per common share on the date of the award, is used to determine the amount of expense to be recognized over the applicable service period. Settlement of RSUs and PSAs will be made in shares of our common stock currently held in treasury.
The following table summarizes RSU and PSA activity during periods indicated:
Units
Balance January 1,
Granted
Forfeited
Shares delivered
Balance June 30,
The amount granted in 2014 and 2013 includes PSAs of 93,660 and 151,955, respectively, exclusive of reinvested dividends.
The following table sets forth aggregate RSU and PSA compensation expense for the periods indicated:
Stock Only Stock Appreciation Rights (“SOSARs”) Under terms of the SOSAR, a recipient receives the right to a payment in the form of shares of common stock equal to the difference, if any, in the fair market value of one share of common stock at the time of exercising the SOSAR and the exercise price. The SOSARs vest ratably over a three year period and have a term of ten years.
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The following table sets forth information related to outstanding SOSARS.
SOSARS
Outstanding at January 1,
Exercised
Canceled / forfeited
Outstanding at June 30,
SOSAR Grants
Weighted average grant date fair value per share
Aggregate grant date fair value (in thousands)
Black-Scholes assumptions
Dividend yield
Risk free rate of return
Volatility
Expected life
The following table sets forth SOSAR compensation expense for the periods indicated:
The following tables provide information with respect to the net periodic costs of our pension and post retirement medical benefit plans.
Pension Benefits
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of unrecognized loss
Net periodic benefit cost
Other Benefits
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Inventories, net of reserves, were as follows:
Raw materials
In-process and finished
Supplies
Long-term debt is summarized as follows:
Revolving credit facility, due Nov. 2016
5.375% Notes, due Oct. 2020
2.05% Term Loan, due Mar. 2023
Total long-term debt
Less current portion
Long-term debt, net of current portion
On November 21, 2011, we entered into an amendment to our revolving credit agreement with a consortium of banks (the “Revolving Credit Facility”) which increased the amount available for borrowing to $350 million, extended the maturity of the facility to November 21, 2016, and instituted a lower interest rate pricing grid.
For all U.S. dollar denominated borrowings under the Revolving Credit Facility, the borrowing rate is, at our option, (a) the bank’s base rate which is equal to the greater of i) the prime rate; ii) the federal funds rate plus 50 basis points plus an applicable spread ranging from 25 basis points to 125 basis points based on our corporate credit ratings determined by Standard & Poor’s Rating Services and Moody’s Investor Service, Inc. (the “Corporate Credit Rating”); or iii) the daily Euro-rate plus 100 basis points; or (b) the daily Euro-rate plus an applicable margin ranging from 125 basis points to 225 basis points based on the Corporate Credit Rating. For non-US dollar denominated borrowings, interest is based on (b) above.
The Revolving Credit Facility contains a number of customary covenants for financings of this type that, among other things, restrict our ability to dispose of or create liens on assets, incur additional indebtedness, repay other indebtedness, limits certain intercompany financing
arrangements, make acquisitions and engage in mergers or consolidations. We are also required to comply with specified financial tests and ratios including: i) maximum net debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”) ratio (the “leverage ratio”); ii) a consolidated EBITDA to interest expense ratio; and iii) beginning December 31, 2015, a minimum liquidity ratio. The most restrictive of our covenants is a maximum leverage ratio of 3.5x. As of June 30, 2014, the leverage ratio, as calculated in accordance with the definition in our credit agreement, was 2.44x, within the limits set forth in our credit agreement. A breach of these requirements would give rise to certain remedies under the Revolving Credit Facility, among which are the termination of the agreement and accelerated repayment of the outstanding borrowings plus accrued and unpaid interest under the credit facility.
On October 3, 2012, we completed a private placement offering of $250.0 million aggregate principal amount of 5.375% Senior Notes due 2020 (the “5.375% Notes”). The 5.375% Notes are fully and unconditionally guaranteed, jointly and severally, by PHG Tea Leaves, Inc., Mollanvick, Inc., and Glatfelter Holdings, LLC (the “Guarantors”). The net proceeds from this were used to refinance our previous $200.0 million, to repay amounts outstanding under our revolving credit facility and for general corporate purposes.
Interest on the 5.375% Notes is payable semiannually in arrears on April 15 and October 15, commencing on April 15, 2013.
The 5.375% Notes are redeemable, in whole or in part, at anytime on or after October 15, 2016 at the redemption prices specified in the applicable Indenture. Prior to October 15, 2016, we may redeem some or all of the Notes at a “make-whole” premium as specified in the Indenture. These Notes and the guarantees of the notes are senior obligations of the Company and the Guarantors, respectively, rank equally in right of payment with future senior indebtedness of the Company and the Guarantors and will mature on October 15, 2020.
The 5.375% Notes contain various covenants customary to indebtedness of this nature including limitations on i) the amount of indebtedness that may be incurred; ii) certain restricted payments including common stock dividends; iii) distributions from certain subsidiaries; iv) sales of assets; v) transactions amongst subsidiaries; and vi) incurrence of liens on assets. In addition, the 5.375% Notes contain cross default provisions that could result in all such notes becoming due and payable in the event of a failure to repay debt outstanding under the Revolving Credit Agreement at maturity or a default under the Revolving Credit Agreement that accelerates the debt outstanding thereunder. As of June 30, 2014, we met all of the requirements of our debt covenants.
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On April 11, 2013, Glatfelter Gernsbach GmbH & Co. KG (“Gernsbach”), a wholly-owned subsidiary of ours, entered into an agreement with IKB Deutsche Industriebank AG, Düsseldorf (“IKB”), pursuant to which Gernsbach borrowed from IKB approximately €42.7 million (or $57.6 million) aggregate principal amount (the “IKB Loan”).
The IKB Loan, guaranteed in full by us, is repayable in 32 quarterly installments beginning on June 30, 2015 and ending on March 31, 2023 and will bear interest at a rate of 2.05% per annum. Interest on the IKB Loan or portion thereof is payable quarterly in each year of the term of the loan with interest accruing from the date the loan or portion thereof is drawn.
The IKB Loan provides for representations, warranties and covenants customary for financings of this type. The financial covenants contained in the IKB Loan, which relate to the minimum ratio of consolidated EBITDA to consolidated interest expense and the maximum ratio of consolidated total net debt to consolidated adjusted EBITDA, will be calculated by reference to our Amended and Restated Credit Agreement, dated November 21, 2011.
P. H. Glatfelter Company guarantees all debt obligations of its subsidiaries. All such obligations are recorded in these condensed consolidated financial statements.
As of June 30, 2014 and December 31, 2013, we had $5.2 million of letters of credit issued to us by certain financial institutions. The letters of credit, which reduce amounts available under our revolving credit facility, primarily provide financial assurances for the benefit of certain state workers compensation insurance agencies in conjunction with our self-insurance program. We bear the credit risk on this amount to the extent that we do not comply with the provisions of certain agreements. No amounts are outstanding under the letters of credit.
During 2008, we recorded $11.5 million, net present value, of asset retirement obligations related to the legal requirement to close several lagoons at the Spring Grove, PA facility. Historically, lagoons were used to dispose of residual waste material. Closure of the lagoons is expected to be completed in 2016 and will be accomplished by filling the lagoons, installing a non-permeable liner which will be covered with soil to construct the required cap over the lagoons. The
retirement obligation was accrued with a corresponding increase in the carrying value of the property, equipment and timberlands caption on the consolidated balance sheet. The amount capitalized is being amortized as a charge to operations on the straight-line basis in relation to the expected closure period. Following is a summary of activity recorded during the first six months of 2014 and 2013:
Balance at January 1,
Accretion
Payments
Gain
Balance at June 30,
The following table summarizes the line items in the accompanying condensed consolidated balance sheets where the asset retirement obligations are recorded:
The amounts reported on the condensed consolidated balance sheets for cash and cash equivalents and accounts receivable approximate fair value. The following table sets forth carrying value and fair value of long-term debt:
Fixed-rate bonds
2.05% Term loan
Variable rate debt
As of June 30, 2014, and December 31, 2013, we had $250.0 million of 5.375% fixed rate bonds. These bonds are publicly registered, but thinly traded. Accordingly, the values set forth above for the bonds, as well as our other debt instruments, are based on observable inputs and other relevant market data (Level 2). The fair value of financial derivatives is set forth below in Note 14.
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As part of our overall risk management practices, we enter into financial derivatives primarily designed to either i) hedge foreign currency risks associated with forecasted transactions – “cash flow hedges”; or ii) mitigate the impact that changes in currency exchange rates have on intercompany financing transactions and foreign currency denominated receivables and payables – “foreign currency hedges.”
Derivatives Designated as Hedging Instruments - Cash Flow Hedges We use currency forward contracts as cash flow hedges to manage our exposure to fluctuations in the currency exchange rates on certain forecasted production costs expected to be incurred over a maximum of twelve months. Currency forward contracts involve fixing the exchange for delivery of a specified amount of foreign currency on a specified date.
We designate certain currency forward contracts as cash flow hedges of forecasted raw material purchases or certain production costs with exposure to changes in foreign currency exchange rates. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges of foreign exchange risk is deferred as a component of accumulated other comprehensive income in the accompanying condensed consolidated balance sheets and is subsequently reclassified into costs of products sold in the period that inventory produced using the hedged transaction affects earnings. The ineffective portion of the change in fair value of the derivative is recognized directly to earnings and reflected in the accompanying condensed consolidated statements of income as non-operating income (expense) under the caption “Other-net.”
We had the following outstanding derivatives that were used to hedge foreign exchange risks associated with forecasted transactions and designated as hedging instruments:
Derivative
Sell / Buy
Euro / U.S. dollar
U.S. dollar / Canadian dollar
Euro / Philippine peso
British Pound / Philippine peso
Euro / British Pound
These contracts have maturities of twelve months or less.
Derivatives Not Designated as Hedging Instruments—Foreign Currency Hedges We also enter into forward foreign exchange contracts to mitigate the impact changes in currency exchange rates have on balance sheet
monetary assets and liabilities. None of these contracts are designated as hedges for financial accounting purposes and, accordingly, changes in value of the foreign exchange forward contracts and in the offsetting underlying on-balance-sheet transactions are reflected in the accompanying condensed consolidated statements of income under the caption “Other – net.”
The following sets forth derivatives used to mitigate the impact changes in currency exchange rates have on balance sheet monetary assets and liabilities:
Canadian dollar / U.S. dollar
U.S. dollar / Euro
U.S. dollar / British Pound
These contracts have maturities of one month from the date originally entered into.
Fair Value Measurements The following table summarizes the fair values of derivative instruments for the period indicated and the line items in the accompanying condensed consolidated balance sheets where the instruments are recorded:
Balance
sheet
caption
Designated as hedging:
Forward foreign currency exchange contracts
Not designated as hedging:
The amounts set forth in the table above represent the net asset or liability giving effect to rights of offset with each counterparty. The effect of netting the amounts presented above did not have a material effect on our consolidated financial position.
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The following table summarizes the amount of income or (loss) from derivative instruments recognized in our results of operations for the periods indicated and the line items in the accompanying condensed consolidated statements of income where the results are recorded:
Forward foreign currency exchange contracts:
Effective portion – cost of products sold
Ineffective portion – other – net
Other – net
The impact of activity not designated as hedging was substantially all offset by the remeasurement of the underlying on-balance sheet item.
The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).
The fair values of the foreign exchange forward contracts are considered to be Level 2. Foreign currency forward contracts are valued using foreign currency forward and interest rate curves. The fair value of each contract is determined by comparing the contract rate to the forward rate and discounting to present value. Contracts in a gain position are recorded in the condensed consolidated balance sheets under the caption “Prepaid expenses and other current assets” and the value of contracts in a loss position is recorded under the caption “Other current liabilities.”
A rollforward of fair value amounts recorded as a component of accumulated other comprehensive income is as follows:
Deferred (losses) gains on cash flow hedges
Reclassified to earnings
We expect substantially all of the amounts recorded as a component of accumulated other comprehensive income will be realized in results of operations within the next twelve months and the amount ultimately recognized will vary depending on actual market rates.
Credit risk related to derivative activity arises in the event the counterparty fails to meet its obligations to us. This exposure is generally limited to the amounts, if any, by which the counterparty’s obligations exceed our obligation to them. Our policy is to enter into contracts only with financial institutions which meet certain minimum credit ratings.
The following table summarizes share repurchases made pursuant to a $50 million share repurchase program which expires in May 2016:
Authorized amount
Repurchases
Remaining authorization
The amounts set forth above include 360,299 shares at a cost of $9.5 million of repurchases completed in 2014.
Fox River – Neenah, Wisconsin
Background. We have significant uncertainties associated with environmental claims arising out of the presence of polychlorinated biphenyls (“PCBs”) in sediments in the lower Fox River, on which our former Neenah facility was located, and in the Bay of Green Bay Wisconsin (collectively, the “Site”). The United States, the State of Wisconsin, and two Indian tribes (collectively, the “Governments”) seek to require (a) a cleanup of the Site
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(“response actions”), (b) reimbursement of cleanup costs (“response costs”), and (c) natural resource damages (“NRDs”). They claim that we, together with seven other entities that have been formally notified that they are potentially responsible parties (“PRPs”) under CERCLA for response costs or NRDs, are jointly and severally responsible under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA” or “Superfund”) for those response actions, response costs, and NRDs, all of which may total in excess of $1 billion.
The PRPs consist of us, Appvion, Inc. (formerly known as Appleton Papers Inc.), CBC Coating, Inc. (formerly known as Riverside Paper Corporation), Georgia-Pacific Consumer Products, L.P. (formerly known as Fort James Operating Company), Menasha Corporation, NCR Corporation (“NCR”), U.S. Paper Mills Corp., and WTM I Company.
The Governments have identified manufacturing and recycling of NCR®-brand carbonless copy paper as the principal source of the PCBs in sediments at the Site. Our predecessor, the Bergstrom Paper Company and later we, operated a deinking paper mill in Neenah, Wisconsin. This mill received NCR®-brand carbonless copy paper in its furnish and discharged PCBs to Little Lake Butte des Morts, an impoundment of the river at the upstream end of the Site.
The United States Environmental Protection Agency (“EPA”) has divided the Site into five “operable units”, including the most upstream (“OU1”) and four downstream reaches of the river and bay (“OU2-5”). OU1 extends from primarily Lake Winnebago to the dam at Appleton, and is comprised of Little Lake Butte des Morts. The Neenah Facility discharged its wastewater into this portion of the site.
We have resolved our liability for response actions and response costs associated with the permanent cleanup of Little Lake Butte des Morts through a consent decree, and amendments, entered in United States v. P.H. Glatfelter Co., No. 2:03-cv-949-LA (E.D. Wis.). Together with WTM I Company and with assistance from Menasha Corporation, we have completed that cleanup except for on-going operation and maintenance.
In November 2007, the EPA issued a unilateral administrative order for remedial action (“UAO”) to us and to seven other respondents directing us to implement the cleanup of the Site downstream of Little Lake Butte des Morts. Since that time, the district court has held that one of the respondents, Appvion, is not liable for this Site. In addition, the United States and the State of Wisconsin have entered into a settlement with another respondent, Georgia-Pacific LLP (“GP”), limiting GP’s responsibility
to the downstream-most three miles of the river. Work has proceeded to implement the UAO, mostly funded by NCR and its indemnitors.
In January 2008, two of the UAO respondents, NCR and Appleton Papers Inc. (now known as Appvion), brought two actions, consolidated under the caption Appleton Papers Inc. v. George A. Whiting Paper Co., No. 2:08-cv-16-WCG (E.D. Wis.) (“Whiting Litigation”), that ultimately involved us and more than two dozen parties in litigation to allocate among the parties the responsibility for response actions, response costs, and NRDs for this Site. Most of the parties responsible for relatively small discharges of PCBs settled with the Governments, resolving their liability. On June 27, 2013, the district court entered a final judgment that (a) neither NCR nor Appvion may pursue any other party for contribution, (b) NCR owes us and the other non-settling parties “full contribution” for any amounts we may have to pay on account of response actions or response costs downstream of Little Lake Butte des Morts or on account of NRDs, (c) NCR is not liable for response costs, response actions, or NRDs in Little Lake Butte des Morts, and (d) NCR owes us reimbursement of $4.28 million in costs we incurred in the past. NCR and Appvion have appealed that judgment. We have filed a cross-appeal of that judgment (as have several other defendants), challenging those portions of the judgment with which we disagree, including the ruling that NCR is not liable for response costs, response actions, or NRDs in Little Lake Butte des Morts. Until the Whiting Litigation judgment is affirmed on appeal, all past and future costs or damages incurred by any person remain the subject of litigation against us.
In October 2010, the United States and the State of Wisconsin sued us and thirteen other defendants to recover an injunction requiring the UAO respondents to complete the response actions required by the UAO and all parties to reimburse past and future response costs incurred by the Governments as well as to pay NRDs. That case is captioned United States v. NCR Corp., No. 1:10-cv-910-WCG (E.D. Wis.) (“Government Action”). To date, litigation of the Government Action has been limited to the United States’ claim against the UAO respondents for a mandatory injunction to require implementation of the remaining work under the UAO, that is, completion of the remedy in the 33 miles of the river downstream of Little Lake Butte des Morts. Following a trial in December 2012, on May 1, 2013, the district court granted that injunction (“May 2013 Order”). The May 2013 Order directs the Company “jointly and severally” along with three other defendants that are also enjoined (NCR, WTM I Company, and Menasha Corporation) to comply with the UAO. An accompanying declaratory judgment declares the Company and those three defendants jointly and severally liable with three
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additional defendants (Georgia-Pacific, LLP, U.S. Paper Mills, Inc., and CBC Coatings, Inc.) that have entered into agreements with the United States governing those parties’ compliance with the UAO. The district court has denied NCR’s motion to require us to contribute to compliance with the injunction. We have appealed the May 2013 Order, as have NCR, WTM I, and Menasha.
On March 26, 2014, the United States lodged three proposed consent decrees under which all parties, other than NCR, GP, and us, would resolve their liability for this Site. Under the terms of those consent decrees, each of the Settling Defendants would pay a cash amount aggregating $56.6 million primarily for NRDs and past response costs, and would have no further obligations under the UAO or to satisfy any judgment in the Government Action.
Cost estimates. Estimates of the Site remediation change over time as we, or others, gain additional data and experience at the Site. In addition, disagreement exists over the likely costs for some of this work. Based upon estimates made by the Governments and independent estimates commissioned by various potentially responsible parties, we have no reason to disagree with the Governments’ assertion that total past and future response costs and NRDs at this site may exceed $1 billion and that $1.5 billion is a reasonable “outside estimate.” Much of that amount has already been incurred. As described below, some of that amount is NRDs. The parties implementing the response action under the UAO in the downstream part of the river estimate the cost of work done in 2013 and the future cost of work yet to be done totals approximately $360 million. The Governments seek to have that work done at a rate estimated to cost approximately $70 million each year from 2013 through 2016, and at lower rates afterward.
NRDs. The Governments’ NRD assessment documents claimed that we are jointly and severally responsible for NRDs with a value between $176 million and $333 million. The Governments now claim that this range should be inflated to 2009 dollars and then certain unreimbursed past assessment costs should be added, so that the range of their claim would be $287 million to $423 million. We deny liability for most of these NRDs and believe that even if anyone is liable, that we are not jointly and severally liable for the full amount. The May 2013 Order does not determine whether liability for NRDs would be joint and several. Moreover, we believe that the Natural Resource Trustees may not legally pursue this claim at this late date, as the limitations period for NRD claims is three years from discovery.
Reserves for the Site. As of June 30, 2014, our reserve for the Site, including our remediation and ongoing monitoring obligations in Little Lake Butte des Morts, our
share of remediation of the rest of the Site, NRDs associated with PCB contamination at the Site and all pending, threatened or asserted and unasserted claims against us relating to PCB contamination at the Site totaled $16.3 million. Of our total reserve for the Fox River, $0.1 million is recorded in the accompanying condensed consolidated balance sheets under the caption “Environmental liabilities” and the remainder is recorded under the caption “Other long term liabilities.”
Although we believe that amounts already funded by us and WTM I to implement the Little Lake Butte des Morts remedy are adequate and no payments have been required since January 2009, there can be no assurance that these amounts will in fact suffice. WTM I has filed a bankruptcy petition in the Bankruptcy Court in Richmond; accordingly, there can be no assurance that WTM I will be able to fulfill its obligation to pay half of any additional costs, if required.
We do not believe that we will be allocated a significant percentage share of liability in any final equitable allocation of the response costs and NRDs. The accompanying condensed consolidated financial statements do not include reserves for defense costs for the Whiting Litigation, the Government Action, or any future defense costs related to our involvement at the Site, which could be significant.
In setting our reserve for the Site, we have assessed our legal defenses, including our successful defenses to the allegations made in the Whiting Litigation and the determination in the Whiting Litigation that NCR owes us “full contribution” for response costs and NRDs that we may become obligated to pay except in OU1, and assumed that we will not bear the entire cost of remediation or damages to the exclusion of other known parties at the Site, who are also potentially jointly and severally liable. The existence and ability of other parties to participate has also been taken into account in setting our reserve, and is generally based on our evaluation of recent publicly available financial information on certain of the responsible parties and any known insurance, indemnity or cost sharing agreements between responsible parties and third parties. In addition, our assessment is based upon the magnitude, nature, location and circumstances associated with the various discharges of PCBs to the river and the relationship of those discharges to identified contamination. We will continue to evaluate our exposure and the level of our reserves, including, but not limited to, our potential share of the costs and NRDs, if any, associated with the Site.
The amount and timing of future expenditures for environmental compliance, cleanup, remediation and personal injury, NRDs and property damage liabilities cannot be ascertained with any certainty due to, among
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other things, the unknown extent and nature of any contamination, the response actions that may ultimately be required, the availability of remediation equipment and landfill space, and the number and financial resources of any other PRPs.
Other Information. The Governments have published studies estimating the amount of PCBs discharged by each identified potentially responsible party (“PRP’s”) to the lower Fox River and Green Bay. These reports estimate our Neenah mill’s share of the mass of PCBs discharged to be as high as 27%. The district court in its May 2013 Order found the discharge mass estimates used in these studies not to be accurate. We believe that the Neenah mill’s absolute and relative contribution of PCB mass is significantly lower than the estimates set forth in these studies. The trial court in the Government Action has found that the Neenah mill discharged an unknown amount of PCBs.
In any event, based upon the rulings in the Whiting Litigation and the Government Action, neither of which endorsed an equitable allocation in proportion to the mass of PCBs discharged, we continue to believe that an allocation in proportion to mass of PCBs discharged would not constitute an equitable allocation of the potential liability for the contamination at the Fox River. We contend that other factors, such as the location of contamination, the location of discharge, and a party’s role in causing discharge, must be considered in order for the allocation to be equitable.
In the 1990s, we entered into interim cost-sharing agreements with six of the other PRPs, which provided for those PRPs to share certain costs relating to scientific studies of PCBs discharged at the Site (“Interim Cost Sharing Agreements”). These Interim Cost Sharing Agreements do not establish the final allocation of remediation costs incurred at the Site. Based upon our evaluation of the rulings in the Whiting Litigation as well as the volume, nature and location of the various discharges of PCBs at the Site and the relationship of those discharges to identified contamination, we believe our allocable share of liability at the Site is less than our share of costs under the Interim Cost Sharing Agreements.
Range of Reasonably Possible Outcomes. Our analysis of the range of reasonably possible outcomes is derived from all available information, including but not limited to decisions of the courts, official documents such as records of decision, discussions with the United States and other parties, as well as legal counsel and engineering
consultants. Based on our analysis of the current records of decision and cost estimates for work to be performed at the Site, we believe that it is reasonably possible that our costs associated with the Fox River matter may exceed our cost estimates and the aggregate amounts accrued for the Fox River matter by amounts that are insignificant or that could range up to $275 million over an undeterminable period that could range beyond 10 years. We believe that the likelihood of an outcome in the upper end of the monetary range is significantly less than other possible outcomes within the range and that the possibility of an outcome in excess of the upper end of the monetary range is remote. The rulings in our favor in the Whiting Litigation, if sustained on appeal, suggest that outcomes in the upper end of the monetary range have become somewhat less likely, while adverse rulings on some issues in the Whiting Litigation and the Government Action and increases in cost estimates for some of the work may make an outcome in the upper end of the range more likely. The Company also believes that the effect of reading the Whiting Litigation decisions together with the May 2013 Order requires the ongoing compliance with the UAO to be funded by NCR, or to the extent that the Company is required to provide any such funding, that NCR will be required to reimburse the Company. There can be no assurance, however, that the May 2013 Order will not have a material adverse effect on the Company’s consolidated financial position, liquidity or results of operation.
Summary. Our current assessment is that we will be able to manage this environmental matter without a long-term, material adverse impact on the Company. This matter could, however, at any particular time or for any particular year or years, have a material adverse effect on our consolidated financial position, liquidity and/or results of operations or could result in a default under our debt covenants. Moreover, there can be no assurance that our reserves will be adequate to provide for future obligations related to this matter, that our share of costs and/or damages will not exceed our available resources, or that those obligations will not have a long-term, material adverse effect on our consolidated financial position, liquidity or results of operations. Should a court grant the United States or the State of Wisconsin relief that requires us individually either to perform directly or to contribute significant amounts towards remedial action downstream of Little Lake Butte des Morts or to NRDs, those developments could have a material adverse effect on our consolidated financial position, liquidity and results of operations and might result in a default under our loan covenants.
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The following tables sets forth financial and other information by business unit for the period indicated:
Three months ended June 30
Dollars in millions
Total revenue
Cost of products sold
Gross profit (loss)
SG&A
Total operating income (loss)
Non-operating expense
Income (loss) before income taxes
Supplementary Data
Net tons sold (thousands)
Capital expenditures
Six months ended June 30
The sum of individual amounts set forth above may not agree to the consolidated financial statements included herein due to rounding.
On April 30, 2013, we completed the acquisition of Dresden for $211 million. Dresden’s results are included prospectively from the acquisition date as part of the Composite Fibers business unit. For additional information related to this acquisition, refer to Note 3 – Acquisition.
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Our 5.375% Notes issued by P. H. Glatfelter Company (the “Parent”) are fully and unconditionally guaranteed, on a joint and several basis, by certain of our 100%-owned domestic subsidiaries, PHG Tea Leaves, Inc., Mollanvick, Inc., and Glatfelter Holdings, LLC. The guarantees are subject to certain customary release provisions including i) the designation of such subsidiary as an unrestricted or excluded subsidiary; (ii) in connection with any sale or disposition of the capital stock of the subsidiary guarantor; and (iii) upon our exercise of our legal defeasance option or our covenant defeasance option, all of which are more fully described in the Indenture dated as of October 3, 2012 among us, the Guarantors and US Bank National Association, as Trustee, relating to the 5.375% Notes. The following presents our condensed consolidating statements of income, including comprehensive income for the three months and six months ended June 30, 2014 and 2013, our condensed consolidating balance sheets as of June 30, 2014 and December 31, 2013 and condensed consolidating cash flows for the six months ended June 30, 2014 and 2013. These financial statements reflect the parent, the guarantor subsidiaries (on a combined basis), the non-guarantor subsidiaries (on a combined basis) and elimination entries necessary to combine such entities on a consolidated basis. Effective December 31, 2013, Glatfelter Pulpwood Company, previously a guarantor, was merged with and into the parent. Accordingly, all condensed consolidating financial statements have been restated to give effect to this merger as of the earliest period presented. In addition, the amounts of intercompany investing and financing activities and the related interest expense and interest income previously presented net for the six months ended June 30, 2013 have been presented on a gross basis to conform to the current year’s presentation.
Condensed Consolidating Statements of Income and Comprehensive Income for the
three months ended June 30, 2014
Operating income (loss)
Other non-operating income (expense)
Total other non-operating income (expense)
Income tax provision (benefit)
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three months ended June 30, 2013
Other comprehensive income
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six months ended June 30, 2014
Energy and related sales – net
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six months ended June 30, 2013
Other comprehensive loss
Comprehensive income (loss)
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Condensed Consolidating Balance Sheet as of
Other current assets
Current liabilities
December 31, 2013
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Condensed Consolidating Statement of Cash Flows for the six
months ended June 30, 2014
Net cash provided (used) by
Proceeds from disposal plant, equipment and timberlands, net
Advances of intercompany loans
Total investing activities
Net repayments of indebtedness
Payment of dividends to shareholders
Borrowings of intercompany loans
Total financing activities
Effect of exchange rate on cash
Net decrease in cash
Cash at the beginning of period
Cash at the end of period
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months ended June 30, 2013
Repayments from intercompany loans
Intecompany capital contributed
Acquisitions, net of cash acquired
Net proceeds from indebtedness
Payments of note offering costs
Repayments of intercompany loans
Intercompany capital received
Proceeds from stock options exercised and other
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the information in the unaudited condensed consolidated financial statements and notes thereto included herein and Glatfelter’s Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2013 Annual Report on Form 10-K.
Forward-Looking Statements This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact, including statements regarding industry prospects and future consolidated financial position or results of operations, made in this Report on Form 10-Q are forward looking. We use words such as “anticipates”, “believes”, “expects”, “future”, “intends” and similar expressions to identify forward-looking statements. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Our actual results may differ significantly from such expectations. The following discussion includes forward-looking statements regarding expectations of, among others, shipping volumes, selling prices, input costs, non-cash pension expense, environmental costs, capital expenditures and liquidity, all of which are inherently difficult to predict. Although we make such statements based on assumptions that we believe to be reasonable, there can be no assurance that actual results will not differ materially from our expectations. Accordingly, we identify the following important factors, among others, which could cause our results to differ from any results that might be projected, forecasted or estimated in any such forward-looking statements:
We manufacture a wide array of specialty papers and fiber-based engineered materials. We manage our company along three business units:
Composite Fibers with revenue from the sale of single-serve coffee and tea filtration papers, non-woven wall covering, metallized papers, composite laminates, and other technical specialty papers;
Advanced Airlaid Materials with revenue from the sale of airlaid non-woven fabric like materials used in feminine hygiene products, adult incontinence products, cleaning pads, food pads, napkins, tablecloths, and baby wipes; and
Specialty Papers with revenue from the sale of carbonless papers, forms, book publishing, envelope & converting papers, and fiber-based engineered products.
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RESULTS OF OPERATIONS
Six months ended June 30, 2014 versus the six months ended June 30, 2013
Overview For the first six months of 2014, net income was $19.3 million, or $0.44 per diluted share, compared with $16.6 million, or $0.38 per diluted share, in the same period of 2013. Our results reflect benefits from our two growth businesses as they delivered a combined 18% increase in net sales. Composite Fibers, driven by the previously acquired Dresden business, and Advanced Airlaid Materials reported improved operating profit of 30% and 22%, respectively, over the prior year period. In Specialty Papers, the first half of 2014 was significantly affected by poor pulp mill performance issues in Ohio, severe weather conditions and higher costs related to annual maintenance outages which led to unfavorable results compared to the prior year. In addition, our results benefited from a lower effective tax rate due to a greater proportion of earnings generated in lower tax foreign jurisdictions relative to the U.S. and a $2.2 million tax benefit related to the revaluation of deferred taxes.
The following table sets forth summarized results of operations:
Earnings per diluted share
Effective April 30, 2013, we completed the acquisition of Dresden Papier GmbH (“Dresden”) for approximately $211 million, net of cash acquired. Our reported results include Dresden prospectively from the acquisition date, including $79.6 million of net sales and $17.1 million of operating profit for the first six months of 2014. The comparable amounts for the year earlier period were $27.7 million and $5.5 million, respectively.
In addition to the results reported in accordance with GAAP, we evaluate our performance using adjusted net income and adjusted earnings per diluted share. We disclose this information to allow investors to evaluate our performance exclusive of certain items that impact the comparability of results from period to period and that it is helpful in understanding underlying operating trends and cash flow generation. Adjusted net income consists of net income determined in accordance with GAAP adjusted to exclude the impact of the following:
Timberland sales and related costs. These adjustments exclude gains from the sales of timberlands as these items are not considered to be part of our core business, ongoing results of operations or cash flows. These adjustments are irregular in timing and amount and may significantly impact the Company’s operating performance. As such, these items may not be indicative of past and future performance of the Company and therefore are excluded for comparability purposes.
Acquisition and integration related costs. These adjustments include costs directly related to the consummation of the acquisition process and those related to integrating recently acquired businesses. These costs are irregular in timing and as such may not be indicative of our past and future performance.
International legal entity restructuring costs. These adjustments include costs that are directly related to actions undertaken to improve the flexibility of the organizational structure to support our growth initiatives. As such, these items are considered to be unusual in nature and not indicative of our past and future and are therefore excluded for the purpose of understanding underlying operating trends.
Adjusted earnings per diluted share is calculated by dividing adjusted net income by diluted weighted-average shares outstanding. Adjusted earnings and adjusted earnings per diluted share are considered measures not calculated in accordance with GAAP, and therefore are non-GAAP measures. These non-GAAP measures may differ from other companies. The non-GAAP financial information should not be considered in isolation from, or as a substitute for, measures of financial performance prepared in accordance with GAAP.
Timberland sales and related costs
Adjusted earnings (non-GAAP)
Acquisition and integration related costs
International legal entity restructuring costs
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Our growth-oriented fiber-based materials businesses reported improved results evidenced by a $10.7 million increase in operating profit. However, total operating income from all of our business units declined $8.5 million reflecting the impact of the decline in Specialty Papers results. Overall, shipping volumes increased 3.8% in the year-over-year comparison.
Composite Fibers’ operating income increased to $36.6 million from $28.1 million in the first six months of 2013 primarily due to the inclusion of Dresden. Excluding Dresden, shipping volumes declined 2.1% although the mix improved.
Advanced Airlaid Materials’ operating income increased to $12.0 million compared with $9.8 million for the first six months of 2013. The improved performance was largely driven by a 4.4% increase in shipping volumes.
Specialty Papers’ operating earnings declined $19.2 million to a loss of $4.8 million. The results were significantly affected by disruptions in pulp production, severe weather conditions through the first two months of 2014 and higher costs of the annual maintenance outages. Volumes shipped declined 1.3% in the comparison, although selling prices increased.
Business Unit Performance
Business Units Results of individual business units are presented based on our management accounting practices and management structure. There is no comprehensive, authoritative body of guidance for management accounting equivalent to accounting principles generally accepted in the United States of America; therefore, the financial results of individual business units are not necessarily comparable with similar information for any other company. The management accounting process uses assumptions and allocations to measure performance of the business units. Methodologies are refined from time to time as management accounting practices are enhanced and businesses change. The costs incurred by support areas not directly aligned with the business unit are allocated primarily based on an estimated utilization of support area services or are included in “Other and Unallocated” in the Business Unit Performance table.
Management evaluates results of operations of the business units before pension expense, certain corporate level costs, and the effects of certain gains or losses not considered to be related to the core business operations. Management believes that this is a more meaningful representation of the operating performance of its core businesses, the profitability of business units and the extent of cash flow generated from these core operations. Such amounts are presented under the caption “Other and Unallocated.” This presentation is aligned with the management and operating structure of our company. It is also on this basis that the Company’s performance is evaluated internally and by the Company’s Board of Directors.
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Sales and Costs of Products Sold
Gross profit as a percent of Net sales
The following table sets forth the contribution to consolidated net sales by each business unit:
Percent of Total
Business Unit
Composite Fibers
Advanced Airlaid Material
Specialty Papers
Net sales for the first six months of 2014 totaled $901.1 million, an 8.4% increase compared with the same period of 2013. Excluding the Dresden acquisition, organic growth totaled 2.2%.
Composite Fibers’ net sales totaled $315.6 million in the first half of 2014, an increase of $61.2 million compared to the first half of 2013, of which the Dresden acquisition accounted for $51.9 million. On an organic basis, shipping volumes declined 2.1% although the mix was favorable. The translation of foreign currencies benefited the comparison by $9.7 million.
Operating income for the first six months of 2014 increased $8.5 million compared to the year-ago period due to the Dresden acquisition partially offset by raw material and other cost inflation.
In Advanced Airlaid Materials, net sales increased $9.1 million, or 6.9%, primarily due to a 4.4% increase in shipping volumes. Foreign currency translation favorably impacted the year-over-year net sales comparison by $3.5 million.
Advanced Airlaid Material’s operating income for the first six months of 2014 increased $2.2 million, or 22.4%, compared with the year-ago period, primarily due to higher shipping volumes and foreign currency translation.
In the Specialty Papers business unit, net sales in the first six months of 2014 decreased by $0.4 million compared with the same period of 2013 as the benefits of higher selling prices were offset by a 1.3% decline in shipping volumes. Higher average selling prices favorably affected the comparison by $7.7 million.
Specialty Papers’ reported an operating loss of $4.8 million for the first six months of 2014 compared with operating income of $14.4 million in the same period of 2013. The decline was primarily due to $9.4 million of costs related to pulp mill performance issues at its Ohio facility resulting in higher per ton pulp production costs as well as increased use of higher cost purchased pulp. These performance issues have since been resoled. In addition, the 2014 results were adversely impacted by $6.6 million of costs related to severe weather conditions as well as $6.5 million of higher costs related to the annual maintenance outages. Energy and related sales increased $4.5 million in the year-over-year comparison as severe weather conditions early in 2014 resulted in higher selling prices for excess power.
We sell excess power generated by the Spring Grove, PA facility. The following table summarizes this activity for the first six months of 2014 and 2013:
Energy sales
Costs to produce
Net
Renewable energy credits
Renewable energy credits (“RECs”) represent sales of certified credits earned related to burning renewable sources of energy such as black liquor and wood waste. We sell RECs into an emerging and illiquid market. The extent and value of future revenues from REC sales is dependent on many factors outside of management’s control. Therefore, we may not be able to generate consistent additional sales of RECs in future periods.
Other and Unallocated The amount of net operating expenses not allocated to a business unit and reported as “Other and Unallocated” in our table of Business Unit Performance, totaled $10.8 million in the first six months of 2014 compared with $21.9 million in the first six months of
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2013. Excluding the gains from sales of timberlands in the comparison, unallocated net operating expenses decreased $8.9 million primarily due to lower acquisition related costs and lower pension expense.
Pension Expense The following table summarizes the amounts of pension expense recognized for the periods indicated:
Recorded as:
SG&A expense
The amount of pension expense recognized each year is dependent on various actuarial assumptions and certain other factors, including discount rates and the fair value of our pension assets. Pension expense in 2014 is expected to be approximately $6.7 million compared with $14.2 million in 2013. The decrease is primarily due to higher discount rates and the impact of amortizing deferred actuarial gains from higher returns on assets in 2013.
Income taxes For the first six months of 2014, we recorded a provision for income taxes of $4.4 million on pretax income of $23.7 million The comparable amounts in the first six months of 2013 were income tax expense of $5.9 million on $22.5 million of pretax income. The effective tax rate in the first half of 2014 reflects a greater proportion of earnings generated in lower tax foreign jurisdictions relative to the U.S. and a $2.2 million tax benefit related to the revaluation of deferred taxes. In addition, due to the expiration of the U.S. research and development tax credit at the end of 2013, no credits were recorded in the first six months of 2014. The first six months of 2013 effective tax rate benefited from such credits by $1.9 million. In addition, the 2013 effective tax rate reflects the impact of certain non-deductible acquisition costs related to the Dresden acquisition.
Foreign Currency We own and operate facilities in Canada, Germany, France, the United Kingdom and the Philippines. The functional currency of our Canadian operations is the U.S. dollar. However, in Germany and France it is the Euro, in the UK, it is the British Pound Sterling, and in the Philippines the functional currency is the Peso. During the first six months of 2014, Euro functional currency operations generated approximately 33.4% of our sales and 30.0% of operating expenses and British Pound Sterling operations represented 6.1% of net sales and 5.5% of operating expenses. The translation of the results from international operations into U.S. dollars is subject to changes in foreign currency exchange rates.
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The table below summarizes the translation impact on reported results that changes in currency exchange rates had on our non-U.S. based operations from the conversion of these operation’s results for the first six months of 2014 compared to the first six months 2013:
SG&A expenses
Income taxes and other
The above table only presents the financial reporting impact of foreign currency translations assuming currency exchange rates in 2014 were the same as 2013. It does not present the impact of certain competitive advantages or disadvantages of operating or competing in multi-currency markets.
Three months ended June 30, 2014 versus the three months ended June 30, 2013
Overview For the second quarter of 2014, net income was $4.7 million, or $0.11 per diluted share, compared with $0.9 million, or $0.02 per diluted share, in the second quarter of 2013.
Adjusted earnings, a non-GAAP financial measure, is set forth in the following table for the second quarters of 2014 and 2013:
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Net sales for the second quarter of 2014 totaled $445.3 million, a 4.5% increase compared with $426.0 million for the same period of 2013.
Composite Fibers’ net sales increased $14.4 million, or 10.1%, primarily due to the inclusion of a full quarter of Dresden’s results in 2014. Foreign currency translation favorably impacted the year-over-year net sales comparison by $6.0 million.
Composite Fibers’ second-quarter 2014 operating income increased $0.9 million to $17.3 million. Selling prices were down $3.4 million due to increased market competition for wallcover and metalized products. A full quarter of shipments from the Dresden acquisition and a positive mix shift improved operating income by $2.6 million. Improved operating efficiencies and lower input costs combined benefited earnings by $1.4 million.
Advanced Airlaid Materials’ net sales totaled $70.5 million, a $4.0 million, or 6.1%, increase compared to the second quarter of 2013. The increase was primarily due to a 4.0% increase in shipping volumes. Foreign currency translation favorably impacted the year-over-year net sales comparison by $2.0 million.
Second quarter 2014 operating income increased $0.9 million, or 17.4%, compared with the year-ago quarter, primarily due to higher shipments of hygiene products and $0.7 million from currency translation. These favorable factors were partially offset by cost inflation and higher freight costs to meet North American customer demand from our European facility.
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In the Specialty Papers business unit, net sales increased $0.9 million, or 0.4 percent primarily due to a $6.0 million benefit from higher average selling prices offset by lower shipping volumes.
For the second quarter of 2014, Specialty Papers’ operating loss increased to $7.2 million compared with a loss of $3.9 million in the second quarter of 2013. We completed annually scheduled maintenance outages at our Chillicothe, OH and Spring Grove, PA facilities which adversely impacted results by $27.6 million and $21.7 million in the second quarters of 2014 and 2013, respectively, reflecting a $5.9 million increase for a broader scope of work. In addition, higher prices for raw materials and energy negatively impacted operating results by $1.7 million.
We sell excess power generated by the Spring Grove, PA facility. The following table summarizes this activity for the second quarters of 2014 and 2013:
Other and Unallocated The amount of net operating expenses not allocated to a business unit and reported as “Other and Unallocated” in our table of Business Unit Performance, totaled $5.6 million in the second quarter of 2014 compared with $11.5 million in the second quarter of 2013. Excluding the impact of sales of timberlands in the comparison, unallocated net operating expenses decreased $4.4 million primarily due to lower acquisition related costs and pension expense.
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Income taxes For the second quarter of 2014, we recorded a provision for income taxes of $1.3 million on pretax income of $6.0 million The comparable amounts in the second quarter of 2013 were income tax expense of $1.1 million on $2.0 million of pretax income. The effective tax rate in the second quarter of 2014 reflects a greater proportion of earnings generated in lower tax foreign jurisdictions relative to the U.S. In the second quarter of 2013, the effective tax rate reflects the impact of non-deductible acquisition related costs.
Foreign Currency We own and operate facilities in Canada, Germany, France, the United Kingdom and the Philippines. The functional currency of our Canadian operations is the U.S. dollar. However, in Germany and France it is the Euro, in the UK, it is the British Pound Sterling, and in the Philippines the functional currency is the Peso. During the second quarter of 2014, Euro functional currency operations generated approximately 32.9% of our sales and 29.8% of operating expenses and British Pound Sterling operations represented 6.4% of net sales and 5.7% of operating expenses. The translation of the results from international operations into U.S. dollars is subject to changes in foreign currency exchange rates.
The table below summarizes the translation impact on reported results that changes in currency exchange rates had on our non-U.S. based operations from the conversion of these operation’s results for the second quarter of 2014 compared to the second quarter of 2013:
LIQUIDITY AND CAPITAL RESOURCES
Our business is capital intensive and requires significant expenditures for new or enhanced equipment, to support our research and development efforts, for environmental compliance matters including, but not limited to, the Clean Air Act, and to support our business strategy. In addition, we have mandatory debt service requirements of both principal and interest. The following table summarizes cash flow information for each of the periods presented:
Cash and cash equivalents at beginning of period
Cash provided (used) by
Net cash used
Cash and cash equivalents at end of period
At June 30, 2014, we had $28.0 million in cash and cash equivalents held by both domestic and foreign subsidiaries. Although unremitted earnings of our foreign subsidiaries are deemed to be permanently reinvested, all of the cash and cash equivalents is available for use domestically. In addition to our cash and cash equivalents, $182.3 million is available under our revolving credit agreement, which matures in November 2016.
Cash flow used by operating activities in the first six months of 2014 totaled $21.4 million compared with $48.2 million provided from operations in the same period a year ago. The year-over-year comparison primarily reflects an increase in working capital usage, primarily related to an increase in inventory and reduction of accounts payable, higher tax payments and payment of customer incentives earned at Dresden.
Net cash used by investing activities declined by $244.0 million in the comparison of the first six months of 2014 to the first six months of 2013. Excluding $210.9 million of cash used in 2013 to acquire Dresden, cash used for investing activities declined in the comparison by $33.1 million primarily due to lower capital expenditures. Through the first six months of 2014, capital expenditures totaled $30.2 million compared with $60.8 million in the same period of 2013. The prior year amount included $25.6 million related to the Composite Fibers capacity expansion project. Capital expenditures for all of 2014 are expected to be approximately $80 million to $90 million compared to $103.0 million for the year ended December 31, 2013.
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Net cash used by financing activities totaled $45.6 million in the first six months of 2014 reflecting cash used to reduce revolving credit facility borrowings, common stock repurchases and dividends. In the same period of 2013, $171.2 million of cash was provided by financing activities primarily reflecting borrowings to fund the Dresden acquisition partially offset by dividends paid on common stock.
The following table sets forth our outstanding long-term indebtedness:
Our revolving credit facility contains a number of customary compliance covenants, the most restrictive of which is a maximum leverage ratio of 3.5x. As of June 30, 2014, the leverage ratio, as calculated in accordance with the definition in our credit agreement, was 2.44x, within the limits set forth in our credit agreement. Based on our expectations of future results of operations and capital needs, we do not believe the debt covenants will impact our operations or limit our ability to undertake financings that may be necessary to meet our capital needs.
The 5.375% Notes contain cross default provisions that could result in all such notes becoming due and payable in the event of a failure to repay debt outstanding under the credit agreement at maturity, or a default under the credit agreement that accelerates the debt outstanding thereunder. As of June 30, 2014, we met all of the requirements of our debt covenants. The significant terms of the debt instruments are more fully discussed in Item 1—Financial Statements – Note 11.
Cash used for financing activities includes cash used for common stock dividends and to repurchase stock. In 2014, our Board of Directors authorized a 10% increase in our quarterly cash dividend. In the first six months of 2014, we used $9.2 million of cash for dividends on our common stock compared with $8.2 million in the first six months of 2013. The Board of Directors determines what, if any, dividends will be paid to our shareholders. Dividend payment decisions are based upon then-existing factors and conditions and, therefore, historical trends of dividend payments are not necessarily indicative of future payments.
Cash used for common share repurchases totaled $9.2 million in the first six months of 2014. On May 1, 2014, the Company announced that its Board of Directors approved a $25 million increase to the share repurchase program and extended the expiration date to May 1, 2016. Under the revised program, the Company may repurchase up to $50 million of its outstanding common stock. The following table summarizes share repurchases made under this program through June 30, 2014:
The total repurchases set forth above includes 360,299 shares at a cost of $9.5 million completed in the first half of 2014. No shares were repurchased in the first half of 2013.
We are subject to various federal, state and local laws and regulations intended to protect the environment as well as human health and safety. At various times, we have incurred significant costs to comply with these regulations and we could incur additional costs as new regulations are developed or regulatory priorities change. As a result of new air quality regulations including the U.S. EPA Best Available Retrofit Technology rule (BART; otherwise known as the Regional Haze Rule) and the Boiler Maximum Achievable Control Technology rule (Boiler MACT), we anticipate that we could incur material capital and operating costs. Recently issued rules will require process modifications and/or installation of air pollution controls on power boilers at two of our facilities. The cost of compliance is likely to be significant. Our current estimate to implement viable options could result in capital spending of between $70 million to $95 million depending on the solutions available to comply with the regulations. However, the amount of capital spending ultimately incurred may differ, and the difference could be material. In addition, the timing of such capital spending is uncertain, although we currently expect to incur the majority of expenditures generally between the second half of 2014 and 2016. Enactment of new environmental laws or regulations or changes in existing laws or regulations could significantly change our estimates.
In addition, we may incur obligations to remove or mitigate any adverse effects on the environment resulting from our operations, including the restoration of natural resources and liability for personal injury and for damages to property and natural resources. See Item 1 – Financial Statements – Note 16 for a summary of significant environmental matters.
We expect to meet all of our near- and longer-term cash needs from a combination of operating cash flow, cash and cash equivalents, our credit facility or other bank lines of credit and other long-term debt. However, as discussed in Item 1 – Financial Statements – Note 16, an unfavorable outcome of various environmental matters could have a material adverse impact on our consolidated financial position, liquidity and/or results of operations.
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Off-Balance-Sheet Arrangements As of June 30, 2014 and December 31, 2013, we had not entered into any off-balance-sheet arrangements. Financial derivative instruments, to which we are a party, and guarantees of indebtedness, which solely consist of obligations of subsidiaries and a partnership, are reflected in the condensed consolidated balance sheets included herein in Item 1 – Financial Statements.
Outlook In the third quarter of 2014, Composite Fibers’ shipping volumes are expected to be slightly higher than the second quarter of 2014. Selling prices and raw material and energy costs are expected to be in line with the second quarter of 2014.
Shipping volumes for Advanced Airlaid Materials in the third quarter of 2014 are expected to be slightly higher than the second quarter of 2014. Average raw material prices are expected to be slightly higher than the second quarter of 2014 resulting in higher selling prices consistent with our pass- through arrangements.
For Specialty Papers, shipping volumes in the third quarter of 2014 are expected to be approximately 5% higher than the second quarter of 2014 reflecting normal seasonal patterns. Overall selling prices are expected to be slightly higher in the third quarter as previously announced price increases are implemented. Input costs are expected to be in-line with the second quarter of 2014.
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Average principal outstanding
At fixed interest rates – Bond
At fixed interest rates – Term Loan
At variable interest rates
Weighted-average interest rate
On fixed rate debt – Bond
On fixed rate debt – Term Loan
On variable rate debt
The table above presents the average principal outstanding and related interest rates for the next five years for debt outstanding as of June 30, 2014. Fair values included herein have been determined based upon rates currently available to us for debt with similar terms and remaining maturities.
Our market risk exposure primarily results from changes in interest rates and currency exchange rates. At June 30, 2014, we had $415.4 million of long-term debt, of which 25.8% is at variable interest rates. Variable-rate debt outstanding represents borrowings under our revolving credit agreement that accrues interest based on one month LIBOR plus a margin. At June 30, 2014, the interest rate paid was approximately 1.83%. A hypothetical 100 basis point increase or decrease in the interest rate on variable rate debt would increase or decrease annual interest expense by $1.1 million.
As part of our overall risk management practices, we enter into financial derivatives primarily designed to either i) hedge foreign currency risks associated with forecasted transactions – “cash flow hedges”; or ii) mitigate the impact that changes in currency exchange rates have on intercompany financing transactions and foreign currency denominated receivables and payables – “foreign currency hedges.” For a more complete discussion of this activity, refer to Item 1 – Financial Statements – Note 14.
We are subject to certain risks associated with changes in foreign currency exchange rates to the extent our operations are conducted in currencies other than the U.S. Dollar. During the first six months of 2014, Euro functional currency operations generated approximately 33.4% of our sales and 30.0% of operating expenses and British Pound Sterling operations represented 6.1% of net sales and 5.5% of operating expenses.
Evaluation of Disclosure Controls and Procedures Our chief executive officer and our principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of June 30, 2014, have concluded that, as of the evaluation date, our disclosure controls and procedures are effective.
Changes in Internal Controls There were no changes in our internal control over financial reporting during the three months ended June 30, 2014, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
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PART II
The following exhibits are filed herewith or incorporated by reference as indicated.
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.
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EXHIBIT INDEX
ExhibitNumber
Description
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